Business owners seek business valuations for a variety of reasons
Article By: Eli Neal, CPA, ABV
Why perform a business valuation?
Business owners seek business valuations for a variety of reasons:
- To settle shareholder disputes
- As part of breach of contract damages litigation
- To assess the value of their business before sale
- To raise additional capital or bring in additional shareholders
- To execute buy-sell agreements with existing shareholders
- To settle marital dissolution
- To comply with estate & gift tax requirements
When will we start to see cannabis business valuations performed?
These events typically happen during the middle-to-end of a business life cycle. In Oregon, recreational cannabis has been legal since October 1, 2015. In the two and a half years since, cannabis businesses have formed, competed for market share, and experienced major shifts in the price of cannabis. The formation of new businesses has slowed and many businesses have entered the middle-to-end of their cycle.
There will always be winners and losers in a new industry, but the dramatic decline in wholesale price will cause many businesses to reassess their lot sooner than expected. Business owners initially planned for wholesale prices above $2,500 per pound, however, they are now competing for half that. Cannabis businesses, without sufficient capital resources and/or management ability to adjust, will collapse or be acquired by enterprises that have adapted.
All of this is to say that the need for cannabis business valuations in Oregon (along with Colorado and Washington) is right around the corner. Business owners need to know the value of their business to make informed decisions about what to do next.
How to perform a cannabis business valuation?
It’s important to realize that the underlying concepts supporting a cannabis business valuation are the same as valuing any business.
Three major valuation approaches are generally accepted by the valuation community to value a business at fair market value:
- Adjusted Net Asset Approach
- Market Approach
- Income Approach
The Adjusted Net Asset Approach is a valuation methodology that estimates the fair market value of a company by subtracting total liabilities from the total assets of the entity, after adjusting the balance sheet to fair market value. This form of value will generally not capture the value of any intangible assets created by the business, such as goodwill.
The Market Approach is a valuation methodology premised on the theory that a business can be valued by comparing the subject company to market transactions. Using publicly traded stocks or reported transactions from the market, the valuation expert will apply an observed multiple to an earnings stream. Unfortunately, public transaction data for cannabis companies is limited at the moment, which makes this approach difficult.
Finally, the Income Approach is premised upon the concept that the value of an asset is equal to the present value of expected future benefits realized through ownership of that asset. The income approach considers a company’s future cash flow stream and applies a discount rate based on the anticipated risk and growth opportunity to arrive at an indicated value of the company.
Regardless of the industry – cannabis included – the principles of a business valuation will not change. Rather, it is the key inputs for these approaches that will be affected by the cannabis industry.
For more information on the specific factors that affect each valuation approach, see our blog where we’ve discussed each approach in detail.