Merger and acquisition (M&A) activity in the cannabis industry continues to heat up as well-capitalized operators seek to expand their national footprint, vertically integrate, increase operational capacity, and enter new markets. As the owner or operator of a cannabis business, if your long-term plan involves selling your cannabis business, there are a number of strategies you can implement now that will help you demonstrate value and secure a healthy multiple when you close the deal — whether that is months, or years, down the road. In the following, we’ll discuss the basics of multiples, how to improve cannabis EBITDA, the importance of intangible assets, effective market positioning, and much more.
Understanding cannabis M&A multiples
While a great number of financial metrics go into the final valuation of a cannabis operation, EBITDA (earnings before interest, taxes, depreciation, and amortization) is the most common method used by venture capitalists and financial analysts to value a business. EBITDA is often used as a stand-in for cash flow (but measuring real cash flow gets more complicated.
In our experience working on both sides of cannabis M&A deals, we often see selling multiples based not on pure revenue, but instead as a multiple of EBITDA. The most common range of EBITDA multiples is 4X-8X.
This is because, as cannabis operators know all too well, revenue is only as good as its comparison to overhead costs. A company could be doing $100MM in revenue, but owe $150MM in taxes and other costs, making the entity undesirable in the near term.
This is all to say that revenue is always good and more is better, the ultimately more valuable metric is EBITDA. To secure a good M&A multiple, there are several ways to focus on a strong EBITDA.
How to improve cannabis EBITDA
EBITDA shows a cannabis operation’s profitability before non-operating and non-controllable items. The following are ways to positively affect EBITDA while also improving the overall financial health of your cannabis operation.
Reduce operational costs
Easier said than done, but this is the most common depressor of EBITDA. To achieve this, you’ll want to review the operations of your business in great detail and eliminate all unnecessary expenses. Typical opportunities to reduce operating expenses include:
- Reducing personnel costs
- Reduce production cost per unit
- Eliminate unnecessary business/travel expenditures
Reassess Owner Salaries and Bonuses
You’ve worked hard to build the value of your cannabis operation, but the real value is in the long-term selling price of your business. One major way you can improve EBITDA is by reducing the salaries of you and your leadership team. There are opportunities to offer ownership stakes in lieu of salary. But you must carefully assess and plan doing this to avoid hurting your return in the long run.
Increase Working Capital with Inventory Management Controls
Especially true for cannabis retailers/dispensaries, poor inventory management practices can have a major negative impact on working capital, and ultimately EBITDA. Implementing inventory management best practices can effectively double profit margins. Consider it this way, every product you’ve paid to produce or purchase that sits in inventory has cost you money but you haven’t collected any revenue. In that way, it has negatively impacted your EBITDA twice because you’ve incurred the cost without generating the revenue. Optimizing inventory management will immediately boost revenue and limit overhead.
Reconsider Real Estate Footprint and Contracts
If you’re paying an excessive amount in rent or other costs to maintain your property, there may be alternatives to take these items off your balance sheet and directly boost EBITDA. For example, in today’s post-COVID-19 environment, do you still need to be paying rent for office space? Similarly, if you own cultivation or manufacturing property, it may be beneficial to engage in a sale/lease-back agreement that takes the property off your balance sheet for a more reasonable monthly rent cost.
Tangible and Intangible Cannabis Assets vs Current and Future Value
In the first part of this article we’ve discussed ways to increase EBITDA. There is also another angle here worth discussing, which is increasing your EBITDA multiple.
In the simplest terms, when a buyer seeks to acquire a cannabis business they are purchasing two things: tangible and intangible assets. In a broad sense, this can also be seen as current and future value.
Tangible assets include everything with physical, easily verifiable value, like real estate/property, facilities, equipment, cash, etc. Intangible assets are much trickier to assess, but may also encompass far greater potential than most tangible assets. Examples of intangible assets include accounts receivable, intellectual property, brand allegiance, etc.
When establishing the value of your cannabis operation it is essential to understand and expand on its potential long-term, or future value. In many circumstances intangible assets are of greater long-term value than tangible assets because tangible assets can be used up more quickly. For example, the patent for a new cultivation technology, or top-selling edibles brand with proven market potential, can generate increasing levels of revenue for years to come. Whereas the flower grown with that technology, or the physical edibles themselves, have a necessarily limited shelf life and limited long-term value.
There are a lot of potential ways to improve your cannabis multiple through intangible value. A good example is developing a “franchise” approach to your organization. This include:
- Well documented Standard Operating Procedures:
- Cash management
- Inventory management
- Detailed marketing plan
- Including metrics about brand loyalty/value specific to your operation
- Documented intellectual property
- Propagation/harvest/trimming procedures
- Unique genetics/strains
- Hardware/software innovations
For example, if you are operating numerous retail chains, you can distinguish yourself from a competitor with a professional operation approach that includes:
- Budtender sales training SOPs
- Opening and Closing SOPs
- Cash handling SOPs
The dispensary chain with consistent training that reduces risk and allows for seamless transitions between locations has significantly more value than an unorganized competitor.
Ease the Transaction to Secure a Healthy Multiple
The final consideration for securing an exit is the many ways you can put your best foot forward and demonstrate good faith to your buyer. When a buyer reaches out to you with an initial inquiry, it is safe to assume that they are also in discussion with several other potential targets within your market. If, let’s say, you’re a successful cannabis cultivator in your region, the buyer has probably reached out to all the other cultivators in your market with similar operational and financial details.
A serious buyer will ultimately engage in the due diligence process where they will conduct an extensive assessment of your operation to validate all physical assets. This is a multi-day process where their team will review all financial documentation and be on-site to perform inventory counts and see operational details themselves.
It is best to prepare for this level of scrutiny well in advance of a buyer’s inquiry. If the buyer reaches out to your three biggest competitors, and they deliver the information to the buyer in five days, but it takes you several weeks to provide that same information, which will the buyer be more willing to pay for?
With this in mind, it is worth the effort to establish proper accounting and financial reporting systems. Not only will you receive up-to-date financial information that will greatly help you improve both revenue and EBITDA, but you’ll also convey “good faith” professionalism if a buyer inquires.
Valuations and the due diligence that support cannabis transactions are essential aspects of any M&A deal and need to be performed by genuine cannabis industry experts. If you’re considering buying or selling a cannabis business, our team of cannabis accountants and advisors can help you maximize the value of any deal. Just reach out to us for a consultation to get started.