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.
For 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.
