A top cannabis private equity fund manager reveals how he picks companies to invest in

The booming cannabis industry has given rise to a number of funds solely focused on investing in the sector.

New York-based Merida Capital, a private equity fund led by former corporate attorney Mitchell Baruchowitz, is one of those funds.

Investing in cannabis has some unique challenges — namely, it’s not legal in all 50 states— so Baruchowitz and his team have come up with a dedicated, sector-specific approach to choosing which companies to back.

Building a personality profile for potential investments

“We use certain cross reference data and information to build a profile of each company,” Baruchowitz said. “I would say that we do a very deep…personality profile.”

Baruchowitz said a company’s personality profile extends to their “pervasive” corporate behavior — not just external statements, but how they treat customers, capitalize on feedback, and interact with investors.

“We’re hypersensitive to those elements,” Baruchowitz said.

Once that behavioral profile is assessed, Merida’s team goes through a due diligence process, peeking under the hood of companies to look at more boilerplate stuff: revenue metrics, executive compensation, and market strategy.

“We’re building a behavioral taxonomy and then we’re then slowly bringing a normal diligence process that has looked at everything under the sun,” Baruchowitz said.

It’s companies at the nexus of the right behavioral and business profile that Merida finds interesting.

Building the scaffolding of a “normal” business

The firm is on its second fund and crossed over $50 million in assets under management earlier this year. Looking at the companies in its portfolio, a few clear patterns emerge, Baruchowitz said.

“We obviously love data,” Baruchowitz said. Cannabis companies employ all types of data to keep track of their product and identify and retain customers. It’s what helps them operate within tightly-regulated state markets, and a number of tech startups dedicated to serving the sector have risen to meet that demand.

“We tend to be really attracted to the scaffolds that are going to help cannabis become a ‘normal’ business,” Baruchowitz said. “So our investment thesis is one that is much more geared towards that scaffolding.”

Like other funds that invest in cannabis, Merida deals primarily with ancillary businesses, like software, data, and packaging, rather than businesses like cultivators or dispensaries that deal directly with the plant itself.

One of those portfolio companies, Simplifya, is a software service that helps cannabis dispensaries comply with byzantine operating regulations, which tend to differ state-by-state, and even county-by-county in some instances.

That’s a key component of what makes the cannabis industry a challenging opportunity for investors and entrepreneurs, Baruchowitz said. Companies that don’t operate in full compliance with the law risk federal intervention — since Attorney General Jeff Sessions removed Obama-era guardrails that allowed state-legal cannabis businesses to operate – and also risk serious reputational damage.

There are few, if any, sectors besides cannabis that are forced to operate with an “illegality” component, where you can’t cross a state border, Baruchowitz said, and that’s what makes corporate behavior so central to Merida’s investment thesis.

“Most companies succeed actually because of the small tactical decisions they make on a daily basis, especially in this industry,” Baruchowitz said. He added that companies with strong governance and mature leadership that “understand[s] the importance of putting fiduciary duty first” tend to perform better over the long term.

Though these companies may move slower because they have a rigorous decision-making process — involving the board, investors, and other formal steps — Baruchowitz said it’s actually a positive in space that’s rapidly evolving.

How companies receive feedback is a critical piece of the puzzle

Baruchowitz said the ability to receive and act on feedback is crucial for any company, in the cannabis sector or not.

“Most of our portfolio companies look at feedback as a chance for them to refine the process by which they make important decisions,” Baruchowitz said.

One of those portfolio companies is Kush Bottles, which develops packaging for cannabis brands and dispensaries. Baruchowitz said he’s in “constant communication” with Kush Bottles’ CEO Nick Kovacevich (they sat on a panel together earlier this month), and the feedback works in both directions.

It’s part of Merida’s active approach to helping portfolio companies grow.

“I’m really a boring man,” Baruchowitz said. “After I do an investor meeting I go back and grind away on our companies and see how we can help them. That’s what excites me — the tinkering in the companies and interacting with all the entrepreneurs.”

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• This investment bank is quietly dominating the booming marijuana industry — but big banks are starting to muscle their way in
• A $22 billion investment firm led one of the largest ever funding rounds for a cannabis tech company — here’s why it’s a big deal for the industry
• Inside Shopify’s strategy for dominating the booming cannabis industry