Cannabis Knowledge & Insights

Cannabis Business Valuations 101

On October 3rd, Marko Glisic discussed his first-hand knowledge on how to properly assess the value of your cannabis business and which main drivers increase your company’s value.

This was the first part of the cannabis business valuation series.  

If you want help with a valuation for your cannabis business, then please contact us to get started or call 800-674-9050.

You can watch the full webinar here:

Parts 2 & 3 of the cannabis business valuation series are below:



You can download the slides here.

Full Webinar Transcript:

We’ll be covering valuations and investments, how to value invest in the cannabis business. this is going to be part one of a three-part series. Part one is going to be more of an overview, part two and three we’re going to do a deeper dive into some fun details.

And then as far as the agenda for today, we’re going to cover valuations 101, Kinda more basics, all kind of more technical but fun stuff. Talk a little bit about this kind of cash flow method, the concept of time value of money, what are the good things to look into a cannabis businesses investment and then things to consider before making any investment.

A little bit about us GreenGrowth CPAS. We’ve been around for about two years. We’ve started off as a tax prep company, so we’ve done over 500 annual tax returns for cannabis operators spreading across all verticals right, so dispensary distribution, cultivation delivery, manufacturing lab testing.

Currently have over 300 clients in California, Colorado, Michigan, Oregon, and Washington. Our second year we started getting into some more fun stuff. Things like due diligence, work audits, assurance related work, we’ve completed over a dozen projects and we’re expecting to hit a seven-digit in revenues in our second full business year. We really have a team of experts, really great professionals ranging from CPAs, CFAs who really have a deep and thorough understanding of tax compliance, assurance related work and valuations. So I think over the past couple of years, we’ve seen definitely a lot of interest in the cannabis industry. you know, we kind of seen the news companies going public, a new merger and acquisitions taking place. Definitely a lot of industry essentially. I think a lot of people are trying to claim their small stake in this growing industry. A couple of difficulties that you kind of tend to see with cannabis industry is that number one, it’s federally illegal and number two, in a state and local level, it’s highly regulated.

And third, just from an operation standpoint, it really takes a lot of deep industry knowledge to be able to operate a business. And so then what, you really see is a lot of investors as opposed to starting their own business, really kind of looking to invest into companies and that’s really where the concept of valuations comes into play. So it’s really kind of deepest meaning valuation is a process of estimating the value of a company or a group of assets. And as part of that process, you’re essentially trying to determine whether this investment is attractive or not.

There’s a couple of different ways to go about valuing a company or group of assets. Three main ones you kind of tend to see is the discounted cash flow method or DCF, guideline, public company method or properly known as GPC. And the last one is guideline transaction method, which was really kind of based off of mergers and acquisitions, as far as guideline public company method, a good way to kind of think about it is, you know, it’s very similar to comparable sales in real estate, right?

So let’s say you’re, you’re kind of looking to, to sell a property and then you can kind of look what are the, offering prices in your neighborhood, right? So if, if a house is going that’s very similar to yours is being offered at a bottom million, then you can kind of use that as an indication of a value for your house. The guideline transaction method is very similar to this method. In a sense. The only difference is that you’re actually looking at sales that have occurred, right? So you would kind of look going back to our example, right? You will look at houses in your market that sold, and so let’s say that how sold for 2 million you and then kind of used that as an indication of value. A similar thing happens really with any, any industry including cannabis industry, cannabis businesses are bought and sold every day, every month, and then you really kind of using the values that those businesses are being bought and sold for is an indication of the value of the company you are looking to invest in.

Out of these three methods really from experience this kind of cash flow method or DCF has really been proven to be the most and the best method for for cannabis industry. And there’s really a couple of reasons. One is, although we definitely do see a decent amount of mergers and acquisitions happening in cannabis industry, it’s really hard to get solid data on them and be able to develop metrics that we can then use to interpolate the value for a business. And then with respect to the public companies, yes, we’re seeing a lot of companies going public there, right? They’re out there in the market. We see the multiples their trading yet. But I think with the general excitement around the industry and, and all the activity we’re seeing there, the multiples tend to be very high and so that can really then skewed the value of an investment when you’re when you’re approaching it.

So then from all these three methods, really discounted cash flow method seems, seems to be the best. And then to dive a little bit more into it in a sense discounted cash flow method relies on projected future cash flows and then using a discount rate or required rate of return as a factor to discounted back to present. Once kind of the method is not really what you’re left with is the present value estimate. And this is an indication of a value, right? So, so let’s say the present value estimate is 2 million, right? If somebody then offering you to buy a company at 3 million, but then you have calculated 2 million, then that would really not make that investment very attractive. Conversely, let’s say again, you valued it at 2 million, but somebody is asking you to buy it for 1 million. Well Gee, that’s a great investment.

