In any valuation exercise, including hemp and cannabis companies, there is always some discussion about exactly when in time – past, present or future – the EBITDA is examined.
As exotic as hemp and cannabis companies might seem to traditional investors, valuations of these companies still follow traditional performance indicators such as EBITDA, OPEX and COGs.
Moreover, hemp and cannabis companies are purchased, sold or invested in on a “multiple of EBITDA” basis. It’s a tried-and-true method of achieving a consensus price between sellers and acquirers.
This valuation method is commonly used to determine value because EBITDA is widely viewed as a proxy for cash flow, and this valuation method is widely preferred over, say, basing a company’s value on a multiple of top-line revenue or discounted cash flow or the value of its assets.
Even when using the multiple-of-EBITDA method, a company’s value depends on the operative time frame that an acquirer/investor will agree to when examining financial statements.
The EBITDA figure that the multiple is applied to is not always the EBITDA from the last fiscal year.
Many transactions today will value a company for acquisition or investment based on trailing 12-month (TTM) EBITDA performance. Other transactions (typically for more traditional companies) will base the multiple of EBITDA on an average of three years trailing EBITDA.
Hemp and cannabis valued on future EBITDA
In high-growth sectors such as hemp and marijuana, where a company shows great promise but may be losing money (or not showing a meaningful profit), owners are reluctant to value the company for investment or sale based on its historical, TTM or current EBITDA.
Most promising companies want to be valued on future EBITDA, as yet unrealized – or at least with some consideration for profits to come.
Let’s look at this in practice.
Most hemp and cannabis companies have made predictions on how profitable they will be, likely for a three-year period: the current year and two more after that.
When owners see that potential profitability and feel confident they can attain the predictions, they often insist that the future EBITDA should be used to establish the value today.
Owners are universally resistant to an investor coming in and basing their valuation for an equity stake (or an outright acquisition) using the low or nonexistent contemporary EBITDA of young companies, because they believe it does not reflect the true value of the company.
This creates a natural tension between an investor/acquirer that wants to invest on the lowest possible EBITDA and owners that want the value based on a future EBTIDA.
The true value, of course, lies somewhere in the middle.
The trick to resolving this tension is to find the operative time frame when the (projected) EBITDA is acceptable to both buyer/investor and owner.
Is there a way to stage the valuation so that the multiple-of-EBITDA method is used, even as the EBITDA changes over time?
Here’s a scenario: A promising company puts itself up for sale (or investment) when its EBITDA is $1 million, but it has great promise for an EBITDA five or 10 times that in the future.
An acquirer might come along and say, “I’ll buy (or invest in) the company over stages. I’ll pay 7X on the current $1 million EBITDA at close. Then I’ll pay 7X on the incremental EBITDA improvement over the following year.”
If this practice is used in an acquisition, it’s called an earnout.
Essentially, the acquirer/investor is paying 7X on EBITDA after it is achieved, or as it is achieved, hedging the bet while inspiring the seller to make sure it hits its numbers.
It is not unusual for the acquirer to change the multiple over that earnout period, perhaps discounting the initial multiple to, say, 5X, and back-loading a higher multiple , say 9X, to reward the expected growth. (Note how that conveniently averages to 7X.)
This same principle can be applied to establishing the company value when it’s not wholly for sale, as when an investor takes a minority position, yet doesn’t want to invest at a high value on the mere expectation of EBITDA.
That investor can come in as an equity shareholder and buy shares on a schedule that ties a multiple to future EBITDAs, over time. It’s all negotiable.
Bottom line: The buyer and seller must agree on which EBITDA at what period in time will be used to establish value.
With that agreement, the rest of the transaction is free to fall into place, because the multiple becomes the element of the deal that’s negotiable and not the company’s EBITDA performance.
John D. Wagner is a managing director of Colorado-headquartered 1stWest Mergers & Acquisitions, which offers a specialty practice in the marijuana and hemp sectors. 1stWest M&A has transacted more than $1 billion in deal values.
