Cannabis business valuations: FAQs and why they matter

As the cannabis industry continues its rapid growth, business owners and investors need to understand the baseline value of their companies. Confidence in valuations paves the way for investment and mergers and acquisitions (M&A), which have surged in 2021.

With so much change in motion, cannabis business leaders should prepare now and familiarize themselves with when to seek a third-party valuation – whether they are a buyer or a seller in an M&A – and what to expect during the process. Exploring five frequently asked questions can help illuminate issues surrounding cannabis business valuations.

What are the benefits of a cannabis business valuation, and what insights can it reveal for owners and investors?

Formal business valuations reveal much more than just the estimated worth of a company. Valuations require an in-depth analysis of a cannabis business’s operations and finances. Valuations can also:

• Help business owners understand how they compare to similar cannabis companies, especially in terms of profitability and projected value.
• Provide insights about marketplace trends that influence company valuation. These insights produce more informed business goals and strategies.
• Reveal internal risks that diminish value, such as regulatory and tax compliance challenges and poor financial data or internal controls. Owners can use these findings to improve processes before a sale, and investors can gain clarity on the risks and benefits of a purchase.

When should a cannabis business owner or investor consider a valuation, and what events can trigger it?

Both owners and investors typically request their own independent, third-party valuation in advance of selling a business, completing an acquisition, seeking financing, or raising capital.

A valuation is required when company leaders grant stock compensation to employees, and it can also be undertaken when owners buy out other business partners. If the company is owned by an investment holding company or private equity group, periodic valuations are required for financial reporting.

What factors affect the value of a cannabis company?

Third-party valuation specialists look at factors within and outside a company’s walls. They analyze financial statements to understand past, present, and forecasted profits and revenue. They review the assets and licenses held, both of which affect value, as does the quality of processes and internal controls, which help to maintain compliance and minimize risk.

Valuation specialists also consider external factors that influence business value, such as other recent transactions and the performance of a company’s direct competition.

What are the challenges of valuing a cannabis business?

Any business valuation is a complex endeavor, and it is particularly so in cannabis. The cannabis industry is volatile and relatively new, and a rapidly changing regulatory environment can make forecasting a challenge.

To determine the value of a cannabis business, specialists often must navigate significant discrepancies between transaction prices and the values indicated by traditional valuation methods. For this reason, the valuation specialist should possess a deep understanding of the cannabis industry, including the nuances of each cannabis vertical, such as retail, cultivation, and manufacturing.

How does the valuation process work, and how can participants prepare?

An accurate business valuation requires diligent and objective analysis. To start, valuation specialists need access to a wide range of company documents: financial statements, tax returns, legal documents, licenses, customer lists, staff rosters, business plans, and records of physical assets, to name a few. Business owners and CFOs should prepare by assembling and organizing these documents in advance and making sure they are up to date.

Business leaders should also anticipate requests for fact-finding interviews with management and other key stakeholders. Finally, leaders should understand that throughout this process and during all staff interactions, valuation professionals must maintain an impartial and objective role. 

Once the information-gathering phase is complete, valuation specialists will analyze the data using up to three different valuation methodologies: 

• Income approach. The business is assessed based on the present value of its projected future earnings.
• Asset approach. The fair market value of all company assets, minus its liabilities, drives this approach. 
• Market approach. Value is established based on the recent selling prices of similar companies or is based on the stock prices of public companies.

Multiple approaches are often used simultaneously to validate the findings of any single approach.

Leaders should expect a business valuation to take between four to six weeks after valuation specialists obtain documents. The final report they receive from the specialists will detail the dollar value of the business and describe the approach and key factors that led to the calculations.

With specific insights in hand, cannabis company leaders can more confidently begin M&A planning or make strategic decisions to drive business growth.