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Valuing a Cannabis Business: Regulations and Assessment

Valuing a cannabis business is one of the most difficult appraisals performed today. We gathered experts for a round-table discussion on the industry and what they see going forward.

In Part 2 of our series on Valuing a Cannabis Business, we talk more about the current state of the industry.

Our panel consists of Quist Valuation seasoned professionals:

  • Anas Elmadhun, Senior Financial Analyst
  • Brian Van Pelt, Financial Analyst
  • Victoria Hall, Corporate Business Development

How do you factor future regulations and projections to provide a valuation for an industry that is shifting and evolving very quickly?

Quist makes assumptions as of a valuation date despite a potential change in government mandates.

Vetting projections and risks become a big challenge when valuing an early stage cannabis company. Investors have been reluctant to look at cannabis companies because there has been a lack of observable market metrics, transactions, and guideline public companies data.

Decisions to invest in cannabis are challenging. The limited operating history of the cannabis companies affects the investor’s ability to understand future operating conditions.

You say there’s a lack of observable market metrics, yet cannabis has been legal in Colorado for 5 years. Why is there no market data?

Because marijuana remains illegal under federal law in the United States and U.S. companies are not able to list on the U.S. exchanges, we can only rely on the market data available for public Canadian cannabis companies. Using a multiple of Revenue and EBITDA methodology is not very strong or reliable either.

A big hurdle for the cannabis industry in the U.S. remains the IRC 280E Tax Code regulation, particularly the rule about the deductibility of business expenses. This rule applies differently to specific business categories (grow vs. retail) and there are different applications of the IRC 280E in relation to the taxation of grower vs. an operating company. Cannabis companies need to pay close attention to how these tax rules affect cash flow.

In the United States, cannabis companies do not have access to traditional banking services and financial institutions remain wary and reluctant to get involved. It is challenging to find capital for cannabis businesses.

All these conditions contribute to the lack of verifiable market data.

Can you provide your overall experience working with cannabis companies?

What we learned:

The scalability of the cannabis business and how expensive it can be.

Because of the extensive regulations for the cannabis markets, these businesses are both expensive to start and expensive to run.

What regulations exist in the Canadian market and how they may be leveraged for the US cannabis companies.

The Canadian government controls distribution and sales channels in their national cannabis market. For more information, see Canada just legalized recreational pot. Here’s what you need to know.

It’s the fastest growing industry in the U.S.

In looking at market multiples, we see an emerging industry, with companies going public and dramatic rise in valuations for publicly traded companies. With the industry going public, we see an opportunity for an unconventional industry to become a regular industry.

In part 1 of our series on valuing cannabis businesses, we talk about the history and challenges in assessing a cannabis business. Find part 1 here.

Have questions about valuing your cannabis business? Quist Valuation can help. Let’s set a time for a free 30-minute consultation. We can discuss the specifics of your business and identify the next steps needed to assess the value of your company.

Schedule your free 30-minute consultation here

Appraising a cannabis business is one of the most thought-provoking valuations that are currently being performed. We pulled together experts in this area for a round-table discussion on this industry and what we see in the future.

Our panel is made up of Quist Valuation seasoned professionals:

  • Anas Elmadhun, Senior Financial Analyst
  • Brian Van Pelt, Financial Analyst
  • Victoria Hall, Corporate Business Development

In the first part of our detailed conversation, we talk about the challenges of valuing businesses in the cannabis industry. In part two, we’ll delve deeper into the future of valuing cannabis businesses.

What challenges have you faced so far in appraising a cannabis business, and how are they different from issues with other industries?

Economies of scale and the geographic reach of cannabis

Understanding the laws and how they affect the cannabis industry in individual markets or states is critical. In most jurisdictions, laws dictate the size and scope of the market available. That is not the case in most traditional businesses.

For example, if a company operates a cannabis business and sells a product in Canada, there is an opportunity to grow. If a company operates a cannabis business in Colorado, the company is limited to business only in the state of Colorado. The potential for growth in the business is a large factor in a business valuation.

Recreational cannabis vs. medicinal.

In the United States, recreational versus medicinal marijuana is a matter of state law as well as an individual area of business. An operator needs a separate license for each respective category. Each category has different characteristics, including different target markets, regulations, and profitability.

