Cannabis Knowledge & Insights

Valuations for Cannabis Retail and Growing Companies

On October 17th, Marko Glisic discussed his first-hand knowledge on how to develop a thoughtful valuation of cannabis retail companies and cannabis growing operations.

If you want specific help with your cannabis business, you can contact us to get started.

You can watch the full webinar here:

You can also listen to the full audio here:

You can download the slides here.



Full Webinar Transcript:

Hey everybody, Marko Glisic with Green Growth CPAs, and we’re back with the valuation of cannabis businesses part two. And before we get started, I just want to let you guys know the information contained in this webinar presentation is meant for guidance purposes only and not as professional, legal or tax advice. Further, it does not give personalized legal tax investment or any business advice in general, and now that we have that out of the way, let’s get started.

The agenda for today is we’re going to go over the last week’s webinar. We’re going to go a little bit more into retail business such as dispensers, deliveries, cultivation, a couple of notes when acquiring some of these businesses, and then we’ll wrap it up.

As far as about Green Growth CPAs. So we started off as a tax preparation firm. We’ve completed over 500 tax returns for all verticals. So the dispensaries, distribution, cultivation, manufacturing, delivery, and testing. We have over 300 clients based in California, Colorado, Michigan, Oregon, and Washington. We’ve performed over a dozen audit related projects in the last year. We expect to hit seven digits in revenues in our second full business year. And just in general, we bring a deep bench. We have a thorough and deep understanding of tax compliance assurance, valuation related work for the cannabis industry. Cannabis is, are our bread and butter, and that’s all we do.

To recap the last Webinar, so we really covered the three common ways to value a company or a group of assets, right? So we said number one, discounted cash flows or also known as DCF, guideline public company method, and the guideline transaction method. And again, from our experience, really the best, best method to understand the value of a cannabis company is a DCF.

We also covered what investors should look for in a cannabis company. So we said, number one, it’s not a leveraged business, right? It doesn’t have a lot of debt that’s going to just drag the operations and cash flows. The worst thing is when each month, or each quarter, each year, you got to take x amount out of your cash flows to pay the lenders ride. Number two, if it’s a mature business, the better it is, right? It’s going to give it a lot more stability, a lot more history, and you can trust management more. Number three, it has a well-developed sales distribution and procurement channels. Number four, it has a clear history of financial reporting rights on a monthly basis. Investors and management are getting those financial reports. They give them an insight into the company and the way it’s operating. And number five, it really has a strong system, internal control, so you can really rely on those numbers, right? Cash reconciliations or inventory counts are done. Balance sheets rec’s are done, all expenses are being approved. There are strong controls on money coming in. Also, another item we covered, that again, I want to really, really underline because they think it’s really, really important is kind of the two factors to really drive this kind of cash flows of the DCF model is projections or cash flows, and number two is the risk. So we said the higher the projections are, the better the cash flows are, the better the value of a business. So what I want to do is I want to jump into a DCF model we have here put together.

So as you can see there’s, there’s about five years here worth of information, of projections, and then we have a terminal period. In the top of the model where we have are the projections. Kind of all the inputs that are really driving the cash flows. And what we have in the bottom is just kind more the valuations assumptions, individuation calculations, to really get that value. So again, everything on the top highlighted blue business assumptions and projections. Everything down in the pink is more of assumptions and calculations.

If we start at the top, really what we see is we have our revenues from revenues, we got our EBITDA from our EBITDA, then we have change in net working capital, we have capital expenditures, and then we have depreciation amortization. In all these items, adding, subtracting these items is how you get your net cash flows at the end. Really what those net cash flows are is really the net money that ends up coming into the business. At the end of the year, so I think what we see here is $109,000 in year one, $143,000 in year two, $217,000 in year three and etc.

And so the way that things work out is if I ended up increasing the cash flows in year one from $109,000, let’s say $209,000, the fair value would go up. So as you can see, really, really important part of valuing a company is really just understanding those projections and what’s driving them. And kind of what’s interesting when you look at valuation assumptions and calculations, there are some differences as you go from one vertical to the next one, but the really the biggest differences you see is really with those business assumptions. With projections, the way you’re looking at projections for a retail operation versus cultivation operation is going to be a lot different. Because you’re looking at two different types of businesses and there are different key metrics driving those projections. So without further Ado, let’s jump into retail projections.

So what I have here is just again at a very high level, an aggregated level of projections for a cannabis retail operation. Can be a dispensary or delivery, right? So with projections, you always kinda want to start at the top, building up the top line, the revenues, because when you’re looking at a retail operation, the two things that are driving it is number one, we have the number of transactions and two is the average spend per transaction.

