Justin Singer - How Regulation Unlocks Opportunity - [Founder’s Field Guide, EP.2]

My guest today is Justin Singer, the founder and CEO of Caliper Foods and Stillwater Brands, two leading companies in the cannabis industry. We start our conversation with a fascinating discussion on how regulation creates or destroys business and investing opportunities, and then go on to discuss the ins and outs of the cannabis industry in detail. You’ll be able to tell quickly how high-quality Justin is as a thinker and operator, and you’ll learn a ton about this nascent business. Please enjoy our conversation. This episode is brought to you by Microsoft for Startups. Microsoft for Startups is a global program dedicated to helping “enterprise-ready” B2B startups successfully scale their companies. If you’re a founder running a B2B company targeting the enterprise, you should definitely check them out. This episode is also sponsored by Vanta. Vanta has built software that makes it easier to both get and maintain your SOC 2 report, at a fraction of the normal cost. Founders Field Guide listeners can redeem a $1k off coupon at vanta.com/patrick. For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club and new email newsletter called “Inside the Episode” at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag Show Notes (2:51) – (First question) – How changes in regulation create market opportunities (5:38) – Why VC’s need to pay attention to regulatory changes (6:50) – Story of Section 230 of the communication decency act (8:54) – Relationships between rules, laws, and free markets (11:56) – How regulatory changes impacted recent business ventures (13:30) – His initial interest in the cannabis space (17:28) – How the industry participants have changed over time (21:04) – An overview of the cannabis industry and different pieces of the chain (25:51) – What has led to delays in the legalization of the marijuana industry (28:52) – How the dosage of the product impacts the business (31:34) – CBD vs THC industry differences (32:53) – How much of this industry is left to be unlocked and potential timing (35:55) – Business and investing opportunities in the space (38:16) – Competitive frontier in cannabis (40:37) – The timeline and pending changes coming (43:03) – Margins and business factors of his business (45:51) – First big break for the business (49:47) – What he learned working under Tim Wu (50:34) – Why we are in the golden error for fraud (52:11) – Avoiding fraud (55:12) – What he wants to learn more about in the cannabis space (56:50) – Kindest thing anyone has done for him Learn More For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club and new email newsletter called “Inside the Episode” at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Patrick O'Shaughnessy?

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• 0:32Patrick O'Shaughnessy?

  This episode of Founder's Field Guide is brought to you by Microsoft for Startups. Microsoft for Startups is a global program dedicated to helping enterprise-ready B2B startups successfully scale their companies. The program has been around for a couple of years, but I recently became intrigued when former Invest Like the Best guest Jeff Ma took over. Microsoft for Startups provides companies access to technology, including Azure Cloud and GitHub, coupled with a streamlined path to selling alongside Microsoft and their global partner ecosystem. Microsoft for Startups has a very compelling approach to working with startups and driving their long-term business value. If you're a founder running a B2B company targeting the enterprise, you should definitely check them out at startups.microsoft.com.

• 1:14Patrick O'Shaughnessy?

  To hear more about the program, stay tuned at the end of the episode to hear from me and current program member Abnormal Security. This episode is also brought to you by Vanta. Does your startup need a SOC 2 report to close big deals? Or do you already have a SOC 2 report and want to make it easier to maintain? Vanta has built software that makes it easier to both get and renew your SOC 2. With Vanta's continuous monitoring solution, you avoid hosting auditors on-site and taking screenshots to prove that you're compliant, so you can focus on building your business. Vanta partners with audit firms who file your SOC 2 report directly inside of Vanta at a fraction of the normal cost. Hundreds of companies, including more than 100 Y Combinator businesses, are leveraging Vanta's today to streamline compliance and focus on building their businesses.

• 1:56Patrick O'Shaughnessy?

  Founder's Field Guide listeners can redeem a $1,000 off coupon at vanta.com/patrick. That's vanta.com/patrick.

• 2:06Patrick O'Shaughnessy?

  Hello and welcome, everyone. I'm Patrick O'Neal, and this is Founder's Field Guide. Founder's Field Guide is a series of conversations with founders, CEOs, and operators building great businesses. I believe we are all builders in our own way, and this series is dedicated to stories and lessons from builders of all types. You can find more episodes at investorfieldguide.com.

• 2:29Speaker 02

  Patrick O'Shaughnessy is the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.

• 2:52Patrick O'Shaughnessy?

  My guest today is Justin Singer, the founder and CEO of Caliber Foods and Stillwater Brands, two leading companies in the cannabis industry. We start our conversation with a fascinating discussion on how regulation creates or destroys business and investing opportunities, and then go on to discuss the ins and outs of the cannabis industry in detail. You'll be able to tell quickly how high quality Justin is as a thinker and operator, and you'll learn a ton about this nascent business. Please enjoy our conversation. So, Justin, I thought that an interesting place to begin our conversation is with your prior life and this interesting view you have around changes in regulation creating market opportunities.

• 3:34Patrick O'Shaughnessy?

  Maybe you could highlight what you mean by that relative to, say, new technologies creating opportunities in the early-stage space or in the nascent equity space. Why is regulation so important and what are some of your favorite examples of that?

• 3:46Speaker 03

  I am a little odd in that I've got the classical business and legal education, sort of the antithesis of what the last 15 years have driven people towards, but it's actually given me, I think, a much more holistic view of where markets come from. It's not inside-out from a technology perspective, it's much more outside-in, like what else is involved in creating this market? That started, the initial interest was in the mid-2000s, late 2000s, when I was in law school, I was looking at telecom markets. So, there was all the spectrum auctions going on. There was, where did the property rights in the advertising time reside? Are they owned by the content owner? Are they owned by the cable provider? Are they owned by somebody else? These were all big questions, and they all determined both the quality of what was going

• 4:29Speaker 03

  to be able to produce, what the axes of competition were, and what the ultimate growth potential of the market was. So, you put that all together, add in- A little mix of time spent in early-stage seed-stage venture at IA Ventures. And the synthesis of all that is my belief, the best venture opportunities are where you have the overlap of massive extent demand, known demand, and some sort of regulatory unlocking event. Some of my favorite examples, I mentioned things with telecom, the broadband spectrum auctions back in the eighties to the nineties, those really opened up a whole marketplace where lots of fortunes were made, lots of economic activity. You look at the inversion of the capital gains tax rate

• 5:11Speaker 03

  versus ordinary income, and you saw the explosion of the funds industry that comes after that. Another one that I really like is the reorganization and turnaround industry, where with the passage of the bankruptcy laws, suddenly you're able to build all sorts of industry, whether it was high-yield debt or junk bonds or whatever it might be, but it was built on top of this platform of certainty where everybody knew how things were going to function in different scenarios. Same thing can be said more closer to my industry, supplements, which for better or for worse, exploded after the passage of the Dietary Supplement Health Education Act, DSHAE, back in 93. Basically, every massive market that you look at, you can trace to some sort of regulatory unlocking

• 5:52Speaker 03

  event, unless we like ignore what's going on today. I think we just saw in the last couple of months, lots of people saying you wouldn't have the modern internet without Section 230 of the Communications Decency Act. Well, I don't know that that's quite the argument in favor that people make it out to be. It is an argument and an admission that regulations matter.

• 6:10Patrick O'Shaughnessy?

  Does it follow that VCs, or I guess all investors, should have an analyst just tracking new regulatory changes and sort of trying to match those against demand?

