Market Approach for Cannabis Businesses (4 of 8)
Welcome to the fourth blog post in 4 Corners’ Cannabis Valuations in Washington State series! Throughout this eight-post series, we’ll be sharing information about the local cannabis industry and walking through the key concepts and challenges of a cannabis business valuation. Today, we’re going over the Market Approach in the context of cannabis businesses.
The Market Approach is a methodology premised on the theory that a business can be valued with reference to transactions involving comparable companies in an open and unrestricted market. The challenge in valuing a business using this approach, and particularly when valuing a small or unusual operating entity, is finding true market comparables. It is unlikely that any two businesses or ownership interests will be alike in all regards.
The two most commonly used variations of the Market Approach are the Guideline Public Company Method and the Guideline Acquisition Method.
Under the Guideline Public Company Method, the business valuation expert calculates the market value of equity using the current price per share and number of shares outstanding of public companies that are comparable to the valuation subject company. Then, a multiplier is calculated based on earnings, assets, cash flow, or, in some instances, revenue. Valuation experts should apply adjustments to the calculated multiples to account for differences between the subject company and guideline companies. These multiples can then be applied to the equivalent measures for the subject company to determine value.
Although cannabis is still federally illegal, there are publicly traded companies whose primary operations revolve around cannabis. The following were just a few of the publicly traded companies listed in New Cannabis Ventures’ Public Cannabis Company Revenue & Income Tracker for July 2021:
Curaleaf (CURLF) is a cannabis cultivator, processor, and dispensary operator (trades over-the-counter in the United States and under the symbol CURA on the Canadian Securities Exchange).
Verano Holdings (VRNOF) creates artisanal cannabis products and operates cultivation, processing, and retail facilities (trades over-the-counter in the United States and under the symbol VRNO on the Canadian Securities Exchange).
Trulieve (TCNNF) is a vertically integrated “seed-to-sale” operation with 85 stores in Florida, and additional stores in California, Massachusetts, and Connecticut (trades over-the-counter in the United States and under the symbol TRUL on the Canadian Securities Exchange).
The list goes on. That being said, I would be cautious using public cannabis companies within a business valuation of a smaller, Washington state cannabis company. First, a valuation expert needs to find a public company (or even better, multiple public companies) that is sufficiently comparable to the subject company.
Next, the Guideline Public Company Method relies on the theory of an open and unrestricted market that is perfectly competitive. With so much uncertainty around the cannabis industry, market reactions can (and are) all over the map and market prices have been incredibly volatile. A business valuation analyst could look for peaks in consumer confidence about cannabis to obtain a high value or drops in consumer confidence to obtain a low value. I would suggest being very careful when employing this method and clearly disclosing the rationale for the public companies selected and the market price used in a valuation report. Even then, at 4 Corners, I’d likely shy away from this valuation approach due to the volatility in the public market.
The other Market Approach, the Guideline Acquisition Method, relies on similar metrics to derive valuation multiples but relies on actual prices paid for businesses in recent transactions OR alternative data sources as opposed to market trading prices for shares of public companies.
At the time of this posting, transaction databases like DealStats and BizComps are just starting to be populated with reported cannabis transactions. The more transactions reported, the more data points to identify trends and conclusions.
When reviewing transaction databases, business valuation professionals need to carefully review the country and state of the target company and the acquirer. Many of the transactions in DealStats are from Canada and, of course, every state in the United States has a nuanced transaction market.
To further complicate matters for the Guideline Acquisition Method, the timing of the transactions matters more than in other industries. Since legalization, prices for cannabis businesses have fluctuated. A business valuation expert needs to sort through the impact of comparing their subject company to a company acquired during “The Big Bang” of the legal cannabis industry. It’s an unstable period and even if appropriate comparable acquisitions can be found, a valuation expert should think about whether any adjustments are necessary to account for industry fervor and possible strategic acquisitions that may not relate to their own subject company.
Due to the challenges of utilizing public company data and finalized transaction data, I’ve had success using alternative data sources for the Market Approach. I’ve used active cannabis business sale listings combined with interviews of local brokers, attorneys, and business owners to inform my valuations. The result is timely, local information from a variety of sources. Triers-of-fact have been persuaded that these data sources are reliable.
If you own or represent a cannabis business in Seattle, Bellevue, or elsewhere in the Pacific Northwest and need a business valuation or financial expert, call 4 Corners Financial Forensics at 425-998-7690 or schedule a video call here; we’ll listen to your situation and help you scope your project. We’d love to help you.
Stay tuned for the next blog post in this series, which will cover the Income Approach and discount rates in the context of valuing cannabis businesses.
You can find previous installments of the Cannabis Valuations in Washington State series at the links below: