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Valuing a Cannabis Business

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.  

When Ken, a successful Colorado business owner, decided to exit his company he wasn’t sure what the options were, nor where to get direction. As he started to make these life-altering decisions, he and his wife were operating out of fear. They had a lot of unanswered questions. The biggest being “What’s the actual value of our business?” They tried some online options that based their worth on financials only. The great team and culture he had built and the extensively documented procedures didn’t factor into the final dollar amount.

Thus, Ken ended up leaving a lot of money on the table.

Get What You’re Worth 

If you are planning to exit your business, don’t let Ken’s scenario happen to you. Instead, make sure to learn the many factors that go into the valuation of your company. Doing the grunt work up front will get you the results you desire later.

First of all, there are many steps you can take to prepare for a transition or sale. Most important is a business valuation. An accurate analysis of your company’s worth will help you determine what steps are needed to reach financial security.

With a professional business valuation, you can expect a review and assessment in a wide range of business elements. The top three common criteria, include:

  1. Financials – A professional will start with your base metrics. It’ll include a review of your company and industry data, historical balance sheet, and income statement analysis. Make sure they consider your financial ratios and trend lines too.
  2. Comparisons – Next, there will be an assessment of companies similar to yours. They may be publicly traded or privately held with the same number of years in business, market penetration, and geographic location. Some professional valuators, like Quist, include merger and acquisition data and proprietary data acquired over 35 years for the current multiples of revenue and EBITDA.
  3. Forward Metrics – Lastly, there will be a deep dive into your forward metrics such as revenue growth and projected cash flow streams along with a risk-adjusted discount rate.

Understanding the significance of these metrics can be overwhelming. So, make sure you work with an experienced team of analysts. Together, they can help you bridge real-world realities with advanced valuation theory. It’s their job to break the data down into easy-to-understand information. Use the information they provide to make better-informed decisions about your exit.

Finally, Know Your Exit Options

In a previous article, we covered the Eight Ways to Exit Your Company. Here’s a broad outline:

  1. Transfer the company to a family member
  2. Sell the business to one or more key employees
  3. Employee Stock Ownership Plan (ESOP)
  4. Prep the business to be sold to one or more co-owners
  5. Cultivate an outside third party to buy
  6. Engage in an Initial Public Offering (IPO)
  7. Retain ownership but become a passive owner
  8. Liquidate

Read about each exit strategy in detail here.

Bottom-line

Make decisions based on facts, not fear. After learning about all eight exit strategies, you’ll see advantages and disadvantages to each. But, not all will be appropriate for you. Most will rule themselves out based on your business valuation.

In conclusion, work with a skilled advisor in exit planning to outline each option in detail. Then, compare the options to your company value. From there you can map out the most beneficial exit path for you and your family without fear of the unknown. The best way to achieve peace of mind is by knowing your worth.

Ready to start your exit strategy with a business valuation? Colorado-based 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 season is quickly approaching, and fear of an audit may be on the minds of some of your clients. While most IRS audits are unlikely (1 in 100), clients filing valuations with estate tax returns are very likely.

“This is the I.R.S.’s last whack at the apple,” said Jonathan Heralds, of Herzfeld & Rubin in his interview with the NY Times. “The single most important factor is credibility. Meticulous preparation of an estate tax return reflecting accurate information supported by thorough documentation attached, enhances credibility.”

Estate tax returns are a convenient way for the IRS to assert additional taxes if they find red flags on a return. Therefore, the best way to handle an audit properly is with an expert as your partner.

Know this about IRS valuation audits

These three red flags initiate audits.

  1. Estates that exceed $600,000
  2. Unreported gifts of more than $10,000
  3. Interfamily transfers and perceived inaccurate information not supported by documentation

“The average business owner grossly underestimates the value of a business,” said Edward A. Slott of Rockville Centre, L.I. “It should be appraised every few years by a professional business valuation expert, and anytime a significant change is made.”

As a trusted tax or financial advisor, part of your role is to anticipate IRS challenges on behalf of your clients. Most importantly, provide them guidance about proper documentation, especially as it relates to valuation.