• 6:19Speaker 03

  I don't know if you can do it with an analyst. Like, I think it behooves VCs to actually pay attention to the whole picture. I'm a bear on things like autonomous cars, and it's not because I don't believe the technology is possible, it's because I don't think the insurance question is answerable, and I don't think the legal questions are answerable around it. That's not because I have some special understanding of the laws around this, it's just I have seen, laws matter, not at the margins, they matter at the core. Technology alone never creates a market, there has to be some insurance. ...of the competition of that technology of the ways that you want it to go in the law. And that's the platform on which companies can stand and fight each other and develop economic activities. Do you need a dedicated person?

• 7:01Speaker 03

  No, because it's also sometimes hard to predict a priori which technological changes or which legal changes are going to lead to massive shifts. I mean, section 230 has like a very strange history. The section that is remainder is the least important part of the Communications Decency Act. The rest of it was all struck down due to a lawsuit with Jordan Belfort. It's actually a really fun little history there.

• 7:22Patrick O'Shaughnessy?

  Can you describe that history? I'm unfamiliar with this entire area. So what is section 230? Why is it important? What's the story there?

• 7:29Speaker 03

  With the caveat that I have not refreshed my memory on this stuff in a long time. So I might get some of these details wrong and I encourage everybody to go look it up and vet me on this. But there were basically three different parts of the Communications Decency Act. This was passed during the Clinton era and the idea was the internet is coming up. We need to preserve decency. We need to watch out for porn, all of the bad stuff. And that was really the thrust of the Communications Decency Act. More of like a moralistic view of how do we prevent things that might be dangerous to children from getting online? And as a part of that, there was this thread of case law that had been coming up that was distinguishing between the publisher and the platform. Trying to figure out it was also there was also debates around like whether it's an interactive website or a read only website.

• 8:11Speaker 03

  The law in general is always trying to make analogies to prior technologies and prior cases. The internet was no different, especially the age of BBMs and message boards. But what ultimately happened is then, I think it was Yahoo stocks. Jordan Belfort's a wolf of Wall Street. People from his firm were pumping up penny stocks on Yahoo forums, doing pump and dump with them. And Yahoo got sued as part of it that they were the publishers and therefore had liability for this. And the ruling that ultimately came down was no, publishers can't be held responsible. At least they aren't strictly liable for the content on their platform. There's a lot more nuance around it than just that at a broad level. That is it.

• 8:51Speaker 03

  And that sort of became the basis for things like UGC, for user generated content, for Facebook, for Twitter. That there was the belief that there was this broad exception where they couldn't be held liable for the content posted on their platform. And that unlocked a lot of activity around UGC. I think without that term, without that clause surviving and remaining surviving clause of all this, because all of the decency parts of the CDA were all struck down as unconstitutional first amendment reasons, then you would have a very different internet. I would argue a better one, but I know many people would argue differently.

• 9:27Patrick O'Shaughnessy?

  It's kind of coupled with this idea of regulatory change being important is just the basic idea of rule sets to begin with. I'd love you to expand a bit more on that, you know, use clever examples from like how football came together, how soccer came together and how this relates to what we think of as free markets. So talk about kind of the relationship between rules, laws and free markets.

• 9:47Speaker 03

  As a lawyer, like I've just been taught, there's no such thing as a free market. You want a free market, go to Russia. Whoever has the biggest gun wins. That's a free market. If you want the rule of law, if you want the bundle of rights for property rights, that is infringing on the true free market, but it is also creating a shared platform of understanding from which people can transact. These were the same insights that underlied the original stock exchanges. Somebody was there to put down and build trust on their common laws, how you create contracts that could be exchanged. The example that you've mentioned about football, the thing that I always like to say is 22 guys beating the shit out of each other in a field doesn't at least suddenly become the Super Bowl. It requires rules, it requires regulations, it requires contracts.

• 10:31Speaker 03

  All these things have to be commonly agreed to. The early days of football, college football in the late 1800s, people were dying quite constantly and there was no rule book. It just became a free for all. Enough players, enough kids died that somebody said, okay, let's put some rules in place here. What does a first down actually mean? What does a catch actually mean? How many downs are there? Once you got these shared set of rules, then the play all became much more constrained around those rules. It wasn't just a free for all where whoever was alive at the end was the winner. You actually had to abide by certain things and those rules have to be tweaked over time as people learn to exploit them. This is not some system where there's a perfect set of rules, there never is, that suddenly things are all going to work in a healthy way. You can create competition through rules. My favorite

• 11:16Speaker 03

  Modern example of this is F1 racing where every couple of years they change the rules around the build of the cars because if you leave the rules in place for too long, the cars get too fast, they get dangerous. Teams that are able to exploit certain things about it also are able to pull away. You get this fundamental inequality. But if you change the rules and vary them up a bit, then suddenly everybody is looking at this new jumble and they're kind of on a level playing field all over again. You get a lot more competition out of that. You get a lot more innovation, activity. You're not just trying focusing on spending 95% of your effort to get the last 5% of the way there. You're spending all your time getting that first 95% all over again. And that's where economic activity innovation really lies or in the opportunity to create things out of whole cloth.

• 12:01Speaker 03

  But you still need some shared basis of what is right, what is wrong? How are we going to interact with each other? How are we going to exchange things? It's a wonderful book. It's called Reinventing the Bizarre, Stanford economist from around like 2007, 2008 that talks about just the limits of markets. They can be used, they can be misused, but you have to make a conscious decision about how you use them if you want to get a economic activity as a result.

• 12:29Patrick O'Shaughnessy?

  Are there any other interesting angles on the regulatory change that have happened recently? Before we move on to the cannabis space for the majority of our conversation that you've watched with interest and this could be, say, in the last five years?

• 12:40Speaker 03

  Crypto and blockchain are looking for the same thing. They're desperately trying to get the Fed to declare them a store of value. I don't follow the space nearly as closely anymore. Every time I hear blockchain, I hear shitty database. They also clearly recognize that some sort of government sanction is required for this to be what they all believe it can be. The obvious one is Uber car shares. This whole industry arose because we weren't enforcing laws around taxis and how they worked, around employment versus independent contractor. You look at Uber, I don't see technological innovation or Lyft. I don't see technological innovation there, although there is some like the distributed dispatch is a technological innovation. But fundamentally, that whole business, that entire, when I say that business,

• 13:23Speaker 03

  multi-billion dollar behemoth of a business that it is, the capital whore. That it is is built around a use of independent contractors at a scale that has just never been done before. And that is built all entirely on a legal issue. And you see now AB5 is out there in California and they're claiming that that's going to kill the business. Clearly laws matter. They would not have been able to build that business in the way that they did if they were required to employ the full-time drivers. And they got to build a very different business that was very favorable to their capital because of that independent contractor relationship and interpretation that was at odds with the pre-existing definition of what an independent contractor was.

• 14:02Patrick O'Shaughnessy?

  Let's move on to your area of interest and operation specifically today in the cannabis space. I don't know that I've ever done a full episode on this topic. I don't think I have. So I'd love you to begin by maybe your origin story, why you got interested. I'm imagining a lot of perceived opportunity is the right potential for regulatory change. But talk us through your initial interest and then we'll get into everything you've learned since.

• 14:23Speaker 03

  It's a story that I think a lot of investors would recognize themselves. I got interested in this space towards the end of 2013. I was teaching entrepreneurship. I was kicking around town doing strategy and operations work for a variety of startups. And I was looking for what to do next. And as part of that, I was kind of interested in getting back into investing, but I didn't necessarily want to go back into venture. I wanted a broader mandate. I have always kind of felt allergic to the siloing of technology as its own sector. Most companies that put themselves up with technology, I'm like, great, you're a CPG company that uses technology, just like every other CPG company. Using technology and being technology were two different things. So I was looking for something broader than that because I, I love technology. I've been deep in it. But I see it as a tool to affect other things, not as an end in itself.