Each organization must understand their industry-specific issues. Success relies on the presence of management expertise and their overall industry knowledge. Because the market is so new and still evolving, it’s critical that management stays ahead of the changes.

Competition within legal cannabis

Colorado cannabis market is more mature and commoditized. This is due to the lack of restrictions on issuing licenses. In other states where cannabis is legal, licensing authorities put more restrictions on growers and on how many businesses can operate in the state. These restrictions affect valuations differently, depending upon the state.

In contrast, in Canada cannabis operators can only sell 50% of their product on the open market and the rest of the product is sold to the government. In some provinces in Canada, 100% of the product is sold to the government who control the margins. In most businesses, legislation does not determine the end customer.  Markets are open.

Market availability and potential growth are factors when determining the value of a business.

Financials within cannabis companies

Financial information is difficult to evaluate when valuing a cannabis business, particularly in the U.S. Availability and credibility of financial and operational data hinders appraiser’s ability to look at the cannabis business objectively.

The disparity between U.S. federal and state laws have resulted in cannabis companies not having access to traditional banking services. This lack of institutional support for any stage cannabis businesses makes tracking transactions difficult.

cannabis businessFor an early-stage cannabis company, vetting projections, risks and calculating capacity becomes a big challenge. A lack of observable market metrics, transactions, and guidelines in public companies’ information precludes investors from looking at cannabis companies using a more traditional approach.

Decisions to invest in cannabis are not easily made. The limited operating history of the cannabis companies and investors ability to gauge operating costs give investors pause.

Your cannabis company’s management team

A seasoned team and experienced growers in place and knowing specifics about cannabis operation are the keys. It’s also important to stay aware of regulations like IRC 280E of the U.S. Tax Code. Cannabis growers and retailers in the United States pay a very high effective tax rate because the IRC 280E limits normal business deductions. Keeping up-to-date with changing licensing requirements and approvals is also a function of an experienced management team.

Valuations often involve competitive benchmarking, but because the cannabis industry is new, how do you overcome this challenge?

As with any new business or industry, understanding the stage of business and company’s risk profile as it relates to an investment and applying a discount rate adjustment for cannabis specific factors such as licenses, leases, and management is our primary valuation approach.

The cannabis industry is compared to highly regulated industries, like the pharmaceutical industry that requires an FDA approval for its products. But we also see regulatory environments changing and more states on the path to legalize medical and recreational marijuana. As the industry matures, we are hopeful that competitive benchmarking becomes a standard.

In part 2 of our series on valuing cannabis businesses, we’ll talk about what the future might bring to valuing cannabis businesses.

Have questions about valuing of your cannabis business? Quist Valuation can help. Let’s set a time for a free 30-minute consultation. We can discuss the specifics of your business and identify the next steps needed to assess the value of your company.

Schedule your free 30-minute consultation here.  

tax reform

Is your business worth more – or less – in 2018?

Now that the Tax Cut and Jobs Act is law, what now? Because these rules affect the value of your business, every business owner needs to be aware of these important changes.

Overall, companies with currently high effective tax rates, low leverage, limited tax attributes and high capital intensity are likely winners in the new world. Take away any of these characteristics and the picture is less clear.

Tax Reform Impacts

Impact on cash flows

Many are wondering if the drop in the tax rate from 35% to 21% will increase after-tax income proportionately. In order to determine the full impact on after-tax income, it’s important to remember that the effective federal corporate tax rate averaged 23% in 2017, implying a much smaller decline in the tax rate than what appears on the surface. As such, after-tax earnings are anticipated to increase closer to 7% in 2018 as opposed by more than 20% as implied by the change in the statutory rate from 35% to 21%.

Over time, the ability to fully expense capital expenditures could lead buyers to pay more for assets or businesses. Also, the limits on the deductibility of interest expense could also offset the impact of lower tax rates on free cash flows.

Impact on rate of return

The rules also affect a business’s value through the cost of capital and anticipating effects on the market equity risk premium. A lower tax rate environment may drive more competitive markets. Potential buyers may think expected profits are riskier or less certain due to the new rates. That additional risk may require an increased rate of return to partially offset the gains.

Companies’ cost of debt is impacted in two ways. First, reducing the marginal tax rate increases a company’s after-tax cost of debt. Second, limits on the amount of interest that a company may deduct from taxable earnings further increase the cost of debt, particularly for those companies that are more heavily leveraged.