So average spend is whenever a transaction gets rung up on a register. Whenever a customer comes in and spends money, how much does a customer spend on average? Is it $30, is it $40, is it $50, is it $60? And then the higher that number is, the better the projections are going to be, the better the top line revenues are going to be.

And that’s going to drive higher cash flows. And same with the number of transactions. The higher the number of transactions each day, each month, each year, the higher revenues are going to be and the higher the cash flows are going to be ones that revenue numbers built up. Really then what we have is the cost of goods sold, so really what the dispensary or delivery service pays for the product and it ends up turning around and selling. Kind of the way the dispensary and delivery owners are thinking through this is they’ll buy a cannabis product from a wholesaler, and they’re going to apply retail markup to it. They’ll see, okay, well I spent this much for this cannabis product and now let me put a retail markup of two times, 1.5 times, two times, three times to get to my retail prices.

And so when you’re really looking at the cost of goods sold, you want to work backward and you’re starting off from the revenues and then you’re applying that retail markup to get to the wholesale cost. Which again, really what it is, is cost a good sold. And again, that retail markup is just going to depend on a lot of things. The product mix of flower versus concentrates versus edibles versus topicals. Again, is going to depend on the type of cannabis brands that are being presented. Are these kind of more top-shelf brands or are they just kind of more regular brands, or cost-effective brands. So there’s going to be a lot of things that go into developing that retail markup number, but again, the higher that retail markup number is the better the projections are going to be. Because what ends up happening is that you’re going to have a better gross margin and then from there, the cash flow is going to be better too. Now once the gross margin is set up, then really what you have is just more kind of you’re selling marketing and overhead type of expenses.

So if we start off with marketing, this is a variable cost. You really want to understand what the relation of that cost to the revenues, to the number of transactions, which really what does it cost this dispensary or delivery to acquire one customer? Is that $2? Is that $5 and kind of what’s their method of acquiring that customer? Is it more social media…things like Instagram, Facebook, is it print, is it Public Relations, or is it more merchandise? Is it Weedmaps? Again, every dispensary and a delivery should be keeping track of this because otherwise, you don’t really know what’s your ROI on marketing. And then once you understand the relationship between the marketing costs and revenues, you can also then understand as the business scales, how do those variable costs, marketing costs, relates to revenues. And really what it should be, revenues are now instead of $3 million, they’re $6 million, does it make sense based on that marketing spend and then as you look within, you really want to reconcile that marketing budget back to the number of transactions.

And then within the number of transactions, you really want to understand what’s the customer model look like? Are these recurring customers or are these new customers? Again, a business that has a lot of recurring customers is going to be a better business than the one that doesn’t have them because this proves that the customers that are coming in are having a great retail experience where they just kind of keep coming back. And so then generally what you can see, and again it really depends on the way the businesses tackle their marketing, how much they want to scale. But for a business that has achieved a certain level of scale, they’re comfortable with it. You can then see that marketing spend going down because what ends up happening that the returning customers keep going up and it’s able to sufficiently generate the cash sales and revenues with less of a marketing spend.

And on the other hand, you might have a business that keeps putting money in because the machine is working. They have a great number of recurring customers. They’re just keep coming back and they know as long as they pour money into the machine, you’re going to keep growing.

From here we’ve pretty much covered all the variable costs, so we’ll look at the product variable cost and two is marketing. What we have now is just the more fixed type of costs, so payroll, accounting, software security, things like that. And really the key with this fixed cost, there’s two-fold. One is the completeness of the costs, do the cash flows, capture all the costs. And I can’t tell you how many times I’ve looked at projections where those costs don’t include everything. There’s always something missing. So whenever you’re looking at pro formas, at cash flows, at projections of a prospective business that you’re looking to acquire, always ask for a lot of detail.

If they give you something like other expenses kind of these aggregated numbers, always ask for that detail because there’s a big, big chance that some of these costs are not included in there. And then the second piece is the accuracy of those costs. A lot of businesses will get overly optimistic with the numbers they’re reporting there. And now that we have a general understanding of all the key assumptions driving the cashflows and again when you look at the performance, it really depends on the way they were built, but for the most part, this is the type of information that should be captured in there. Now that we have the pro formas and they show what the cash flows are going to be for year one, year two, year four, year five. Now let’s, let’s try to get some comfort around them.

Let’s try to understand, really do those numbers make sense? And so what we want to do is we want to see if the business has some history of doing business and what the actual numbers are. Then what you can do is you can take those projections and reconcile them back to the actual numbers.