• 15:06Speaker 03

  And part of that process of pitching myself to funds was developing pitches on market places and market spaces that I thought the fund should invest in. And two of the spaces that I was really interested in were underbanked and cannabis with Colorado and Washington on the verge of legalizing. Which they did in January of 2014. And I kept getting laughed out of the room. Nobody was taking me seriously. Like, I got a lot of stoner jokes, but I kept taking it really seriously. I'm like a big fan of the early days of Venture, back in like the Don Valentine days when everything was unstructured. There were no clear deal terms. There was no standard sheets. There was no anything. It was just... The lack of structure was the opportunity. I'm like a big believer that, once there's a vault guide to something, all of the real opportunity is gone. There's been a vault guide for Venture for 15 years now.

• 15:50Speaker 03

  There was no vault guide to cannabis. This was all brand new and was changing rapidly. And that was really attractive. And the fact, nobody could have built up expertise in this already because it hadn't existed, was a real attractive thing to me. So, started looking at the space first in a search vehicle format. We were thinking about it as a fund manager, which was to my background in line with that. I was looking at different companies to invest in. We were trying to be safe by investing more on the technology side, trying to avoid plant-touching operations, dealing with all the legal complexities of touching the plants, given state-level laws was a big concern. And a couple of things happened, more or less all at the same time. First, we saw this race to potency going on with edibles, where everyone was just trying to shove as much THC as possible

• 16:34Speaker 03

  into the smallest container possible. We also made the decision that like, hey, if we're gonna be in cannabis, let's be in cannabis. Why are we nibbling around the edges? Let's take this full risk. If you're gonna take a risk, just do it. And then, the third thing that happened was my grandmother asked me for a pot brownie. And those three things all happened within a week of each other. And what was really interesting with my grandmother is that she didn't want to get high. She just wanted to feel better. And I couldn't offer her anything that would make her feel better. I had this one brownie, there's 100 milligrams. I cut it up into 20 pieces. I individually bagged them. I told her to eat half a morsel and wait two hours. It scared the hell out of her. She was never gonna try it. Even offered her a joint, and she was like, no, I'm not a marijuana user.

• 17:17Speaker 03

  Self-identity was a big part of this. So, we just started looking at this as an opportunity and in terms of functional foods. These are compounds that we know have effect. There's no question about it. That's usually the biggest question with any new food or supplement. Does it do anything in this? Pretty obvious THC does something. How can you put it into formats that are mass acceptable? That don't change people's identity and that are consistent enough that they can feel comfortable using it anytime during the day. And that we can feel comfortable investing in building our brand against because we know that the experience is going to be the same from day to day. That's when we oriented ourselves very much as a food company focused on cannabinoids rather than a cannabis company playing with food. And it's been like that ever since.

• 18:00Patrick O'Shaughnessy?

  You said before we started recording that in the early days and maybe still today, this industry is filled with a lot of bullshitters. I'd love to hear your take on sort of what the evolution has been like of the quality of the industry participants. Before we get into some of the kind of market sizing stuff, which I find so fascinating.

• 18:16Speaker 03

  I don't want to denigrate the early participants in the industry in any way. I don't think they were more full of shit than today's participants. Today's participants are better credentialed, but they are also full of shit. It's not even intentional. Most of it is just unconscious ignorance or just arrogance. Gotten a lot of people who are like, oh, I'm well aware of how this market works. That's great. I've been in here six years and I've been studying it every day of my life and I don't even know that I know a thing about it yet. Good for you. I'm proud of you. So in the early days, you had a lot of people who were renegades. They were doing something that was quite strictly illegal. When we joined the industry in 2014, I like to joke that we were taking handcuff risk at that point. We were, but not nearly to the extent that people were a couple of years before us.

• 19:01Speaker 03

  You had to really be comfortable operating without any sort of business controls, operating fully cash. Don't worry about accounting, just flying by the seat of your pants to operate in that business. And I think when that all went legal, a couple of things happened. Investors came pouring in and they looked at the marketplace and they treated it the way they normally look at a marketplace they're new to. Let me see where the leaders are and I'd like to invest some money in them. Well. They forgot that schema doesn't really work. The largest players in an illegal market who have been given the color of law are still the same people they were before they were given the color of law. They just were people who were willing to take risks that nobody else was willing to take. Criminal risks that nobody else was willing to take. Those are not generally the traits associated with building a responsible business that

• 19:46Speaker 03

  has cost controls, good accounting practices, governance, good project management. But they were the characteristics of the early market. It was really interesting, early days, back at like the beginning of 2014, I went to what was then probably like the world's largest marijuana conference, which was held at the airport Holiday Inn Express by Logan Airport in Boston. And it was me in a room with 30 guys. 15 of them were stoned out of their mind, talking about the great shatter in flower that they were growing. Another five of them were lawyers and doctors, understood what this could do and were really interested. And then the rest of them were real estate guys who owned a bunch of warehouses that really wanted to get grows in them so they could get that really good cannabis IR that everyone was shooting for in those early days. It's obviously changed dramatically.

• 20:31Speaker 03

  I think up until last year at least, or up until this year, you had a lot of people who still thought this was all just going to be easy. I graduated from grad school right into the teeth of the great recession. 2009, I had two advanced degrees and no work experience, so I got a very clear taste of what things look like in a down market. And I think there are a lot of people in this industry now who have no conception of what a down market is. Add to that the whole promise of marijuana and this imagination that it's just suddenly going to go legal and everything is going to change on a dime. No, these things are complex. The retail system is complex, the distribution system is complex, the production system, these all have to be brought up individually. There was a lot of people up in the early days who thought they could be first and be the Warren Buffett of weed.

• 21:13Speaker 03

  Never mind that none of them even knew what Warren Buffett did. They just thought, I'm going to integrate everything, I'm going to take a piece from everything, and it's going to be fantastic. Yeah, but then you never do anything well. And everything is expensive. And none of the accounting actually works. And what if the market changes? It's just, there were a lot of these hopes and dreams that didn't bear any relationship to how the world has ever worked in reality.

• 21:36Patrick O'Shaughnessy?

  I would love to walk through the industry a little bit for the uninitiated, myself included. I think of as sort of supply chain and value chain. What does sort of the end to end industry look like? What are the major stops along the way? And then we'll get into Caliper and Stillwater.

• 21:51Speaker 03

  There's two things we got to differentiate. One is the CBD industry versus the THC industry. Those are wholly different industries with wholly different infrastructures and wholly different regulatory structures. Let's start talking about the THC industry because that's the one that everyone's tried to nationalize, even though it is federally illegal. And when you look at the THC industry, you're really looking at 50 different industries. Each state has its own set of laws and has its own market structures. Someday, there is just going to be an absolute glut of economic research papers on the natural experiments of new markets with different market structures in the context of marijuana, which products they create and which behaviors they incentivize. So I could talk to Colorado directly and a couple other, but in Colorado at least,

• 22:33Speaker 03

  there's a three-tiered system that's based on the same model as alcohol. So you've got cultivators, you've got processors, and you've got retail. There's a couple other that come up, but broadly speaking, you've got tiers. You've got the people who grow the pot, you've got the people who extract the pot and make the products, and then you've got the people who sell it. There is no like distribution infrastructure, there is no co-manufacturing infrastructure. This was a big learning for us in the early days. When we first came to Colorado and said, we want to launch microdose tea product, we talked to people who were in CPG and they were like, oh, you've got to go find yourself a co-man. Well, co-man aren't legal allowed to manufacture marijuana in Colorado. You actually have to go and get a license to be a marijuana manufacturer and you can't manufacture anything else. To get that license, you have to attach to real estate.

