So you went and started a cannabis business. Congratulations! Now, here’s a question for you: what’s it worth? And if you don’t mind us asking: how did you make that determination? Is it supportable?
Recently, we have written about the future of cannabis funding and the basics of investment rounds. The valuation question looms large when capital is injected into a cannabis venture in exchange for ownership, as it would in any other industry. The valuation question may also come up at other points in the lifecycle of a cannabis business, including for tax reporting (c-to-s conversions, charitable conversions (now available in Oregon)); financial reporting (purchase price allocation, portfolio valuations); and litigation (shareholder disputes, damages, fraud). If you are like me, you have even hired, examined and cross-examined professional appraisers on valuation issues in arbitration and in court.
Of course, valuation of a “going” cannabis concern is different than valuation of any other type of business. This is largely due to federal prohibition, which results in heavy taxation of pot operators and highly differentiated local markets. A license in New York State or Hawaii, for example, may have a much higher value than a license in Oregon or Washington, because of the exclusivity involved. However, legislation in an “open market” state may be much more favorable, and every business has its own characteristics, like location, lease and allowed activities.
One common characteristic across the board with cannabis companies is risk. Arguably, risk assessment may be the biggest challenge within the cannabis sector. Federal prohibition aside, state regulation is so new that pot firms face an ever-changing regulatory landscape. Another substantial challenge for any pot business appraisal is the lack of operating history, both for the individual business and for the industry as a whole. Appraisers like to use comparables, but in legal marijuana markets, those are hard to come by.
Despite these challenges, pot businesses sometimes must be appraised or valued, and appraisers need to work with what is available. As in other industries, there are three general approaches to valuation of a pot business: the asset-based approach, the market approach and the income approach. Each approach carries a unique methodology and, depending on the situation, one approach may be preferable to another. For example, an asset approach would probably not be helpful with a start-up enterprise, and an income approach would not be availing in a shareholder dispute. To understand why, here is a very brief overview of each.
- The asset approach looks at the business as a sum of assets and liabilities used to determine its value. This approach asks “what would the cost be to create another business that would produce similar economic output?”
- The market approach looks at similar businesses, and asks “what are other, similar businesses worth?”
- The income approach considers the expectations of someone participating in the business. This approach asks, “what economic benefit will an investor of time or money receive?”
Within each approach, discounts to the business’ ultimate value may be applied for lack of control, lack of marketability or other factors. Capitalization rates may vary. And ultimately, the answer to the seemingly simple question “what is this business worth?” may come out differently, depending on the approach as well as appraisal objectives.
Hiring a valuation expert may be hard to avoid in certain situations, like taxation or shareholder disputes. But for other purposes, like funding a cannabis start-up, an expert opinion may not be required. Still, anyone seeking money from third parties must be able to state and support what a cannabis venture is worth. No savvy investor will believe your cannabis venture is worth $5 million, for example, if you cannot show them why. As attorneys who regularly deal with funding new marijuana businesses, we are often able to help with this.
Today, marijuana industry appraisals are more speculative than in other areas. This will change as markets mature and it will change dramatically when federal prohibition ends. For now, anyone raising money in this industry should understand basic principles of valuation. An accurate assessment up front may even help avoid disputes in the long run.
