Valuing a cannabis-related business is not much different from valuing any other business, except for one important fact: This business is based on a product that is illegal to grow or sell under current federal law. So how do you deal with this challenge in states that have legalized it?
Valuation practitioners Jim Marty and Ron Seigneur both practice in Colorado, one of the first states to legalize adult recreational cannabis. As authors of the special report What It’s Worth: Value and Business Challenges in the Budding Cannabis Industry, they share some of their vast knowledge on the most frequently asked questions when valuing a business in this growing industry. Download the complete article to see additional details on each of these questions, plus more FAQs.
How do I approach the cash flow analysis?
When valuing a cannabis business, you can often approach the cash flow analysis with the same formula used in many other valuations: Present value of any asset is equal to the cash flow divided by the risk less growth, as shown in Exhibit 1. The critical issue in this industry, though, is the lack of reliable historical cash flow information, which requires the application of a discounted cash flow analysis based on projected performance.
How do I vet forecasts?
When assessing a forecast in the cultivation sector, for example, make sure you tour the warehouse and the garden; ask what kind of crop the cannabis growers are expecting to have in the next six months and what their annual capacity is. Get a firm understanding of the expertise involved in the grow and how much tenure these individuals have.
An important factor to consider is the number of plants in the ground. There will be three cannabis harvests or more a year because cannabis growers plant in phases. This “perpetual garden” practice ensures plants can be harvested and dried weekly. In addition, various parts of the plant can be sold—not just the desirable flowers that dry into what are called the buds. The leaves can be harvested and sold to the infused products manufacturers. Ask what the lines of revenue are and about the cannabis growers’ expansion plans.
How do I go about tax affecting the cash flow?
Generally, when tax affecting the cash flow, you want to apply a fairly high marginal rate by taxing the gross profit. If the business has not been handling IRC §280E, regarding the deductibility of business expenses, in compliance with how the IRS would like to see it, you may need to book an unrecorded liability for potential IRS audits. If the dispensary has had IRS audits, ask whether they have been resolved. Remember many dispensaries have only been in operation for a short period, so check for the possible liability of IRS audits. How is §280E handled? If the dispensaries have been ignoring §280E, consider making a valuation adjustment to record potential IRS tax assessments.
What are the risk factors of valuing cannabis businesses?
When considering risk in a cannabis business, never forget that the federal government considers selling cannabis illegal. You need to understand the Department of Justice (DOJ) memos and the IRS chief counsel’s memo and consider how they affect your risk.
These memos certainly appear to reduce risk; the DOJ is saying,
“If the dispensary owner stays compliant, you are actually doing what we want you to do.”
In fact, the Cole memo basically quotes the Colorado regulatory system, and the guidance it provides is being practiced in Colorado. Nevertheless, even if your clients are playing by the rules, the DOJ is watching. If they break any of the rules—if the cannabis is consumed or grown on public lands, if it gets into the hands of kids, if it crosses state lines—then there is an issue. You have to know your client. You want to make sure your client is ethical and not coloring outside the lines because you don’t want to be involved in that.
The cannabis industry is still young and continually evolving. Ensure you’re in the know on this ever changing industry—download the complete article with more FAQs and in-depth details.
Plus, check out BVR’s resources on the topic of valuing cannabis businesses, including the special report What It’s Worth: Value and Business Challenges in the Budding Cannabis Industry and our newest offering, The Cannabis Industry Accounting and Appraisal Guide.