• 23:16Speaker 03

  Well, that real estate, based on whatever the city ordinances are, might have to be a thousand feet back from everything imaginable, whether it's schoolyard to a halfway house to just open space that might one day be zoned residential. Then you have to find a building that doesn't have a bank note on it. Because if the bank has a mortgage on it, they're going to veto the lease. So you've got to find a wholly owned building that meets all those setbacks and is in a city or county because it's not really the state that legalizes, it's the state. State that allows for legalization, cities and counties that legalize. So you got to find it in a city or county that has legalized and has rules that you can actually live with. So that's all part of getting the license, huge pain. Then you've got to start producing your stuff. So we, from the beginning, we did not want to cultivate.

• 24:01Speaker 03

  We looked at cultivation as a commodity. You do really well in the early days when the prices are high, demand is high, supply is low. And everyone will just buy out anything on the shelves. There's an expiration date on that. Markets mature and you could make a lot of money as a retailer. But you also have to understand that most customers in this market are either tourists or highly priced elastic. So it's a really hard market to make that in. We were more interested in branded goods because we felt like it was going to be much more generalizable beyond one state. We felt like that was really the linchpin between what we viewed as a raw material, which is the cannabinoid, and a finished good product that actually had a consistent experience around it.

• 24:44Speaker 03

  And that's really been the locus of our investment in R and D ever since is just understanding how to qualify a good cannabinoid. What does that actually mean? The raw material, these are things, we've got a ton of food scientists now, all from major food companies. And like to say, they're very good at qualifying agricultural materials. They have learned how to do that in the large food and cannabis has its quirks. But fundamentally, you're qualifying an agricultural commodity, trying to convert it into something that is useful for processing. And then you're trying to actually manufacture it. And there's a really interesting sidecar conversation to be had about things that held the cannabis industry back. One of them is the U.S. over the course of the last a number of decades, has evolved to a co-manufacturing infrastructure for consumer goods.

• 25:28Speaker 03

  So the same, it's sort of a parallel story. AWS has with technology where you used to have to build everything soup to nuts. You have to manufacture it all yourself. And then there came these people who just built up the manufacturing infrastructure and you could rent time on their lines. So you didn't have to invest in it. Well, all the equipment that they had to rent time on was national scale. Even if the state allowed you to work with them, turning on their lines would produce 10 times more inventory than you could ever sell. So there was this mismatch. As an aside, beyond that too, the equipment manufacturers themselves stopped manufacturing small-scale equipment. It was really hard to just find stuff that could be used in a single-state environment. So there was just a lot of complexities to be worked out in this market for it to actually function, because everyone was trying to assume like, okay,

• 26:12Speaker 03

  what I see in CPG, that's going to work in THC. It's like, well, no, there's 15 reasons why that structure doesn't work here. All of the tricks that you've got, you've now got to figure out new tricks. None of those work.

• 26:23Patrick O'Shaughnessy?

  Any other interesting backstory or timeline points, just in terms of why it took so long for this to happen, that you think are important antecedents to kind of where we sit today, whether that's laws, regulatory, or kind of the social stigma of it?

• 26:37Speaker 03

  There's no scientific excuse for marijuana to have been sitting around Schedule 1 for as long as it was. This was known, when the schedules first came out, there was the Schaefer Commission report that immediately recommended rescheduling, the Nixon administration put in a drawer. In the early laws, all the way back to the Stamp Act and Tax Act, it was racism against Mexican immigrants. The word marijuana, prior to the Marijuana Tax Act, cannabis tincture, which is marijuana tincture, was one of the top three most used drugs in the country. You can go back to the US pharmacopeia and find lots of tinctures there. You can find bottles from Bayer with cannabis tincture in them. And then it was decided that this was associated with unwanted Mexican immigrants, and therefore, we need to legalize as much as possible. Then you've

• 27:18Speaker 03

  got, coming up on the Controlled Substances Act in the late 70s, there was an interview with one of Nixon's aides where he straight up admitted, we couldn't criminalize being black, we couldn't criminalize being anti-war, but we could criminalize the one thing that they had in common, which is the love of marijuana. And that hard-on-crime and tough-on-crime mentality, the racist elements, all of that just hung around for a long time. And then you just had this cohort issue, where you've got a whole generation of political leaders who still believe that this is a political third rail, despite the fact that it's got 67% approval among the population at large, and even 51% approval among Republicans. It's just one of the strongest mental models that I have is cohort replacement. Some things don't shift

• 28:00Speaker 03

  until the people who are holding them back are gone. And I think this fits that bill very much.

• 28:06Patrick O'Shaughnessy?

  It's fascinating and so screwed up in so many ways. When you really dive into the history here, it's this sequence of bizarre events that lead to a very large macro outcome. So I appreciate those little touch points there. I think definitely something for people to go look up because it's hard to believe some of this stuff until you go read the laws.

• 28:24Speaker 03

  It's hard to believe it. It's also, it's hard to conceptualize. The concept of a drug is a mental frame and the concept of any illegal drug is a mental frame. Can't tell you how many conversations I had more in the early days of this company where people would be like, well, I don't do drugs. I'm like, you got a nice wine cellar over there, man. Well, no, that's not really a drug. I'm like, those are some nice prescription opioids on your cabinet. Well, that's not really a drug. My doctor prescribed it. I'm like, your coffee, really enjoying that caffeine, right? No, not a drug. These are all drugs. They all augment physiology. The question is really, what is the safety profile? What is the effect? Marijuana, THC, CBD, these are fundamentally no more less dangerous than caffeine. It's interesting to compare how caffeine has been regulated over time versus how marijuana

• 29:08Speaker 03

  has been regulated over time because it is just a very natural counterfactual that is fascinating about what is accepted and what is rejected and what that does to two things that have a very similar safety profile. If anything, marijuana safety profile or THC safety profile is better than caffeine's.

• 29:25Patrick O'Shaughnessy?

  It raises an interesting question of degree. So I think the impact of smoking a joint or something is, at least in my experience, a little bit more impactful than a cup of coffee. But I think one of the things you've learned is that, I think you mentioned, understanding the actual molecule better and sort of dosing and what that range might do to people. Say a bit about how that figures into the business plan, the products and sort of how you build the brand.