Then you know, you’re, you’re buying something from 1 million that you intrinsically really believe it’s worth 2 million. You know, when doing discounted cash flow methods. Some of the things that come into play are risks, projections and then couple of other factors such as cash in hand, if the company has any attractive assets ride like land or piece of equipment, any existing that or liens type of ownership, the type of entity, but really kinda the two main things I want to focus on here is the risk and projected cash flows.

These two things are really kind of the biggest, biggest drivers of the model and the value, right? So the way to kind of think about it with projections and free cash flow is really the bigger that those are, the greater the value of a company is. So kinda to think about it, you know, let’s say you’re trying to invest in a business and business A versus business B and business A is cash-flowing a million every year versus business B, that’s cash flow 100,000 every year.

And those are cash flows that are then going back to you as an owner will clearly then business A that’s cash flowing at a million a year is a way, way more attractive investment. And as far as the risk diverse, because the risk is inversely correlated to the value, right? So the greater the risk, the lower the value of a business. And a good way to think about is, let’s say you have two businesses, right? One is a startup and one is an established entity, mature company, right? And the mature companies already cash flowing, they already have a great management that has a proven track record, they have a great product, great brand, solid distribution, everything can think of, right? And then you have a startup, they just starting off, great idea, beautiful product projecting amazing, amazing cash flows. But it’s a startup. It doesn’t have as much activity, right? So the risk is a lot higher.

So even though these two businesses are projecting exact same cash flows, clearly startup businesses have riskier and therefore you would put less, less value on it, right? Meaning you will be discounting those cash flows a lot more. So kind of going back to what we said, we have our free cash flows and then we have the risk or the discount rate, right? And so that’s really kind of where that concept of risk slash discount rate slash time value of money comes into play, right? The riskier the businesses, the more you’re going to discount those cash flows.

A couple of things with the DCF method, it does have certain disadvantages and that is that the method is really only as good as its inputs. And we said two main inputs are projective free cash flows and the risk and, and these are the inputs that again, their estimates and they’ll be coming from the company you are trying to acquire.

So they’re inherently going to have a bias to kind of make those things as optimistic as possible. And so this is really where you want to do good due diligence or get a professional to help you with that. Think about it this way. For example, for a cultivation operation, a big driver in projected cash flows is the yields. How many grams per square foot that operation is yielding now, and again, the bigger the yield is, the bigger the top line is going to be, ride the revenues and the rest of cash flows. And then the bigger the value’s going to be, but again, this is going to be an estimate, so you don’t want to take these things at face value. You want to make sure you do your due diligence, right? So then, in that case, you kind of look at actual results from, from prior years, right?

And really challenged the management really challenge the previous owners or the founders and see why. Why are these kind of key assumptions that are drawing projections? Why are they reasonable, you know, what are they basing them off of?

Let’s see. A couple of things to look for in a good cannabis business, a company that doesn’t have a lot of debt is that’s usually a good indicator. And the reason why is that debt is a source of funding, right? So let’s say you, you do acquire a company that doesn’t have any debt. Now you’re able to go out to the capital markets and raise some more funding through different debt instruments, whether we’re talking about convertible notes, secured or unsecured loans, et Cetera, et cetera. But this in a sense gives you a cheaper source of capital versus raising an equity, then you can invest back into your business and scale it up.

So that’s why versus a company that already has or it is very leveraged. Not that many lenders will be willing to invest in it for the obvious reason that they don’t necessarily think that the company would be able to return that money if it’s already very, very leveraged.

Another good indicator for more mature and stable companies, right. If there’s a company that is already an established brand, it has multiple years of operations, has a strong management team, individuals with a varied diverse background ranging from, you know, for cultivation, a strong growing team that’s been doing it for years or decades. For manufacturing a good manufacturing and marketing team. So really that kind of proven track record goes a long way.

A couple of other things that are very important, well-developed sales distribution, procurement channels. Again, ideas are great. I think we all love a great idea, but if those basic business processes are not put in place and they’re not already functioning and those need to be put in place, once you acquire a company, and again, these seem like basic things, you know, putting together strong sales theme that has clear KPI’s, know who their target dispensaries are that needs to go to sell to or a purchasing and supply team that needs to identify vendors from whom to purchase the right product and that the product is of the right quality, et Cetera, et Cetera, et cetera. If these things are already put in place, then you’re going with a proven model and that makes this business a lot more attractive versus again, a startup entity that’s just the pure idea.