So for example, if an average spend in the past has been $30 and now the projections are showing $60, every time a customer comes in, in the future, the business is expecting they’re going to spend $60 on average. Whereas for the past three years cannabis customer really just spent $30. That’s a big gap that needs to be explained, right? What is it behind that? Are there some sales strategies or some marketing strategy? Same with the average number of transactions. Again, if the average number of transactions in the past have grown at a factor of 10 percent and now we’re looking at them growing at 50 percent. There’s a gap there that needs to be explained.

So the question now is how do you kind of get a better sense of this actuals. How do you in a sense do due diligence over them? And so a big, big source of information is going to be a point of sale system in cannabis businesses. In the cannabis industry, just by the virtue of being very regulated, the point of sales systems are very robust and they capture a lot of good information. So from a good point of sale system, you’ll be able to capture average transaction amount which is the average spent, the average number of transactions per month. You’ll be able to see the returning versus new customers. You’ll be able to see the markups. So just through the point of sale system and really doing extensive due diligence through it, you’ll be able to get really good comfort over the revenues and costs of goods sold.

And then really what you’re left with is more below gross margin type of items. So as we’re saying marketing, rent, utilities, payroll, and all that information should be captured in a company’s accounting software. What are they using? Quickbooks or they’re using zero. And again, behind, you know, let’s say if we’re looking at rent, there should be a lease agreement behind. And if we’re looking at payroll, they should be payroll runs and payroll data that are captured in the payroll software ride, whether it’s Gusto, ADP, or some other provider. Again, security, they’re going to be invoices behind it. So again, a really good practice is to go through those, make sure that those fixed monthly costs are accurate, they’re not under reported. Also, another item that the can cover by looking at the books is the completeness of expenses. Is there something that’s showing up in books as a recurring cost where you see it every single month, but it’s not in a projection, and if it’s not in projections, again, it’s a big gap. What was their explanation?

That pretty much wraps up the retail cannabis part of the presentation and we’ll jump into cultivation. So again, we cultivation is, as I was saying, the assumptions are going to be a little bit different. With the retail and cultivation, they are fundamentally two different types of businesses. One is business to consumer, direct to retail. The other one is more business to business. So the metrics and the cost structures for cultivation business are going to be a lot different. What we have here is more of a high-level summary of assumptions that go into cannabis cultivation operation. So usually you start off with the square footage. And the square footage, a big note here is that when you’re looking at the square footage, don’t just look the square footage of entire facility because it’s going to include a lot of other things that are not necessarily directly related to the yields and the harvests.

So for example, square footage used for packaging, for parking, for drying, these are the items that won’t really have any impact on the yields. So really what you want to look at is the square footage of cannabis canopy over the flowering space. And you can see in this example we’re using 10,000. Then you want to look at the yield. It can be expressed in a lot of different ways. One way we tend to look at it the most is grams per square foot. So this is kinda per square foot of canopy space. How many grams are being yielded at each harvest? In this case, we have 35, but the number can really vary. You know, you can go even up to 60 grams per square foot and so that’s really how we kind of get grams yielded per one harvest and then you’re going to apply the number of harvests.

And again, that can vary. It can be four, it can be five, maybe it’s less and that’s how we get total grams harvested and total pounds harvested. And from there you’re applying the price per pound to really get to your top line, to your revenues. Once we have our revenues, then really where we’re going, then more down towards the costs of goods sold and other expenses. Cost of goods sold is going to be composed of multiple types of items. So you’re gonna have your packaging, your growing supplies, your labor. It’s going to be both. Trimming labor is going to be just the growing labor, right? The master grower, assistant growers. Then there’s going to be a lot of utilities involved, so electricity, water, et cetera. And a lot of these costs are variable. And so it’s very, very important to understand the relationship of those costs back to the pounds produced and depending on what type of grow it is, right? Are we talking about the indoor grow? Is this a greenhouse or is this an outdoor grow is going to differ a lot, but a good way to kind of value the cost of goods sold number in totality is to look at the cost per pound.

So once all of those costs of goods sold are accounted for, what does that cost per pound come to? Is it $300 per pound? Is it $400, $600, $700. And again, generally, what tends to see indoor grows, have a higher cost per pound because it does take a lot of a lot of electricity to run that type preparation and then comes the greenhouse. And then from there, really the kind of the most cost-effective way of growing is really outdoor grow because you are relying on natural elements to support your grow.

And so we, if we kind of look at the different costs of grows and cost per pound, generally what I see is the indoor grows are, are the ones that are most expensive and that’s because you have a lot of additional costs like electricity can cost quite a bit, just the build-out of the facility, to depreciation amortization on that.