• 29:50Speaker 03

  I basically throw out almost all research done before 2016. I throw out all research done around some inhalable marijuana because we just don't know. All joints are not the same. Every joint is different. Every person is different. The amount that you're actually consuming is unknown. Edibles were actually sort of our first opportunity to control that input and reduce the variable there to something that what came out on the other end was actually observable and. Useful. We do a lot of work at our company with some academic partners on studying the pharmacokinetics of our products. We want to know how much THC is actually absorbed into the bloodstream in different formats, how much CBD is actually gets into your body, and how much do you take in a pill, but how much shows up in your blood. And it turns

• 30:33Speaker 03

  out that everybody is different. It's wild. Person-to-person variance in terms of who absorbs what and how much, even in water soluble versus water insoluble formats is crazy. Some people just can't get high. Some people don't absorb CBD. Other people can only get high through edibles, which absorb through different pathways than inhalables. And this is all great science that should have been done 30 years ago, but has been delayed until now. So, look at a lot of the old studies and just like, I don't know what to draw out of that because you've, there's a question of magnitude. I think it's almost criminal to ever talk about direction of effect without talking about magnitude of effect. And this is in pretty much any circumstance. There are absolutely risks

• 31:14Speaker 03

  with THC. I'm never going to play that down, but the magnitude of those risks have been wildly overblown. And we are learning more and more about that, especially at different dose levels. THC is kind of three different drugs at once. A sub-five-milligram dose for most people, it's like a light anxiolytic. Perfectly fine, people can function, operate, no problem whatsoever. Five to 10 or five to 15, you're starting to get real stoned. You're getting high for most people, although it changes again, like different people have different tendencies, at least with THC. Once you start getting like above 50, it's a psychedelic experience almost. It's not one that most people care to repeat. But before you can really start discussing what's the effect of marijuana, that question

• 31:55Speaker 03

  has as many multitudes as what's the effect of computers. There's a lot of nuance that has to be baked into there before you can start answering that question with any sort of specificity that's useful.

• 32:06Patrick O'Shaughnessy?

  What's the most interesting difference between the CBD industry and the THC industry? And what are the relative sizes? I couldn't even wager a close guess as to how kind of revenue basis or something, what the difference between the two was.

• 32:18Speaker 03

  I've seen good numbers. The legal THC industry, I think, is sitting in like the 10 to 20 billion range today. The illegal industry is sitting in the 60 to 70 billion dollar range for THC. And this is in America. CBD, I've seen estimates that this year you're talking like 2 to 4 billion. I think those are probably a little bit high. It's really hard to tell. CBD is just unregulated. THC is actually more regulated than CBD right now. THC, like, yeah, the FDA won't touch it, but at least the states are paying attention to it. Before a product gets on the shelves in well-regulated states like Colorado, it has to go through cannabinoid testing, which is imperfect science that is developing, but at least it's something. So you at least know what you are taking to a greater degree than you used to.

• 33:03Speaker 03

  CBD? No, there's none of that. Companies are self-regulating, but self-regulation isn't a thing. Self-regulation is just asking for trouble. There's no incentive to actually abide by the rules. When I lobby on this issue, I keep saying, the returns on lying are far greater right now than the returns on doing the right thing. And that's a regulatory fault. That is something that regulators can change. The answer is by putting in place regulation.

• 33:25Patrick O'Shaughnessy?

  How much do you think is left to be unlocked and on what timeline? So it sounds as though it's just still early days. When I asked, what are the top three variables that matter for the future here? You said regulation, regulation, and regulation. So what does that mean and look like?

• 33:38Speaker 03

  Almost all of it is left to be unlocked. When you think about, like I said, the THC market right now is 50 individual states that operate all on soup to nuts supply chains, more or less. The national industrial food supplement and beverage supply chain is, in the US, is probably the most robust in the world. The marijuana supply chain looks nothing like that and could benefit wholly from that. There's this degree of scale and structure that hasn't been put in place yet. There's a breadth of use that hasn't been put in place yet. There's no reason why a lot of products can have 1 to 2 milligrams of THC in them. That is not an intoxicating dose. There's no reason to treat that the way that we do. The 10-milligram stuff? Yeah, that should be treated like alcohol. That's great. It should be.

• 34:19Speaker 03

  I think the CBD, we, God, we know so little. We know that it has bioactive effect. We know that, I mean, it was approved as a prescription drug. It clearly has bioactive effects. It's got good anxiolytic properties. It's got good anti-anxiety properties, good anti-inflammation properties, but we don't know at what levels it has those and for which people and for what conditions. This is the sort of thing that only really comes through research and experience and just putting it in the markets and structuring the market so that you can continue to collect good data, especially as a regulator. And so you can make good decisions on how to build for this forward. CBD, the tinctures that are the most popular part of the CBD world right now, CBD 1.0, was all these tinctures that would go everywhere.

• 35:00Speaker 03

  Well, the best research we have suggests that those things are 6% bioavailable. 94% of what you consume is getting excreted out without entering your bloodstream. It's no wonder that people don't have a good experience with that product. It's also basically an intermediate good. Nobody runs out and says, you know what my favorite thing in the world is to do is to drop raw crude oil on my tongue with an eyedropper. That's not a consumer product. There's also sets of claims that have to be developed around this, but that takes time and research. Once you get past CBD THC, there's cannabinoids in general. This is a category of ingredients. I think people make overbroad claims when they say it was 113 identified cannabinoids that all have bioactive effect. Yeah, maybe to some degree, but the real question is going to be which ones of those can be produced

• 35:45Speaker 03

  in an economically efficient way and brought to market with a safety profile that matches what we as a society are comfortable with and sold for a profit. The answer to all of that is probably going to be, I don't know, I think I'd be happy with three to five additional follow-on cannabinoids in the next decade that would come up there. This is a set of materials that are the most fascinating bioactives that anybody on my team has come across. I've got people who've spent the last 25 years at Eminem Mars working in their functional ingredients divisions and Wave and Horizon Organic. These are food scientists who have been paying attention to nutra, to bioactive and functional ingredients. This is the most exciting space of new science any of them have ever seen.

• 36:27Patrick O'Shaughnessy?

  Can you talk a bit about the kind of business and investing angles here? So one interesting question is, does some of the opportunity exist because it's so fragmented? And the big brands, big CPG brands can't deploy their scale and their marketing advantage to just go win the space right now? Talk about that transition period and sort of where you think the pockets of potential value are for entrepreneurs and investors.

• 36:51Speaker 03

  So there's two things that I think are holding back the big brands. One is you're absolutely right. Federal illegality is holding them back. Anybody who has an existing business line to protect can't afford to take the risk of operating this. We've said from the beginning that one of our big benefits is that Coke isn't sold on the same shelves as we are. We're not sold on the same shelves as they are. It sucks that we can't sell on their shelves, but it's great that they can't sell on ours. Dispensaries are a unique environment, operate much more like jewelry stores than CVS. Budtenders drive 70% of the sales of new product sales because people come in and they know they want an experience. They don't know which product to get it with. So this is all opportunity that is available because the big players aren't coming in and able to spend time on it. So you can succeed at a small scale and really make it work.

• 37:33Speaker 03

  The other thing is the lack of federal legality just cuts all the advantages out from those big players. Those guys have all built up infrastructures that are designed to serve massive markets. If you told Coke, I need you to produce enough soda to serve one person a day, they're like, great, we do that five times a day. No problem. If I'm like, great, I need you to produce enough Coke to serve 100,000 people, they're like, shit, I don't know that I have equipment that I could turn on and turn off without losing all my money on it. That's too large of a scale. They also don't know, like, that thing that I want to produce, what's the right formula for it? How do you get to the right formula? You have to start small and work your way up. Big companies are not great at that. I think that has been a real advantage to the marketplace.

• 38:15Speaker 03

  Just all of the things that make it hard are the things that keep Coke and Pepsi out and the things that keep innovation and small operators and opportunity in. At some point, they're going to come in and that'll be a different world. But in the meantime, as long as you have the right understanding of what the opportunity set is, which has to take into account what the demand side looks like, where you can ship to, truly what the market is, and you build your production platform to match that, then you've got a great opportunity. If you overbuild relative to the opportunity, you could get into trouble real, real quick.

