Election countdown: Why marijuana capital markets could thrive in 2025

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The marijuana capital markets have experienced a whirlwind over the past few years – and this year’s elections around the nation show little sign of affecting the capital markets no matter who comes out on top.

Historically, investors have shown high hopes for the cannabis industry, particularly in the wake of evolving state-level legalizations.

Yet the capital markets have changed dramatically.

As of October, cannabis stocks such as the AdvisorShares Pure US Cannabis ETF (MSOS) are down more than 85% from their all-time highs.

Despite this sharp decline, the regulated U.S. marijuana market is larger than ever, growing from $27 billion in 2021 to an anticipated $32.1 billion by the end of 2024, according to the MJBiz Factbook.

Nearly half of states have legalized regulated adult-use marijuana, and more than 40 have embraced some form of cannabis legalization.

What’s the catch?

In the aftermath of the 2020 U.S. election, cannabis investors (largely retail) flooded the market, banking on federal reform under the Biden administration.

However, with little reform progress during the administration’s first two years and the onset of high inflation and a rapidly rising interest rate environment in 2022, capital markets continued their downward spiral.

Additionally, many mature markets were left with inflated expectations because of a surge in marijuana consumption during COVID-19, which turned out to be temporary.

For the first time in history, five of the oldest U.S. cannabis markets experienced year-over-year sales declines in 2022 and 2023.

What’s changed?

Despite these setbacks, the investment opportunity in cannabis has never looked brighter.

Several major catalysts are in play today that could significantly reshape the industry.

One of the most promising is federal rescheduling: Moving marijuana out of its current Schedule 1 classification would eliminate the Section 280E tax burden, which prevents marijuana businesses from deducting most normal operating expenses.

This shift also would open the door for increased research and development and could lead to further incremental reforms, as marijuana would no longer be categorized alongside heroin and other harmful substances.

Additionally, the industry is eyeing the potential passage of the SAFER Banking Act, which would provide cannabis companies access to traditional financial services.

These reforms could drive a capital markets boom in the cannabis sector, leading to healthier business multiples.

This is a good time for a disclaimer: Although these favorable factors support an optimistic outlook, it is important to recognize that future market behavior is subject to numerous risks and uncertainties, including regulatory developments, market conditions, and other factors.

However, with a larger, more mature market and the potential for tangible reform on the horizon – coupled with the lowest valuations seen in years – the opportunity for investors to enter the cannabis space has never been more compelling.

How to tackle the market

The cannabis industry today presents a landscape of both challenges and opportunities.

Mature states are experiencing market consolidation, creating a more competitive environment.

Ironically, this shake-up is making it easier to identify strong operators.

When capital was freely flowing, distinguishing top-tier talent was difficult.

But in today’s environment, where profitability is paramount, the best operators are easier to spot.

Meanwhile, newer markets – particularly those transitioning from medical-only to adult use – are experiencing rapid growth, presenting significant opportunities for businesses and investors alike.

These states represent a total addressable market (TAM) surge, and limited-license regimes further enhance the competitive edge of businesses operating there.

Additionally, cannabis brands with staying power, growing market share and innovative strategies – such as tapping into the booming cannabis beverage market – are showing resilience in competitive markets.

The advent of the intoxicating hemp industry has allowed cannabis beverages to thrive, adding another dimension to the industry’s growth potential.

This is just a taste of the opportunity set we are eyeing today.

What investors are looking for today

In today’s cannabis investment landscape, investors are highly selective.

They are seeking well-managed businesses with experienced, competent leadership that demonstrate strong growth potential and scalability.

Moreover, companies that can sustain their competitive differentiation over time – whether through intellectual property (IP) protection or a well-guarded business plan – stand out to investors.

Businesses with a solid moat – whether it be around their IP or their unique business model – are particularly attractive.

In a highly competitive space such as cannabis, long-term success will depend on having a sustainable advantage.

What businesses can expect

For cannabis operators looking to raise capital, the path ahead requires careful planning and strategic positioning.

Investors today are focused on profitability.

Businesses should prioritize financial discipline and put their heads down to drive sustainable profits.

When positioning your company for investment, it is critical to triangulate valuations using public and private comparisons.

It’s also important to acknowledge that the cost of capital is high in today’s market.

As such, businesses should focus on profitability unless their growth absolutely demands external investment.

Raising capital in this environment will be expensive, and only companies with a clear and compelling growth trajectory should pursue it.

Of course, every business is different, and companies should consult their trusted advisors to assess their individual circumstances.

Historic opportunity?

Despite the challenges cannabis businesses face – including regulatory uncertainty, evolving consumer behavior and macroeconomic trends – the investment outlook is bright.

With a maturing market, potential federal reforms and favorable growth opportunities in key states, now is a compelling time to invest in cannabis.

For both investors and businesses, the next few years could present a historic opportunity to shape the future of this dynamic industry.

Tiby Erdely is a founding partner at Denver-based Key Investment Partners, which provides institutional-quality investment management for the cannabis industry. He can be reached at tiby@keyinvestmentpartners.com.