A couple of other things to look for is clear financial reporting and just in general strong internal controls, right? I think often what you see in a lot of industries, but especially in cannabis industries are talent and management teams that can run the operations. They can create a great product. They can bring in the customer through the door, you know, they can purchase the right raw materials, they can motivate the people under them and just create a great brand, but that’s only half of the story. The other half is the back office. The stuff that’s not fun, but it is very important…the strength of their accounting team, internal controls. Are they producing numbers regularly and accurately to the top management and investors so they can evaluate how the business is progressing?

You know, we’ve run into countless, countless and countless situations where we’ve walked into companies and we’ll see a massive difference between cash in hand and cash in the ledger. And then the question is where did that stuff go? Where did that cash go? Also had another problem you see with the lack of financial reporting, in general, is that that it becomes as the business scales, it’s a lot harder to manage that business. Like if you have one sales guy it’s a lot easier to manage them. But now if you have a sales team of 10, 15, 20 people, what are the KPIs? What are the numbers, how is that sales team doing? So the companies that already have these processes established are less riskier versus companies that do not have strong internal controls than not have strong financial reporting are a lot riskier, right? Cause you gotta think about what you’re walking into.

So in a like sense, companies that they then do have strong, strong financial reporting and strong internal controls, down the road when you’re trying to exit that business and sell to somebody else, somebody else will also be doing that due diligence, right? Whether that’s an I-bank, a private equity firm or a hedge fund or even just the private investor, they’ll be doing their due diligence.

And so in a sense of all these things are lacking, you know, independent cash counts, independent controls, financial reporting you’re going to result in a business would a lot worse valuation than a business that actually has all these things fully developed and flushed out.

I see a lot of questions coming through we have a few more things to finish up and if we have time in the end, I’ll try to get to them. If not always, feel free to reach out to our team. We’d be more than happy to talk to you offline and dedicate the right time to you so we understand the problems and the things you’re dealing with.

And I often get asked how long should a deal take and again, it really, really depends. It depends on kind of what the other companies offering, what you’re comfortable with, how long you’ve been in the business, how well you understand the space. I mean, number one is you want to make sure you do your due diligence and, and that kind of goes into, you know, making sure you go out there, you observed the operations, right? Or get a good, good professional team that has deep industry expertise that can help you with those things. Make sure you understand and read the legal documents and run those by your attorneys. Make sure you run the financial models to value this company. And, again, that can take anywhere from, you know, couple of few weeks to a couple of months, you know, or you might be just investing in a company that’s recently starting and they’re about to have their first harvest. Right? And you might want to see how much they yield at first, the first harvest. You may be in their projections they’re seeing they’re going to yield 55 grams per square foot. Well, Gee, you know, maybe we should wait a month and, and, and see what the yields actually ended up being because this is going to drive a lot of things. Right? So again, very, very much depends on your individual circumstances. But again, I would say the couple of factors that would drive this is you know, the due diligence, right? And the legal side, making sure you, you do older, required due diligence taps and that your attorneys are comfortable with the way the purchase agreement is structured.

And some of the other good things on the operational side to kind of look for it for in a good business would be a good yield and a low cost per pound for cultivation operations. For manufacturing operations, it will be strong brands, brands that have been around for a while. They have great sales, great sales growth. For dispensaries, it’s really kind of the ones that have a high average transaction, high frequency of purchase they’re located in. They have a great, great real estate position.

Couple of things to do before really getting into any investment in a cannabis business. Obviously, this is a very, very regulated industry. At a federal level, it’s still illegal and state of local there’s a lot of laws and ordinances that are regulating these businesses. So number one, what we always advise people getting to space is make sure whoever you’re trying to do business with has a license and is a good standing with the state and local authorities.

Number two, make sure you’re always doing background checks. Again, these are the people you will be in business with for years, hopefully. Right? In a sense, a business is like a marriage, right? So you want to make sure you do your background check and you did both on the entity and on the owners, on the management, the entire team.

Also make sure what is the capital structure, kind of, what are you getting into? Did it already have some debt, who are the equity investors kind of really who owns what and who does the company owe money to?

Number three, make sure that on the tax side there’s really no surprises. The last thing you want to do is invest in a business. And then down the road, it ends up being that that business now owes hundreds of thousands of dollars to the government. Right? And, and we’ve seen cases, I think a great, but sad example is the Alterman case that, that was a recent tax ruling.

In a sense the dispensary operator got challenged on their I believe it was 2010 and 2011 taxes. So this was kinda years after they got challenged on it by IRS and then they ended up paying hundreds of thousands of dollars in back taxes. I think their operation was probably doing about $800,000 top line and then end up paying $300k to $400k taxes plus a massive tax penalty of, I think, was anywhere from 70 to $100,000. So you can see how non-compliance can really be detrimental to somebody’s business, right? For an operation of really just doing $800K in revenues a year and they end up paying so much in back taxes. Right? And so you don’t want to be in that position where again, you’re looking at a great company, an attractive brand they’re doing well they’re growing, but then they’re not up to date with their taxes, and you end up investing in that company and you’ll land in that situation.