• 38:48Patrick O'Shaughnessy?

  What do you think is the competitive frontier for your businesses, consumer brands versus others? Is it the quality? Is it the brand itself? Is it relationships with bud tenders? I've never heard that term. That's hilarious. What is the competitive frontier? Where will this battle be won or lost?

• 39:05Speaker 03

  Again, it depends on timing. It's very easy for a lot of investors who have gotten used to just investing in D to C brands on Instagram, or as a friend of mine calls it, like QVC for millennials, where they just have platforms, they spin up a brand, they slap it onto a commodity product and make some money off Facebook ads, know whether they're profitable, move on with their lives. We're not there yet. A brand without consistency is just a logo. You actually have to produce a consistent product, and that is actually really hard. Specialize in turning cannabinoids water soluble. The reason why we do that is so they can be placed into water-based food systems and as well, so low-fat food systems. And we've also discovered that there's a much better absorption profile. So people

• 39:45Speaker 03

  actually get what they have bought into their bloodstream. To do that consistently, it's taken years of R and D investment. And I think when people go too fast with too much money, they go in the wrong direction. I think you saw this with Constellation had this whole thing when cannabis 2.0 came down where they were like, oh, like can liners, the aluminum can liners, we're eating the THC, so we have to delay the launch. Well, yeah, that's because you treated a $2 million problem like a $2 billion problem. That was a solved problem already, the can liners, and it's solvable if you have a small line and good food scientists who can operate flexibly. But again, there's new science here. What is the shelf stability? Work in an acid versus a base. Will a base break down CBD? The answer is yes. Do you need a high acid environment for it to actually

• 40:28Speaker 03

  live in? How long does that CBD stick around? Does it degrade below the label claim? These are all like the structured parts of the food and supplement supply chain that have to be verified before they can be scaled. And I think a lot of people were just, especially if you're trying to do brand, you want to go straight to scale because you want the cheapest way to get there. We're in an infrastructure phase in this industry. You've got to be in it for that. You've got to understand what you're getting into. Someday, will brands win? Sure. Brands win when you have commodity infrastructure that everybody has access to. That's the only way to differentiate. But today, quality and capabilities are how I think you differentiate yourselves. You actually have to build the platforms on which you operate. You don't get to go out and just rent somebody else's.

• 41:10Patrick O'Shaughnessy?

  What are your thoughts on sort of where this all goes from here? So if the first part of this was the handcuff risk, the second part is sort of the state by state period of time, and maybe the third piece is some sort of federal unifying law? What is the timeline for something like that? And when will we look back on this and just think, wasn't that a crazy period of transition?

• 41:30Speaker 03

  So on THC, I think you could see a lot of movement next year, depending on the outcome of the election. Obviously marijuana reform and social justice reform and criminal justice reform are all tied very closely and for many obvious and deserved reasons. CBD, you had Senate Majority Leader McConnell legalizing the production of hemp at the end of the 2018 Farm Bill, but FDA has been slow to actually accept responsibility for the derivatives of hemp that that legalized, namely CBD. FDA's claimed a three to five year timeline. I think it's wild for a food public health regulator to just ignore a market where 20 to 40 million people a day are consuming a product totally unregulated because they don't have enough information.

• 42:12Speaker 03

  No, you regulate the market where you can, and then you improve regulations over time. You don't look for perfect and in the meantime leave consumers to twist in the wind. So that goes back to my point of like, you need regulators who want to regulate, and I don't think we have that right now. I think hopefully we will have that by this time next year. And if you have regulators who are dedicated to the concept of public health, who are dedicated to imposing the will of Congress and enshrining that in administrative policy, you could have CBD regulation next year. You could clear up the banking issues around THC next year. You can get THC probably starting with decriminalization, but heading towards legalization within the next 24 months. These are all things that could have been said at any time in the last four years.

• 42:53Speaker 03

  But one thing that I do believe is if THC and CBD have managed to make this much progress throughout the administrations of Attorney General Sessions and Bill Barr, the two most anti-marijuana people I could imagine, God, I can only imagine what happens when there's somebody who is making their life's work to destroy it. So we could be looking back on this three years from now, I think with wonder. I kind of hope that the next president, whoever he might be, would embrace marijuana in a similar way to how President Obama embraced gay marriage. Maybe he was circumspect at the election, but then he got it across the finish line once he was in office. And I think that's totally a plausible analogy that could happen here.

• 43:35Patrick O'Shaughnessy?

  Can you walk us through the business itself and sort of what it looks like in terms of almost like an income statement walkthrough? What kind of gross margins are we talking in a business like this? How does sales and marketing figure in? What are other notable key aspects of a business that determine its long-term kind of margin potential?

• 43:53Speaker 03

  Again, it's different at each stage in the supply chain, so I can really only speak to my point as a products manufacturer. The margins are quite good. You're talking 30 to 40% EBITDA. And the key thing there is we don't have a huge sales force. We've only got 330 stores to sell to. We've got a sales force of three. This is on our THC business side. So that's Stillwater Brands, our THC business. It operates, we serve 360 dispensaries covering a population of around 8 million, total population of state population around 8 million. We self-distribute to them through a mix of couriers and our salespeople directly dropping off. There's not a lot of advertising to be done. So I don't think people fully appreciate that Google and Facebook won't take money from CBD or THC companies.

• 44:38Speaker 03

  If you have seen those ads, then they were placed there against public policy and usually through some sort of workaround that was probably enabled by the sales team at those companies, but frowned upon by the legal team. So it's not like you can spend your, burn a hole in the earth, performance marketing, even if you wanted to. I mean, the way you do it is you have to, if you want to put an ad on Instagram, first you have to go out and buy like an affiliate placement and get an article written on some third-party site, and then you have to have them buy an ad against that article that links to your website. The transaction costs, neoclassical economic sense, are just massive in this space. And yet still, 35% EBITDA. So one thing we said a lot, we really pay a lot of attention to operational control.

• 45:22Speaker 03

  We pay a lot of attention to our margins, pay a lot of attention to good process because we believe that if we can learn to function in an environment as fucked up as this, the headwinds are only receding. So it's just, we're moving from the advanced level. As we get towards clear federal legality, you're retreating towards more of an easy mode. And hopefully just more and more opportunities open up for us. But for right now, you're just facing problems everywhere you look. Everything takes five times longer, if not 10 times longer. It takes three vendors to find one who can do the job. Each one of those vendors takes two months to figure out whether they know anything. It is a blanket rule in this space for my staff. Don't believe people when they tell you things. It was a blanket rule for me as an investor, but it's especially a blanket rule for me here.

• 46:07Speaker 03

  And it's not because people are even lying. I think people are just, their optimism, they can't distinguish between optimism, sales and lying. So I've seen like raft after raft of people come through with just huge plans that never made any sense and never materialized.

• 46:23Patrick O'Shaughnessy?

  Taking back to that founding story, I love the pot brownie story as sort of the origin insight or something. What after that would you classify as sort of the first big break for the business? So if you've had any step change improvements and sort of the prospects of the business, what was the first big break that stands out in your memory?

