By Chris Walsh
How do you assess the value of a cannabis company?
This is one of the most vexing questions for investors and marijuana business owners alike.
It’s exceedingly difficult to come up with an accurate valuation, given the industry’s relatively short history, high volatility and complex regulatory structure. Throw in the immense amount of risk and the fact that marijuana is still illegal federally, and it can feel like throwing darts at a board.
But it’s a critical metric: A valuation helps business owners determine how much they will sell their company for and, in turn, gives potential buyers an idea of how much they should pay. It’s also an important figure for investors and can play a big role in legal disputes.
Ron Seigneur, who has more than 25 years of experience in valuations and will speak at the upcoming Marijuana Business Conference and Expo in Las Vegas, talked to Marijuana Business Daily about strategies and considerations for appraising companies in the cannabis industry.
What industries have you been involved with on the valuation front in the past?
It’s been all over the board – restaurants and hospitality businesses, professional services firms and everything from feed lots in Kansas to bottling companies in Dallas to high-tech companies.
What are the challenges in appraising a cannabis business, and how are they different from issues you encounter with other types of companies?
The biggest challenge is trying to figure out the risk profile of the operation. That’s challenging for obvious reasons – the regulatory oversight and the incredible pace that the industry is changing at.
With any closely held business, a big part of what we do is figure out a proper risk-adjusted rate to apply to cash flow. We often use an income approach, where we project out what we think the enterprise will make in terms of future cash flows, and then what someone would compensate [the buyer or investor] for given all the uncertainty associated with the future.
When trying to do that same exercise with a business in this industry, though, it can be difficult. You have federal issues on one end and local regulations and competitive juices on the other end. It’s a supreme challenge for a business appraiser.
Business valuations often involve examining how a company stacks up against its peers. But isn’t this difficult given that the industry is so new?
Often there are no reliable benchmarks in the cannabis industry from a business appraisal point of view.
If you’re valuing a fast-food restaurant, you can find hundreds of comparable transactions of fast-food businesses bought and sold over the years. But in this industry, it’s so young that there’s next to no market data to rely on. So you have to use the income approach, where you incorporate cash flows and the risk-adjusted rate that I mentioned before.
But that’s difficult too when you have businesses that have been operating six months or a year compared with other industries where businesses have operated 5, 10 or 15 years and you can look at historical trends so you’re fairly comfortable about future.
So how do you overcome this hurdle?
We analyze the business and look at what investors expect to receive in the public stock market, add in the additional risk of being invested in this industry and use our professional judgement.
The devil is really in the details in terms of how much we add for that unsystematic risk. With all the regulatory oversight and leasing, banking, cash and security issues, we might see someone need a 40%-50% return [to invest in or buy a business]. In other more established industries it might be 20%-25%.
What other factors are important when it comes to valuations?
Location, competitors, the depth the company has in management, whether it has good operating procedures and a formalized long-term lease, and other aspects like whether there’s adequate parking, visibility and access.
It’s important to do a management interview and conduct a site visit because so much of what we do is based on experience and professional judgment, and numbers only mean so much.
How much should a business or investor expect to pay for an appraisal?
If it’s just a calculation of value, it’s usually between $2,500 and $4,000, where if it’s a conclusion of value [a more in-depth look at the company that is more like an audit as compared to compiled financials] it can range from $8,000 to $12,000 on the higher end. These ranges are predicated on starting with current, reliable financial data.
What changes have you seen in how valuations are approached in the marijuana industry?
For folks who are involved in it every day, it seems like a mature business. But to me it’s still got a lot of change that’s happening. You might find some valuations that were done a year ago, and in many industries they would still be relevant, but in this one they are not at all.
Are you seeing much activity in terms of mergers and acquisitions in the cannabis space right now?
A little bit, but a lot of people who would love to be involved are waiting on the sidelines because of residency requirements in owning or investing in a cannabis business, particularly in Colorado. There’s a lot of pent up interest that haven’t resulted in actual deals being consummated.
Some people are paying more than they should given the wide range of business risks. Time will tell if valuations made now are too low or too high. We’ll have a better sense three to five years from now.
What advice do you have for companies preparing for a professional valuation?
My advice is to keep good records, have current financials and play by the rules. And probably my biggest tip is try to develop some projections for your business. We’re trying to figure out what future cash flows are. We need a starting point to say here’s what we think the business will do in the next three to five years. It’s really helpful for us if the business has some of operational data and projections to help us in that respect.
Ron Seigneur is managing partner of Seigneur Gustafson LLP, a Colorado firm that provides valuation and litigation support services.