For many marijuana business owners, return on investment is based more on its exit value than on its net profits. This is particularly true for minorityshareholders not involved in the business’s day to day operations; their goal is to build up the business as much as possible so as to maximize its sale value. Think of this as the private equity model of investing.
But with little real market data on marijuana business valuations, valuing a marijuana business is at least somewhat speculative. Whether you are looking to buy or sell a marijuana business (or maybe just get a better sense for the value of the business you already have and want to keep), this post should teach you a thing or two about how valuation operates.
There are several different common methods for valuing businesses, but the easiest ones for back of the envelope calculations are an asset-based valuation or an earnings-multiplier valuation. A business that’s been operating for a few years has brand recognition, customer lists, trained employees, custom facilities, goodwill with the public, and many other assets that can have high dollar figures attached to them and are relatively easy to value. In valuing a cannabis business, do not forget that in states with a limited number of marijuana licenses, the license itself has its own inherent value. Just by way of an example of this, in Washington state, there have been deals valuing retail marijuana licenses between $250,000 and $1 million in transactions that took place before any licenses were even formally issued and before even one day of business was done.
Asset-based valuation, however, is limited as it does not do a good job accounting for a business’s earnings potential; for ongoing and profitable businesses, the earnings multiplier method is usually more useful. Using this method, a base multiplier — generally three to ten times the business’s annual net revenue — is used to determine a final business valuation. For example, a retail store with $200,000 in net revenue per year would yield a $1 million valuation using a multiplier of five. When using this method, the tricky point is deciding on the multiplier. Generally, the multiplier reflects business risk and industry standards. In the marijuana industry, where no real standards have been set yet, the early market will determine where that final multiplier rests. Federal legal issues remain a key risk factor, but lack of information on statewide customer demand also leads to uncertainty, and both of these risks tend to reduce the multiplier.
So, how does one increase the potential valuation of a business before a sale? If you are looking either to sell your cannabis business or merely to increase its valuation now for an eventual sale, here are a few key points that will help you maximize your sales price, based mostly on what we have seen so far in the sales on which we have been involved as cannabis business attorneys:
- Buyers of cannabis businesses typically want to see a track record of profitability, and they also want to see that the business has good potential to expand future earnings. It is important for the seller to be able to show that its marijuana business has been set up with the necessary infrastructure to allow for its future growth and to be able to show that it will not be bogged down with unnecessary costs. This includes being able to show that the business is complying with applicable state and local laws and will be able to sail through any due diligence review with flying colors.
- Buyers of cannabis businesses want to know that the selling company has locked down its trademarks. A strong and protected brand brand can add immense value to a company.
- Buyers are generally not interested in taking on existing debt as part of their purchase of a cannabis business, so try to avoid it.
- Buyers want a cannabis business with a good (preferably long-term) lease and short term sales contracts. Make sure any bad lease or bad sales contracts are short-term, and lock in sweetheart arrangements for the long term to benefit the buyer later down the road.
- Seller financing of the final price plays a key role and marijuana business sellers who are willing to accept payment of something other than an up-front lump sum check are likely getting higher valuations.
If you’re a buyer looking to purchase a marijuana business, you not only need to perform your due diligence regarding the marijuana business’s future prospect by 1) checking up on all financing sources, 2) reviewing the criminal background history of the owners, 3) checking the business’s track record with the state licensing authority and its reputation in the marijuana industry, but you also should ensure that the transaction is lawful under state law. Many states restrict the buying and selling of a marijuana business and our cannabis lawyers have been approached to represent various parties in deals that simply cannot work because of state law limitations.
You also should never totally disregard that, if you purchase a marijuana business, you will be engaging in a federal crime and there’s obviously at least some risk, and the sale price should reflect that.
Business valuations are tricky in every industry, but because marijuana marketplaces are still just emerging and are still unregulated in certain states, such valuations are more challenging than others. However, we do expect real numbers will soon demonstrate the actual value of these businesses in Washington and Colorado, which will make valuation easier in all states with state-legal cannabis. Until then, as always, buyer beware and seller be savvy.