• 46:40Speaker 03

  After we decided to become a food company, we wanted to produce a product that would serve my grandmother, 90-year-old seniors. And the product we came up with was called Stillwater Tea. It was two and a half milligrams of THC and it was explicitly designed not to get you stoned. It was supposed to replicate the feeling you would get from taking three deep breaths and have that last for a couple hours. And we went out to sell this to dispensaries and were met with a collective WTF. We had one bartender was like, dude, I take 300 milligrams for breakfast. Why are you pitching me a two and a half milligram product? To which the response is, first, man, you've got a problem. But second, this product isn't for you. This product is for other people. Some would get it, we would get people, would give it to their mom, bartenders and her mom or their grandmother,

• 47:24Speaker 03

  and they would love it and then they would become real advocates for it. It never really took off and it turned out because you have to account for what your retail channel is. And the people walking into dispensaries just weren't that interested in low dose products. We couldn't market to try and bring in more people. And the dispensaries themselves didn't really have much interest in going outside that core customer base. They were making money and they didn't have to do any work. Everybody loves making money when they don't have to do any work. So. We couldn't get that target customer that we had built this product around to even get in front of us to even try to make the sale. And that was a big learning for us. It's sort of like you can't fight the Fed. You can come in with the market and want to say, have all these big ideas for how things should work. Why aren't these products merchandised?

• 48:08Speaker 03

  Why are they all behind glass? Why am I listening to a bud tender as if he's a pharmacist? Why can't we advertise and talk about the things that we're doing? But then there's like the market as it is and you've got to figure out a way to sell into that. Fortunately, we had on the backend, this nice little innovation story where to produce the water soluble component of the teas, we were basically creating these crepes of slurries, which is like an Elmer's glue type feeling, texture, and then breaking them up by hand. And we were dumping the granules into tea sticks. The tea stick was our form factor. It looks like a stick pack with a bunch of perforations. It functions as a tea bag. But as part of that, we had to have granules of a certain size. So all the granules that were smaller, the fines, we were basically throwing out.

• 48:53Speaker 03

  Well, our yield was turning out to be like 50% of our THC, which is our core input there. And that was fine with a two and a half milligram product, but when we realized we had to introduce a product that would get bud tenders excited, so we made a 10 milligram tea. We realized that, man, you can't get by with a 50% yield on a 10 milligram product. We're just getting destroyed on margin. So we looked at a couple of different things we could do, whether we could try and find a different way to granulate, but we ultimately decided was, hey, this powder part, the water soluble piece was really the most interesting piece. Why don't we just package that up into packets and sell it as its own product? And that became Ripple. Ripple is like a little stick pack, odorless soluble, flavorless, clean label soluble THC and CBD mixes, drops straight into a beverage and dissolves instantly.

• 49:38Speaker 03

  And that was the product that came out of those two things together. The need for a high dose product that would get bud tenders excited, the need for a process or a use of the waste so that it didn't destroy our margins. And suddenly that, what was before waste, became our growth engine. That was the product that took off. Everyone got really excited by the idea that you can make anything an edible. And then they got really excited even further because we started discovering that people were giving us these anecdotal reports that they were getting high faster with Ripple than they would when they were taking other edibles. And we believed them, but we couldn't prove it until we went out and actually did the studies.

• 50:16Patrick O'Shaughnessy?

  What a fascinating turn of events. Really cool story to look back on. I'd love to bookend our conversation with another couple of questions, just bigger picture, kind of harkening back to your background as an investor first and then wrap up. So my first question is, you mentioned studying under Tim Wu. What specifically you learned from Tim? What made him special? What do you take away from your time learning from him?

• 50:37Speaker 03

  I don't want to oversell my relationship with Tim. I don't think he would know me from Adam at this point, but he did have the best class I took and he was my major writing professor. But the big thing from him was just that market structures matter. That was what he was really talking about back then. I think it's still what he's talking about today. These things don't just exist in a vacuum. Markets don't come out of a vacuum. They're not naturally occurring. There's nothing natural about them. They are created by man. Therefore, they need to be created with intention if you hope to get out of them what you expect.

• 51:07Patrick O'Shaughnessy?

  You also mentioned that you were intrigued by Jim Chanos's idea that this is sort of the golden era for fraud. I'd love to hear why that idea is interesting to you and kind of what it means to you.

• 51:16Speaker 03

  That just feels like sort of violently true at this point. There is absolutely no penalty for lying or bullshitting at this point. We are rewarding the bullshitters from top to bottom. And that's fine, I guess. I think there is a belief that you need founders who almost bullshit themselves to create companies out of nothing. But I think that that's a form of idolatry that I think is just straight up wrong. There's absolutely no reason. Founders are not different from other people. They may be more tolerant of uncertainty. Some of them are good businessmen. Some of them are bad business people. They are also humans. They are leaders of humans. And I think actually putting together an organization where everybody is treated as a human, where everybody is not asked to participate

• 51:59Speaker 03

  in a cult, where they are not asked to put the company over themselves, where they just said like, this is a job and I need you to be good at it. And then I need you to go home and enjoy your family. That's a much healthier way of doing business. And I don't think you would see any reduction in good innovation that actually has societal benefits off of that. If anything, you'd see the exact opposite. I think most innovation these days is geared towards things that can really raise the value of equity, but not necessarily the standard of living of all the employees within the company. Yeah, I hate this notion that founders are aliens who are just really good at some sort of thing. Most of the time, they're actually atrocious human beings who are just being carried by competent people within their organization while they're being treated like children internally.

• 52:44Patrick O'Shaughnessy?

  If you had to re-enter that world and be backing founders actively, how do you avoid that problem? What would your advice be to investors who are primarily making bets on people to avoid that type of person?

• 52:56Speaker 03

  So you have to structure it. Jerry and I talk about this all the time, and I am fully on board with him. We're both on board with Kahneman and Gary King. There's no such thing as intuitive investing when it comes to people. Those are complex, open systems. If you tell yourself, "I just like the cut of his jib." They turn out to be great, that's luck. Good for you. That was not something that is repeatable. But what you can do is you can create structures, decision-making structures, that try and look for landmines. Weed those out. You can try and raise the floor of whomever you hire. Don't think it's possible to hire a perfect person. What perfect means is different in the context of an organization, a team, a time. But I do think you can at least construct a hiring process to probe for things like integrity, to probe for things like a willingness

• 53:40Speaker 03

  to play games with the truth, to probe for just the difference between somebody who can describe things versus somebody who can actually do things. I think you focus on those, and Jeff Smart has this great-

• 53:50Patrick O'Shaughnessy?

  Smart hiring thing, yeah.

• 53:52Speaker 03

  The book is fine. His PhD thesis is much more interesting, about how you actually set up decision structures for unstructured decisions. My best resource for this, and something I think a lot about too, is the CIA. CIA's internal library on making structured decision-making in unstructured situations is as good as it gets. You think about what an investor is doing. They are trying to predict an inherently unpredictable, complex system, which is itself impossible to predict a point outcome. But you can at least start predicting ranges of outcomes if you structure your thinking well. And you can avoid falling in love with a specific outcome, given that the same facts might also align with a multitude of other outcomes. These are just things that I think are really important. I also think it's super important to always play the counterfactuals.

• 54:36Speaker 03

  Anytime anybody on my team is like, "When you guys did this, that was so smart." I was like, "Yeah, that was smart, but let me tell you about the three other things we wanted to do before we landed on that one that were stupid, that could have worked, and we could have been going in a totally different direction." I tell the story about, you just heard the story about what happened with Ripple. That story could have gone in a bunch of different directions. We could have doubled down on low dose. We could have decided we need to spend more money on performance marketing. Maybe that would have worked. I can't say that it wouldn't. But I think it's really dangerous to get into the mindset, "It was always going to be this way and it was always going to be this way because I'm so good." Bullshit. I don't care how good you are. The world is complex. Luck is massive, a massive factor.

