The Growing Need for Cannabis Business Valuations

As the legalization at the state level continues to increase, the need for business valuation is increasing.

The reasons for business valuations are varied and include the following:

  • Transactional, which might include the acquisition of an existing business or the buy-in or buy-out of an ownership interest.
  • Planning, which might include gifting and succession planning opportunities.
  • Litigation, which might include ownership disputes or matrimonial actions.
  • Section 409A valuations, in instances where the fair market value of the entity is needed for equity-based compensation plans.
  • Upon conversion from a non-profit entity to a for-profit entity, which is a taxable transaction.

Approaches Considered

The approaches considered in the valuation of cannabis businesses include the asset, income and market approaches. The approaches are described as follows:

  • Asset Approach – The value of the company’s assets and liabilities are determined, with the difference between them equating to the value of the company’s equity.
  • Income Approach – The value of the company is typically determined by calculating the present value of the future projected income streams. This approach is calculated using what is known as a discounted cash flow method and is commonly used because many cannabis businesses either do not have a long track record in terms of historical earnings or their expected future earnings are anticipated to be dissimilar to historical results, where the reliance on historical results would lead to an inaccurate conclusion of value.
  • Market Approach – The value of the company is determined based on multiples derived from publicly traded companies or data derived from the sale of privately-owned companies.

Methods Considered

The methods available using the asset approach include the net asset method, which entails adjusting the assets and liabilities to their fair market value so that the adjusted equity is determinative of value. This is typically used when the entity is not usually profitable and has little if any intangible assets.

When using an income approach, it is common for the Discounted Cash Flow (DCF) method to be used in the valuation of cannabis practices. The DCF method encompasses projections of future cash flows of the company after consideration of revenue, expenses, debt repayment and capital expenditures. It is important for the valuation analyst to carefully review the assumptions made regarding growth, operating costs, necessary capital outlays and nuances specific to the industry including taxes.

The market approach includes the Guideline Public Company (GPC) Method, whereby metrics derived from publicly traded companies are used to determine the value of the Company being valued. Care must be exercised when using this method as multiples can vary for a number of reasons.

Another method is the Guideline Merged and Acquired Company Method (GMAC) whereby the value of the Company is estimated based on actual transactions involving similar businesses. Although there is some data regarding transactional events, one must exercise caution when using the data as it may include synergistic premiums.

Conclusion

Given the regulatory issues surrounding the cannabis industry, items that may affect the profitability of the Company such as tax burdens caused by excise taxes and the inability to deduct certain expenses pursuant to section 280E, recent court case precedence, an overall understanding of the industry as well as an understanding of geographic and jurisdictional nuances, it is important to engage a valuation analyst with experience in the industry. Withum has valued a multitude of cannabis businesses in several states in addition to providing accounting services for a large number of both plant-touching and non-plant touching business enterprises.

Contact Us

For more information on this topic, please contact a member of Withum’s Cannabis Sector Services team.