And then really kind of the things you should look for, there’s the local taxes, right? The cannabis business, local taxes. You should look at the state taxes, which can be income taxes, sales taxes, excise taxes, payroll taxes. And then on a federal level, income taxes and payroll taxes. Number five. Again, make sure you do your due diligence. Go out there and observe the operations right? If they claim they have 13,000 plants in the field, go there and observe and make sure that it’s actually there, you know. If they have any cash on hand, count it up and compared to their books. If there’s a big difference between those two, this is a big risk. And again, it might still be the right decision for you to invest in this business, but you should price it properly, right? You know the cash in the books is hundred thousand dollars more than the actual cash on hand. Well Gee, you know, that’s indicative of the founders and management really not kind of running that business the right way, not having a proper handle of things. And if you want to get involved with that, that should be priced properly.

Number two, confirmed their receivables. Make sure they say that ABC dispensary owes money to them, that that’s truly the case analyst and confirmed their customer list. I mean, their customer list is going to be the function of their revenues, so make sure you’re really kind of comfortable with that list.

Number nine, make sure you’re analyzing the projections. Again, a value of a company is a function of free cash flow slash projections and the risk. So in identifying what are the key assumptions driving projections, is it the yield per square foot? Is that the average size of a transaction? Is it the frequency of which the customer comes back? Is it how many dispensers that are capturing in a particular area? Is it the selling price of their product? Is it the cost per pound of flour they’re producing? Is it the cost per pound of an edible they’re producing? Is it the average markup that a dispensary is putting on the wholesale product it’s buying?

Make sure you really kind of identified all the key assumptions that are driving the cash flows Now, doesn’t mean you have to look at every single little assumption that makes no difference, right? Look at the big ones, the big dollars, the big, big drivers of cash. Another thing, people tend to be very optimistic about this thing. You know, they’re only going to capture certain expenses, right? So make sure that they’re listening to expenses is complete, right? Are they including payroll tax? Payroll tax can be significant. I mean that can be close to 10 percent off of your payroll.

Are they including the packaging fees, including the lab testing fees. Are they including the excise tax? There’s a lot of different cash outflows that, that the business might not be presenting to you. And this is where we as professional experts come in and assist different investors, right? We have deep knowledge and understanding of the different operations, whether it’s cultivation, whether it’s manufacturing, whether it’s retail, the regulatory and tax framework that’s present in the industry. And that gives us an ability to really identify all these different expenses and risks that would affect your investment decision.

And, just to kind of summarize everything again. Cannabis businesses should be definitely valued before making an investment decision. Again, making any investment decision is a big decision and you got to make sure that you’re properly valuing the business you’re acquiring and you’re doing all the required due diligence for it.

Number two discounted cash flow in our experience and we’ve been doing this for a while, is the best and most effective way to value cannabis business. Number three, make sure you’re pricing in the risk, identify all the factors that are driving the risk for this business and make sure you factor them into your valuation.

Number four, great cannabis businesses are well established, mature, have great cash flows, little debt, great brand presence, and they’re complying with local, state and federal laws. Number five, make sure you do your due diligence before investing in any cannabis business as we said, you don’t know what you can be walking into and if you don’t have the right expert help, it can really cost you. And then lastly, ask yourself, at what value am I getting the company right? Why am I investing in this business? Make sure you do that due diligence and really understand why you’re getting into this. Is it really that you’re buying it because it’s a great brand, right? Are you buying it because you feel the cash flows are great or maybe you’re buying because the cash flows aren’t that great, but you know what, they can be better. You know, if you can jump in and restructure a couple of expenses, streamline things, maybe you start purchasing products at bulk, at a discount, right? And that going to add a few solid percentage points to the margins. You know, or maybe you know, you think you should be targeting a different market segment. It might be a very good investment, right? So she just really got to understand what are the key drivers that are driving you to make this decision.

So, that wraps up the first Webinar of a three-part series. I can see some questions in the chat box. Again, feel free to reach to us on the website. I mean, a lot of these questions are very nuanced and, and I want to make sure I give you the right time of the day to talk through them and resolve them.

And then in the next two webinars, we’re going to cover a couple of things. We’re going to do a deep dive in each vertical. So part two where we’re gonna focus more on cultivation, manufacturing and dispensing. And then in part three, we’ll focus more on delivery, testing and ancillary cannabis businesses. We’ll talk about looking at business assets, equipment and facilities build outs, you know, kind of a couple of key areas that contribute to successful business and investments. And again, if you have any questions or need help with your business or making an investment decision, again, feel, feel free to contact us at our website or directly call the number provided.

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