Then from there we kind of move more to the mixed grow, with greenhouse or we have some benefits of natural elements and an outdoor, but you also still have to spend some money that is related to indoor and they’re really kind of the most effective one that you see is the outdoor grow really where you’re, you’re relying to most unnatural elements to grow the plants. You’re still going to have some spend to grow at labor and nutrients and soil and etc. Once we kind of have now the revenues and costs of goods sold, flushed out really then what you have is operating expenses. And again, this is gonna be your selling marketing overhead and again, you’re selling and marketing for cultivation operation. They’re probably not going to be that significant in general. A lot of the cost for growing operation do pertain to cost a good sold.

And so again, it’s really just a matter of understanding these costs whether they’re completely accounted for and whether they’re accurately accounted for. And there are two ways to go about that. You really have to look at the company’s books, said there are zero, QuickBooks and a lot of information should be captured in there. So, you know, if they’re showing 3 million in revenues, we should be able to go back and pull up invoices and cash receipts support to vouch that if they’re showing this cost per pound, right, we should be able to understand, how much was spent on labor. What did the payroll records show for labor, how much was spent on rent, whether the copies of leases and payment support for rent? So again it’s very important to vouch for all this information. If there are showing the yield is 60 grams per square foot, but in the past, they’ve only gotten 20 grams, that’s a big gap that needs to be explained. We got to figure out how they’re bridging the gap.

And you might come across some business opportunities. You’ve done your due diligence. Some of these metrics look terrible. It looks like this business has a lot of weaknesses versus strengths. That might not be a bad indicator because now you can bring in and bring your skillset and your perspectives and turned this thing around. You may come in, get a good deal in this business and then turn it around and scale it up. So then we’ll be like some situations. So let’s say for the retail operation, that average spend per transaction is pretty terrible. The big question is have their budtenders had proper sales training. When a customer comes in, does the budtender really understand what they’re looking for and is it able to bring them to the product categories that would elicit that higher spend per transaction.

Number two, what’s the number of transactions is low or do they have a good social media presence? Are they running daily deals? Do they have any discounts for? Do the have loyalty programs. With a loyalty program, if you get a recurring customer that comes there twice a month every month now for just spending very little money in terms of marketing to bring that person through the door, that’s going to be a stream of cash flows. This is going to support your business for next months or years. So there’s a lot of different ways that when you walk into a business or you can look at to improve the metrics and bring up those cash flows which down the road that are going to increase the valuation when you’re looking to sell the business. Same thing for cultivation operations.

You know you might look at some of these metrics and the yields look terrible. They’re yielding 10, 15 grams per square foot, but then they have a great facility. It’s very sizable. The location is amazing. It’s nestled right where you want it to be, where you can easily distribute the product. The shippers can come and pick it up. Well, then it’s really just a matter of bringing the yield up. And that can be done in different ways. Are the nutrients appropriate? Should a master grower be different? I mean, I’ve had clients where they’ve brought in a different master grower in and their yields have doubled. And it can be a lot of different things, maybe the growing methodology doesn’t make sense anymore. People have been using it for 20, 30 years and it’s antiquated, but there’s so much more our new stuff that can be really used to improve the yields.

So this wraps up how to look at these two types of businesses. But let me just tie it all for you with key takeaways. So again, we said number one is you got to understand the key assumptions driving this business, whether it’s for retail, we’re saying average spend per transaction, a number of transactions or whatever for cultivation, the yields, the grams per square foot. Number two is always making sure you do proper due diligence around those. Actually look at the point of sale system, look at the payroll systems, look at their books, look at the contracts, look at the invoices, and again, some of this stuff can get pretty complicated and overwhelming, so make sure you can’t get in touch with a with an expert team that can come in and has a deep understanding of both finance, accounting, and cannabis industry and can come in and help you with this.

Number three is again, there’s a lot of opportunities out there. Some of these deals, you come across my look like terrible deals with companies may look like they’re terribly run, but that’s where often you’ll see the biggest gems. There’s a good opportunity for a turnaround by bringing your skill set, whether it’s bumping up the sales bump, bumping up those marketing numbers, getting better yields. And again, a big takeaway is always to make sure that the business you’re looking into is compliant on, on all the levels, right? Whether it’s taxes: Federal state payroll taxes, excise tax cultivation, tax, sales tax, and also do they have the proper licensing. What I mean you might, you might be walking into a total mass for business, might look great. The projections are great. Everything is great, but the basics are in there. Then you’ll be in a position when you’re being chased down by, by the IRS and the federal agencies and state agencies over regulatory stuff.

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