• 55:16Speaker 03

  The best thing that you can do is put yourself in a position to have better, larger options than you had before. As long as you keep on doing that, eventually you're going to find the option that you can really lean into. I'd say that a lot with this company. This company is the largest lever that I ever hoped to hold. And it got that way because we just started with a very small lever and kept putting ourselves in a position to go out and find things to add on to that lever. We couldn't pick exactly which one was going to be the thing, but at least we had the opportunity to go after them.

• 55:45Patrick O'Shaughnessy?

  In the cannabis space specifically, what do you not understand well today that you wish you did?

• 55:50Speaker 03

  Cultivation is fascinating to me. I know I don't understand it. I know enough of it to know that it's complicated. I think that everywhere you look in the cannabis supply chain, it's easy for it to look simple, especially once you start scaling it up. Things get very variant very quickly. Just because you understand something, the way it operates at one scale, doesn't imply you understand how it will operate at another scale. That's one that is always scaring me is just trying to understand, what's the next model that's going to work for thinking about this industry? I knew a guy once who got his PhD in the philosophy of friction. And he described it to me as,

• 56:29Speaker 03

  "The way that friction works at a molecular level is different than the way it works at an inch level is different than the way it works at a mile level." The philosophy of friction is when do you change your model for what works? Something that describes the molecular level and now you've got something that describes the step up. If you try and take the molecular model and apply it to the inch model, you're not going to get anything predictive. And the models I have for marijuana, are they just Colorado specific? We're going to find out soon. We're going into Michigan next year. Is this as unique of a market as I believe it to be? Or are there lessons in this market that are transferable to other states? Or is each state truly unique from top to bottom and everything has to be relearned? We don't know yet.

• 57:10Speaker 03

  And that's both scary and wildly exciting. That's what keeps it new and fun.

• 57:16Patrick O'Shaughnessy?

  Well, Justin, I've learned a ton today. Like, I feel like I really didn't know anything about this space coming in and now do. So I really appreciate your time. My closing question for everybody is to ask for the kindest thing that anyone's ever done for them.

• 57:27Speaker 03

  I will tell you, at least in my professional career, the kindest thing that anyone has ever done in my professional career was Roger, Eric Berg, paying me out of his own pockets to be an intern at IA when they were a friends and family company, which got me out of a job in San Francisco that I hated, which got me back to New York with my wife, or at that point, my girlfriend, now wife, which led to me having a kid, a dog, and a company. And all just because he was willing to spend not much money to get somebody who he thought was smart and could help the fund.

• 57:57Patrick O'Shaughnessy?

  Fantastic.

• 57:58Speaker 03

  Yeah, could easily have pinch pennies, but he did it. And man, am I grateful. It was kind.

• 58:03Patrick O'Shaughnessy?

  Fantastic. Well, Justin, thanks again for your time today. I've learned a ton and I hope to say and such.

• 58:07Speaker 03

  Yeah, thank you. I appreciate it. Best to you.

• 58:11Patrick O'Shaughnessy?

  This episode was brought to you by Microsoft for Startups. Microsoft for Startups is a global program dedicated to helping enterprise-ready B2B startups successfully scale their companies. In our five-part mini-series, we are talking to Evan Reiser, CEO of Abnormal Security, about his experience with Microsoft for Startups. In this week's episode with Evan, we talk about technology shifts and picking a cloud provider.

• 58:34Patrick O'Shaughnessy?

  What has changed about companies' sort of cloud adoption? I would count us and our business in the same category of like slowly and then suddenly, you know, we had to adopt this sort of thing. So maybe just describe what exactly, because this sounds like a technology platform shift that often makes new companies possible. What exactly has changed and why is a company like yours positioned well for that?

• 58:53Speaker 04

  Yeah, I think there's two things. One is just how do enterprises work? And then the second is what are the new platforms that allow small teams to do a lot with very little? So I think in the former category, like the general shift is enterprises, IT stacks moving into the cloud and the prevalence of Microsoft 365 is just an example of that. So that enables all this IT and security data to be available in the cloud and therefore accessible via APIs. And so if we wanted to build our product 10 years ago, we would need a fundamentally different architecture that wouldn't allow us to get as much data at the same level of detail and deploy some quickly. And I think with the, with the general rise of cloud infrastructure and cloud computing, and even more specifically, some of the higher level services like Azure AI Cognitive Services,

• 59:36Speaker 04

  those are tools that allow relatively small engineering and data science team to go build these world-class enterprise-ready applications, you know, very quickly.

• 59:44Patrick O'Shaughnessy?

  So you were just started in 2018, so you're a very young company, even though you're moving quickly. I'm curious what the experience was like at the beginning as you thought about what tools to deploy. This is one of the more interesting things for me now because the toolkit available to founders, say, eight years ago is very different from what's available today. You can do a lot less building of commoditized stuff or stuff that's not your core competence here. So how did you think about that? How did you address the problem of what stack of third-party partners are we going to use to build this company on top of?

• 1:00:17Speaker 04

  We already made some mistakes early on, and there's some areas where we're very thoughtful and some areas where we're less thoughtful. When we started, right, we knew just like the speed to market was going to be very important for us. So we started off by just using the, what we're most familiar with, right? And we didn't do a lot of research in a lot of areas. One example, you know, inside cloud infrastructure, when it comes to things like cloud infrastructure, it's not really just a technology decision, it's really a business decision. And the reasons why, you know, we decided to invest on Azure, I think there's kind of two sides. On the technology side, we had to have the most secure and the most kind of privacy-centric platform to build on top of. I think the second thing is purely for my business, and we need a technology platform that would enable us to spend more time focusing on customer problems and not on kind of rebuilding commodity technology.

• 1:01:01Speaker 04

  So being able to use higher-level services, like especially around AI and machine learning, computer vision, getting that out of the box just allows a startup like us to do a lot more faster. Of course, I realize the irony of me being a enterprise technology CEO and saying it wasn't a technology decision, but I really think the reason we ultimately decided to invest in the Azure platform was really around some of the business benefits. A lot of that came down to just saying, what is most valuable to the company? For a company like us, we currently work with maybe, you know, three or four percent of Fortune 500. So the biggest challenge for us is, hey, how do we get the other 95%? We wanted to reduce the costs required for us to go and market and acquire customers. And so there's great programs like the Azure co-sell program,

• 1:01:44Speaker 04

  which actually enables Microsoft sellers to go sell our solution, right? And help work with us to help solve customer problems. I think the other thing that was really important on the business side was we wanted to increase our success. With customers by aligning to their strategy. So a lot of CIOs today are interested in consolidating their architecture into the Microsoft ecosystem. They want fewer and fewer point solutions that are independent and they want one interconnected ecosystem that that works well. So you know, the ability to enable our customers to basically invest in the Microsoft ecosystem, to buy our solution and then get Azure consumption credits as part of that to reward them for their Microsoft ecosystem investment. Like that was another key piece. Big thing for us is that we realized that cloud infrastructure was much more a business decision.

• 1:02:26Speaker 04

  And in the past, I would have offloaded that to maybe the engineering team and had them kind of decide. But for us, we brought that to the board and we said, hey, we think that's all in, right? This is actually more important for the business. We can get a lot of benefits for both the company and for our customers by investing in this Microsoft platform overall.

• 1:02:43Patrick O'Shaughnessy?

  To find more episodes or sign up for our weekly summary, visit investorfieldguide.com. Thanks for listening to Founder's Field Guide.