Ever try valuing a business that is 100 percent illegal?
Specifically, one shrouded in irrational exuberance, lacking audited financial records and topping the U.S. attorney general’s hit list?
Because “plant touching” marijuana related businesses (MRBs) have only been operating between a decade in Colorado to as little as several months in 29 other states, few reliable business valuation benchmarks exist and most are jurisdictional-specific.
Four stages of a marijuana-related business
The Comprehensive Drug Abuse Prevention and Control Act of 1970 prohibits marijuana’s manufacture, distribution, dispensation and possession and lists it next to heroin as a Schedule I controlled substance having “a high potential for abuse” for which there’s “no currently accepted medical use in treatment,” 21 U.S.C. Sections 801, Et. Seq (1970). Those manufacturing, distributing, or dispensing marijuana, or touching it at some point along the supply chain (planting, cultivating, harvesting, processing/extracting, testing, packaging, disposing, transporting and dispensing), are deemed “plant-touching” MRBs.
Valuing the enterprise is critical to all four plant-touching MRB stages: formation; application; operation; and exit. Formation is where the enterprise comes together, chooses, documents and registers an entity structure (e.g., a limited liability company), and starts fundraising. While more established industries’ investors are content with a 20 to 25 percent return, due to the legalized marijuana industry’s profound uncertainty, federal, state and local regulatory oversight, and banking and security issues, MRB investors often seek a 40 to 50 percent return. MRBs best able to demonstrate their worth have the greatest chance of raising funds.
Application involves an MRB seeking a license from the state to grow, process or sell marijuana, which usually requires demonstrating “capital sufficiency,” 28 Pa. Code Ch. 114.29(a) (a grow processor applicant must demonstrate “at least $2 million in capital, $500,000 of which must be in cash or on deposit with a financial institution,”) Because Pennsylvania’s competitive process received approximately 900 applications for 38 licenses, each applicant’s likelihood of success hinges on its value proposition’s luster.
The longest stage, operation, encompasses licensed, plant-touching MRBs growing, processing and selling marijuana. Because a successful operation requires constantly increasing the “footprint” (i.e., more square footage, yield, plants grown and product sold), achieving greater efficiency, raising capital and bringing in—and paying off–investors, valuation is always at issue.
Exit is the “cash out” where the enterprise merges with, or is acquired by, another entity. Critical to the equity transfer is an agreed upon valuation by both the acquiring and acquired entities and their respective investors.
Liquid assets and cash flow
While all forms of valuation are subjective, like every other business, a plant-touching MRB’s worth can be best anchored by the value of its appraisable assets.
Liquid assets and cash flow are the easiest to value. How much cash does the MRB have in the bank and what other capitalization does it possess (investments, lines of credit, loans, etc.)?
If a grow or dispensary is operating, a leading valuation indicator is the MRB’s “cash flow analysis,” i.e., an examination of its cash inflows and outflows during a specific period beginning with a starting balance and generating an ending balance after accounting for all cash receipts and expenses paid during the period.
However, because most plant-touching MRBs are not particularly cash rich, well-funded, or capable of producing reliable historical cash flow information, liquidity is often lacking and any cash flow analysis will be based on projected performance rendering it more of an estimation than a valuation.
Real estate, licensing and intellectual property
Ownership of real estate and hard, transferable production assets is also used to value a plant-touching MRB.
For example, having the deed to, and equity in, real estate used to grow, process and sell marijuana both helps define and enhance an MRB’s value. Beyond commercial real estate’s sheer worth, any parcel that is built out, correctly zoned for, and capable of marijuana production and sales is distinctive, desirable and highly valued.
The adage “location, location, location” has a particular resonance for plant-touching MRB’s worth in light of factors including market served, urban-based grow versus larger, state-of-the-art technology containing rural facilities, and access to sufficient electricity, water and waste disposal. Similarly, dispensaries’ valuation is enhanced by factors including access, indoor loading area, adequate parking and visibility.
Another tangible asset is the value of the license based on the existing/estimated market. For example, Pennsylvania’s Medical Marijuana Act authorizes 25 grow/processor—and 50 dispensary—licenses to serve its 12.8 million residents. Because estimates indicate that if only 1 percent of its population obtains medical marijuana cards, Pennsylvania’s market will yield between $100 and $150 million annually, each licensee may be presumably valued as a proportional fraction of this sum.
Further, as they may be grandfathered into, or receive “most favored nations” status regarding, “adult use” licensure, medical marijuana licenses may have a secondary or dormant value in developing markets.
Intellectual property ranging from branding, to ownership of a proprietary strain, to innovative cultivation or extraction methodologies also may substantiate an MRB’s valuation. For example, some dispensaries lock up exclusivity to sell celebrity strains like Marley Natural (promoting itself as official Bob Marley cannabis brand) or Charlotte’s Web (reputed to being particularly successful in treating seizures).
Further, to define a distinctive brand or message designed to increases sales, many MRBs list celebrities and sports figures on their boards. Virtually every MRB is working on a valuation-boosting “secret sauce” ranging from a more efficient grow and extraction strategy to a more patient-friendly sales platform to trademarks, trade dress and graphics.
Operation and team specific factors
More subjective valuation tools include plant-touching MRB’s operation and team.
Factors weighed in assessing a grow operation include number of plants in the ground, ensuing six months of estimated crops and annual capacity. When determining a dispensary’s worth, items such as internal controls preventing license-stripping issues like employee diversion are closely examined.
Both the management and operational team can increase enterprise’s perceived worth. What is management’s history in this industry, relevant business experience and ownership/stake in the enterprise? What is management’s strategy for expanding revenue lines (selling less desirable plant parts to infused product manufacturers) or addressing falling price points (arising from increased capacity, advancing technology and competitive pressure).
On the operational side, because the lead cultivator is the team’s weightiest member, a thorough understanding of his expertise and growing history (including how many crop failures and why), lighting scheme and targeted plant sizes and varieties produced can significantly enhance valuation.