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CannaSold is the Cannabis Business Expert when it comes to Exit Strategy and Valuation. Key Factors in Valuing a Cannabis Business
There are four primary verticals in the plant-touching space: cultivation, manufacturing/processing, distribution, and retail/delivery. Depending on the regulatory framework where a business is operating, a company may have a stake in one or more of these verticals. Operating in more than one vertical can provide a company control over its product quality and supply, and increase its margins, multiplying its company value.
Ultimately, in assigning value for a cannabis company, its crucial to analyze the key value drivers for each business. For example, for retail businesses, the building’s location and local competition are key factors for assessing value. Meanwhile, for cultivators, the business’ expense profile and product quality are more important.
Having an ambitious strategic plan is one thing, but more important is whether or not the business can execute that vision. Investors putting capital into this industry look first at the leadership team in place to assess whether they have a collective history that suggests an ability, and willingness, to overcome roadblocks, make sound decisions, and ultimately sustain long-term growth.
While the cannabis industry may be new, the need for valuation certainly is not. There are countless methods that businesses, investors, and industry experts utilize when performing valuations. The following are the four most commonly used methods to assess value in the cannabis industry. The appropriate valuation method(s) depends on the company being valued, and will likely include a combination of approaches.
The Discounted Cash Flow (DCF) method states that the value of a company is the present value of all future projected cash flows. The DCF method requires developing a multi-year projection of the company’s future cash flows, along with identifying an appropriate discount rate.
Strengths: Theoretically, the DCF method is the most accurate method for valuing a company, if the assumptions are accurate. This method allows the appraiser to adjust the financial forecast for different operating outcomes and assumptions to analyze the impact of value.
Weaknesses: The DCF method requires making a myriad of assumptions about a company’s future performance and risk profile – and the valuation is only as good as the assumptions used. “Garbage in, garbage out.” For young, fast-growing cannabis companies, identifying realistic assumptions is a complex process.
Building on the old business adage of “something is worth what someone will pay for it,” the Market Transaction Method analyzes the valuation metrics, or comps, of similar privately-owned enterprises or properties that have been sold or have raised capital. The most common valuation metrics utilized are Enterprise Value / Revenue and Enterprise Value / EBITDA. By examining similar transactions, an approximate value can be determined by adjusting for company size, growth, and other factors.
Strengths: Based on actual valuations achieved by companies in the market, the Market Transaction Model is an excellent gauge of what valuations are truly being achieved in the market.
Weaknesses: While the market may say one thing, the realities of a business and its operations ultimately determine value. This method requires access to data for similar companies, which can be difficult to obtain given that the majority of transactions completed are private and there are few industry valuation metrics available. Also, as the market evolves, valuations change, so the older the data the less relevant it is.
The Guideline Public Company Method values a company by analyzing the valuation metrics of comparable publically-traded companies. Similar to the Market Transaction Method, adjustments must be made to account for differences between the subject company and the comparable companies.
Strengths: The price of publically-traded companies are based on market data and easily accessible. Additionally, quarterly earnings reports and other investor reports can provide detailed financial and operational information.
Weaknesses: Utilizing this method requires identifying public companies that have comparable business operations, which can prove difficult for smaller companies. There has been an exponential increase in the number of companies going public, which is making this method more accessible. However, public company valuations are very volatile and can swing heavily due to market factors independent of the company’s fundamentals. For instance, the Marijuana Index, an index tracking the top cannabis stocks, increased more than 200% in the three months leading into California going legal in January 2018.
The post Cannabis Business Sales – Expert Analysis Business Valuations appeared first on HumanitasConnects.
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