Fortunately, the world is warming up to medicinal and recreational cannabis. As of October, 2021, recreational cannabis is legal in 19 states, Washington, D.C., and Guam. With this increase in legalization, comes an expansion of cannabis business ventures as well as all of the cannabis compliance and business valuation considerations that come with them.
Cannabis Industry Valuations: An Overview
As a relatively new and consistently-changing sector, there are many questions around how to account for the $11.6 billion and $18.6 billion cannabis growers and dispensaries accumulate in annual revenue, respectively. Given the industry’s infancy and unique legal nature, there are a few issues craft cannabis cultivators and distributors may run into. These include:
Federal Regulatory Issues: Still listed as a Schedule 1 drug under the Controlled Substances Act of 1970, federal intervention is impossible and it may be difficult to acquire capital for cannabis start-ups and business expansions.
Tax Burdens: Given different legality classifications at the state and federal level, cannabis is in a tax limbo. According to section 280E of the Internal Revenue Code, taxpayers engaged in the sale of controlled substances aren’t permitted to deduct typical business expenses—leading many to wonder, can the small local farmer thrive in today’s legal industry?
Industry Changes: The cannabis industry is rapidly evolving, nearly to the point of being considered volatile. In order for a cannabis business to stay relevant, they have to constantly invest time and money in staying up to date with technology, licences, and more—all of which impact the value of the company.
So then, how does cannabis business valuation even happen?
How to Conduct Business Valuation in the Cannabis Industry
Unlike other industries, when folks in the cannabis world sit down to dive into how to conduct business valuation, they’re faced with two main setbacks: insufficient market data and, as a result, dependence on projections.
Less than a decade old, the industry doesn’t have a lot by way of data or comparable companies. This poses a risk of inaccurate market multiples (indicators used to value a company), which can ultimately compromise the business valuation. Without data or years of historical records, valuations often rely on cash flow projections—money that is expected to flow in and out of a business. For small businesses or those just starting out, these projections are far less accurate than those of a stable business, or that in a more data-backed industry.
Still, many of us are asking the question, how much is my business worth?
Obstacles aside, valuation specialists are able to provide their services using three different valuation methodologies:
Income Approach: Considering expected future earnings, an income approach will assess either capitalized or discounted cash flows. This looks at a period of cash flow considered to be a good representation of future cash flows, or considers projections with an applied discount rate.
Market Approach: This type of valuation takes into consideration similar companies or stock prices of public companies.
Asset Approach: Often used when asset value is perceived to be higher than cash-flow stream and business earnings, an asset approach will subtract liabilities from the assets. This is accomplished by assessing either net liquidation value (current value for holdings and assets) or net asset value (value of holdings and liabilities adjusted for fair market value).
When and Why to Get a Business Valuation
Sure, a business valuation will reveal the worth of a company. But in reality, it can do so much more. A formal business valuation can support a cannabis business in a few key ways:
Valuations can help a business owner understand their place in the market, how they stand up against similar companies in terms of project value and profitability.
A valuation might reveal internal risks like regulatory challenges and tax compliance issues, or missing financial data. With this knowledge, business owners can help to address any shortcomings before a sale.
Formal valuations may shed light on marketplace trends. Increased understanding of market influences on business valuation can help an owner to make more informed business plans.
At Giving Tree Farms, we’re constantly learning how to navigate the world of cannabis business valuation and cannabis compliance. We’re fortunate to have the support from others in the industry through our partnership with farmer-owned cooperative, Hive Mendocino. Fellow farmers help us keep up with a quickly-evolving industry, and they help you fulfill your business needs! Need an order filled? Create a wholesale account today.