As the cost of debt and equity capital increases, the value of a company decreases. Potential increases in company value due to improved cash flows may be offset by increases in the cost of capital.

Impact on multiples

In a market-based approach to valuation, the current increase in share prices may already echo the expected changes in tax rate. However, to truly understand the impact on value, it is important to apply forward-looking multiples that reflect a company’s earnings under the new tax law.

In the current environment where there are fewer acquisition targets than buyers, M&A transaction multiples could expand. Corporates that experience lower effective tax rates and repatriate more than $2 trillion in cash held offshore will have more cash to spend on M&A. There are varying data points that suggest that the changes in the tax law will sustain the incredible run seen in transactions with valuations increasing another 0.5x EBITDA.


“No matter what you think about the tax reform package, there is one thing that is not debatable: it will impact equity value and affect corporate behavior in the coming year.” ~Aswath Damodaran, Professor of Finance at the Stern School of Business at NY


Company Value

Your company’s value is based on many factors, including the company’s assets and its market value. The ability to depreciate equipment faster and the potentially lower tax burdens change the value of your business. Due to the sunsetting of certain provisions such as interest expense deductibility and the expensing of certain qualified capital expenditures, the impact on earnings going forward will be quite varied. Don’t be surprised if longer-term forecasts are requested in order for the impact of the tax changes to be fully reflected in your business value. It’s time to evaluate your company’s new value. Plan now for a more profitable 2018.

Have questions about how the new tax laws affect the value of your business? Quist Valuation can help. Let’s set a time for a free 30-minute consultation. We can discuss the specifics of your business and identify the next steps needed to assess the value of your company.

Schedule your free 30-minute consultation here.  

When Anthony decided to start his own software company, he knew he’d need an investor to bring his idea to life. So early on, he dedicated time and effort to position his company for equity financing. In doing so, he had to learn how investors would value his business that had yet to demonstrate meaningful revenue or profitability. At first, the path was unclear. But eventually, he realized three important business valuation drivers that all early stage companies should know. By being able to clearly communicate the value of his company around these value drivers, he was able to secure financing from an angel investor.

So, how exactly did Anthony create value within his business before the ask?
He crafted a value story that was realistic, coherent, and compelling. While Anthony spoke the “language of an entrepreneur” (one around opportunity, optimism, and vision), he knew he had to also speak the “language of an investor” (one around reducing risk and improving returns).

Here’s the secret sauce:

1. Assemble a Strong Management Team
The management team is one of the most important value drivers that a business can have. The key word here being “team.” Commonly, entrepreneurs tie their company’s value directly to their involvement in all operational aspects. Contrarily, investors want to see a group of people who possess complementary skillsets. Specifically, they want to view the team’s ability to work together in setting objectives, monitoring activities, and motivating employees. All of which are qualities that help funders determine the likelihood of future growth and success. Thus, strong teams can drive higher prices.

2. Develop an In-Demand Product or Service
Increased demand and opportunities for growth are the first two things investors look for in business. They want to see specific cash flow strategies and a diverse customer base. Companies with a single client accounting for more than 10 percent of overall sales is a red flag. Those who have plans for new products and product lines get viewed more favorably. Investors also like a marketing plan that tells a good story. They should be able to see upfront the problem solved and the unique business solution. Essentially, investors want assurance that the business has momentum. The best way to assure them is a written plan documenting a clear strategy for growth.

3. Define and Document a Clear Growth Strategy
A well-written business plan and brand strategy can increase the value of a company because it helps investors see the risks and rewards. Good plans document all systems including automated and manual procedures that generate revenue and control expenses. They also list the methods used to identify and track customers, as well as, deliver products and services. Standard business procedures and systems that are well-documented add value to the final asking price.

In conclusion, it’s the business owners job to tell the company’s story. Craft a tale that shows value using the three strategies listed above. A company that demonstrates limited risk and real returns can attract investors at a premium price even in the earliest stage of business.

To learn more about early stage valuation drivers, join Quist at Colorado’s Longmont Startup Week, July 24 through 28. Entrepreneurs, wanna-preneurs, intrapreneurs, creatives, techies, inventors, business owners, and investors are all invited to attend as our guests. Register for our presentation “The Art and Science of Valuing Your Startup” on July 25 at 9 AM here