Alternative Approaches to Valuing Cannabis Businesses Stacey D. Udell


As of September 30, 2020, cannabis has been legalized for medical applications in 33 states and for adult use in 11 states and the District of Columbia. United States cannabis sales are estimated to reach $11-$13 billion this year and expected to exceed $28 billion by 2023 according to the Marijuana Business Factbook1. Federal legalization would expand the recreational cannabis market exponentially, with potential annual revenues estimated at $50-$60 billion, compared to the $72.2 billion domestic wine market, the $46 billion pizza market, and the $37 billion beer market2.

The fundamentals used to value a cannabis-related business are no different than those in other appraisal assignments, including the valuation date; standard of value; premise of value; and methods and approaches of valuation. But there are distinct differences in how those fundamentals are applied in valuating cannabis businesses.

Asset-Based Approach
Many enterprises in the cannabis sector are so new they have limited, if any, operating history. Similar to any other start-up or development-stage business, a close study of costs associated with the specific business model can provide a foundational reference point compared to other valuation approaches and methods. The Adjusted Net Assets Method is based upon the value of a company’s assets, net of its liabilities. Adjustments to the balance sheet are made to mark the assets and liabilities to market value, as well as to reflect the value of any off-balance sheet items.

Market Approach
The Comparable Transactions Method is based on prices paid in sales of private companies in the same or similar industries, as reported by investment bankers or business brokers. Multiples of revenue, EBITDA, EBIT, earnings, cash flow, etc., can be computed and applied to the subject company to determine the value of that business.

The Guideline Public Company Method uses market multiples of comparable publicly traded companies. The value multiples are ratios derived by dividing the guideline company’s market capitalization or enterprise value (“EV“) by various measures, including revenue, net income, EBIT, and/or EBITDA. The public company multiples are typically adjusted to compensate for differences between them and the subject company based on performance metrics and the operational and risk profile.

Empirical market data in the cannabis space is anecdotal at best. Even with the limited data that can be found, it is subject to limitations due to jurisdictional differences. In addition, given the rapid changes occurring within the sector, market-based transactions become obsolete very quickly as compared to other more stable industries.

Income Approach
Valuations using the income approach are based on the theory that an investment in a business is worth the present value of the future benefits it will produce for its investors. The future benefits are discounted back to present value at a rate of return reflecting the investment risks—that is, the degree of uncertainty associated with realizing those returns on investment.

The Capitalized Cash Flow Method is considered when a company generates a reasonably stable return that can be assumed to grow at a constant rate into the future, or alternatively, when historical performance has been somewhat volatile and this volatility is anticipated in the future as well. Currently, this is not applicable to the cannabis industry.

The Discounted Cash Flow Method is used when future operations are expected to be volatile or different than the past. This method involves the use of discrete period projections until operations are assumed to stabilize (in the terminal year). The present value of these amounts is added to the terminal value. The terminal value represents future cash flow in the terminal year reduced to a single amount assumed to grow at a sustainable rate into perpetuity.

Well-reasoned, detailed financial projections are key to the valuation of an enterprise operating within the cannabis sector. The application of a Discounted Cash flow Method using an appropriate risk-adjusted discount rate often becomes the cornerstone of the valuation process.

When getting a valuation in the cannabis industry, it is crucial owners and management find professionals with experience in the industry. HBK Cannabis Solutions is a dedicated team of cannabis industry subject matter experts within HBK CPAs & Consultants, an Accounting Today Top 100 CPA firm. We were among the first accounting firms to specialize in the cannabis industry and have worked beside entrepreneurs in all industry segments—cultivators, processors, retailers—from single facility to multi-location and integrated operations. We counsel owners, management and investors in multiples states and countries, helping them with key financial activities: from planning start-ups to connecting operators with investment bankers to facilitating M&A; from pre-offering projections, state applications and licensing to management planning and operations.

1 – Marijuana Business Daily Factbook 2019 (February 2020 update)

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