Be aware that the IRS likes to challenge:

  • Multi-tiered discounting on related entities;
  • Company specific risk premium;
  • Discounts on liquid assets;
  • Pass-through entities that have an ambiguous business purpose; and
  • Entities that have unclear control features.

Consequently, your tax and estate planning clients are likely at risk for an audit. Make sure they know their options for managing and defending against an IRS audit.

Key Takeaway

In conclusion, the stakes are both emotionally and financially high when an audit is pending. So, arm yourself with a specialist who has high credibility. Preferably one who has effectively defended valuation methodologies against the IRS for both small and large clients.

When an audit does occur, your best defense is a good offense. Hence, your professional understanding of the issues surrounding valuation and related tax implications will reap long-term benefits for your clients.

Quist Valuation has 35-years of experience in business valuation. We have performed hundreds of valuations for gift and estate tax purposes and successfully defended valuations on behalf of our clients to the IRS with positive results. We understand the common challenges and proactivley address issues in our reports in order to best position our clients with the IRS. We’re a proud partner in preventing and managing audits when they do occur. Contact us to see how we can assist your clients in a valuation or prepare for an audit. Connect online or call 303-494-1664.

Mo Siegel started Celestial Seasonings in 1969 by hand-picking wild herbs in the mountains of Boulder, Colorado. He turned the herbs into tea, then sold his blends to local health food stores. Quickly the Celestial brand gained traction. It became known as the “tea that’s good for people and the planet.” This unique branding attracted national attention and soon became a household name in stores across the country. As Celestial’s brand loyalty grew, so did their product line. Eventually, they expanded into markets like green, chai, wellness, and iced. Each addition increased the value of their company. So much so, that in 2000 they struck a deal with Hain Food Group to be acquired for approximately $390 million.

Celestial Seasonings is one example of how brand expansion can skyrocket a company’s value. The process was slow but strategic, resulting in steady revenue growth and a multi-million-dollar partnership. Here’s how they did it.

3 Ways to Leverage Your Brand to Increase Your Company Value:

1. Create Brand Loyalty and Trust

A brand is the company’s identity. It’s the product or service delivered plus the emotional benefit offered. Brands create customer loyalty which in return dictates growth rates, margins, and risk. Learn how a strong brand can influence company valuation here.

It took Celestial 26-years to expand their product line. During this time, they built fierce brand loyalty through consistent delivery of goods consumers could trust. When it came time to grow, they already had name recognition and a competitive position in the market.

2. Strategic Brand Expansion

Established brands are better equipped to branch out and add variety. They can take greater calculated risk because of their pre-established reputation. It gives them the freedom to try new strategies that attract niche enthusiasts. A riskier market indeed, but offers the potential for higher margins.

When adding products, though, a few key factors must be considered:

  • How does this product align with the mission?
  • How much will it cost to add a new product line?
  • How will the product be used? Is it an addition or replacement?
  • How will the new product increase profit?

Answer these questions first, then start the developmental process.

Celestial started their expansion with green tea. From there, they added new brands approximately every four years – often setting market trends. By 2009 their popularity had grown so much that the demand had them introducing new flavors each year.

3. Branding Partnerships 

Strategic alliances help brands penetrate new markets. Together, they’re more likely to endure greater risk and command superior pricing. A combined package and trademark communicates higher value to consumers and investors. Plus, it symbolizes longevity.

In 2013, Celestial leadership took their creativity and innovation to the next level by partnering with Whole Foods, Trader Joe’s, and Sprouts. They developed product lines exclusively for these big-name brands. Their alignment created new cash flow streams on top of current sales. Thus, increasing their bottom-line and company value.

Value, growth, and partnership are all important parts of a strategic valuation. All three should be defined in a business plan, making it easy for investors to see the potential for high returns. Celestial Seasons was able to do this by understanding the value of a strong brand. They set their foundation early and crafted it over time. So, when it came time to leverage their value, investors were willing to pay top dollar – knowing the return would be significant for all parties involved.

Want to know the value of your brand? Colorado-based Quist Valuation has 35-years’ experience with strategic valuations. We’ve helped countless businesses, within all industries, understand the strength of their brands. Our team of experts can walk you through the process and help you determine the true value of your business.

Schedule a consultation with Quist here.