There are a number of reasons why a cannabusiness owner or investor might seek a business valuation. A valuation is essential for getting an accurate assessment of your business for financial reporting, estate planning, M&A transactions, and more. We sat down with Cannabis Advisory Services (CAS) Director, Jennifer Cohen (JC), to get her thoughts on reasons to consider a valuation.

CAS: When should a cannabis business owner or investor consider a valuation, and what events can trigger it?

JC: As the cannabis industry continues to evolve, business owners and investors will need to understand the value of their companies. Third party appraisals help to provide information in this complicated industry in the form of an independent assessment. Valuations may be required in selling a business, completing an acquisition, seeking financing, or raising capital. Valuations are also used for tax planning and compliance purposes such as when an owner in a cannabis business passes away or is interested in gifting an interest in the business to someone else.

CAS: Does a business need to be operational for it to seek a valuation?

JC: No. Just like any other business, a cannabis business can be valued at any stage including pre-license, post-license but pre-revenue, early stage, and operational.

CAS: What are the challenges of valuing a cannabis business?

JC: All business valuations can be challenging regardless of the industry. However, as the cannabis industry is still maturing, its rapidly changing regulatory environment can make it difficult to forecast the future and assess risk. Appraisers must be aware of current regulations, especially as it relates to IRS code 280E, when valuing a cannabis business.

In addition, the lack of market data in the industry makes it difficult to use the market approach when valuing a cannabis operation. Because the industry is relatively young, there are a limited number of comparable companies and transactions to calculate market multiples. Although publicly traded companies do exist in the Canadian marketplace, it can be difficult to make comparisons to startup companies in the U.S. due to differing regulatory conditions. However, these companies can provide a basis for starting an analysis as cash flow projections are very important to the valuation of a cannabis business. In addition, the growing trend of cannabis companies getting listed in the U.S. in over the counter (OTC) exchanges such as OTCQX, OTCQB, and Pink should provide additional market data over time. Regardless of the market information available, challenges may arise when valuing a start-up operation and appraisers must be able to assess the reasonableness of a client’s projections.

CAS: What factors should be considered when forecasting future cash flows in this industry?

JC: In general, three types of information should be considered when forecasting future cash flows in the cannabis industry. The first is historical financial information, if available. This includes historical financial statements and tax returns. Appraisers will analyze this historical information for trends where possible. However, for early stage companies in this industry, growth rates will likely be high in the first few years of projections. The second consideration is non-financial information which includes the background and history of the business, business risks, key customers and suppliers, competitors, facilities, management expertise, ownership, the depth of products and services, and future strategic initiatives. The third consideration are external factors such as the regulatory environment, socio-economic conditions, consumer demand, and access to funding among other factors unique to the business.

For more information on the valuation of your cannabis business, please contact Jennifer Cohen at Citrin Cooperman’s Cannabis Advisory Services team is here to help you focus on what counts.