What is your company worth?
From looking for an investor or trying to be acquired by a company to looking at employee option plans or dealing with a partner that wants out of a venture, there are many reasons why a business valuation is essential.
At Cannabis Conference 2022, panelists in the session "What's Your Company Worth? How to Build a Business Valuation" discussed the importance of a business valuation and critical components that can increase or decrease your business's value.
Hubert Klein, a partner at Eisner Amper, an accounting firm, said that a valuation today could differ in a month, especially in the cannabis industry, where rules and regulations often change.
Outside of trying to raise capital for your business, Klein says there are many reasons a company would need a valuation.
"People that own these businesses also have other issues they have to deal with," Klein says. "If someone dies, you need a valuation for state purposes. If someone gets divorced, you need a valuation. … If shareholders don't get along or if people don't get together … there's a value to that business that is subject to distribution. Someone would have to come in and value it so that they could decide what would be fair regarding what the other side would get as a result of legal action."
He added there are many accepted approaches and methodologies used when creating a business valuation.
"There's an income approach, there's an asset approach and there's a market approach," he said. "Unfortunately, the market approach, because the space is so new, is a little more difficult than some of the other industries out there today."
Doug Hannah, co-founder and partner of Silverleaf Venture Partners, a cannabis investment firm, said there are many things he considers when looking to invest in a business, starting with where a company is in terms of its growth cycle and its total addressable market (TAM).
"Is this a total addressable market of $5 million? Or is it a total addressable market of $5 billion?" Hannah said. "That helps us come up with those valuations on what it is that we want to fairly price based on making the investment at this time.
"For instance, … for [someone] that has a 40-acre hemp farm in Colorado, the TAM on that is only so enormous. You can only grow so much hemp on that 40 acres versus if you are a tech company and the world is your oyster, where you can basically send your technology worldwide at a touch of a button; that total addressable market is going to be a lot larger."
Hannah and Klein said when valuing a business, they also consider the risk factors surrounding the industry. For instance, cannabis is still federally illegal and a Schedule I Controlled Substance under the Controlled Substances Act. Moreover, there's limited access to banking, and taxes remain high on cannabis under the IRS Tax Code 280E for Marijuana Businesses.
For example, the tax on your business could change your cash model and impact the return to a hypothetical investor, Klein said.
"Your traditional models of what you look at, there's additional risk," Klein said. "What's one of the biggest risks everyone in this room deals with? It's not federally accepted. … The MORE Act, the SAFE banking act—those are all things, when we are valuing a company, we have to take that into account because those are going to impact that cash flow and shrink it."
Hannah added that while the cannabis industry is exploding, these restrictions make it very difficult to value cannabis companies.
"This is a federally illegal industry, and last time I checked, the lowest federal law trumps the highest state law," Hannah said. "We still don't have normal banking or interstate commerce. … The cannabis industry is exploding, but it's all these other restrictions that make it so hard to value a company."
Outside of what a potential investor might look for when valuing a company, several factors can increase or decrease your business value. Here, Hannah, Klein, and Claudio Miranda, co-founder and CEO of Guild Enterprises, share vital components to consider that can help increase the value of your business.
1. Build A Solid Team
Hannah said from a venture capital (VC) perspective, the company's CEO is one of the first things they evaluate.
"We go through and rate the CEO and see if he's someone who can bring them to an IPO (initial public offering) or exit, or do they need to bring someone else in to do so?" Hannah said.
He also looks at the company's team under the CEO, as he said the team is critical to the company's execution.
"At the end of the day, if there is no execution, the company will not hit the valuation we are looking for. So, my suggestion as a VC, … is that we really would love for our portfolio of companies to surround themselves with really good talent, but talent that works well together," he said. "We want to invest in a company that has a great sales force, great leadership, … and all of it goes well together."
On the other hand, while the team is significant, Miranda says it's also crucial to consider who your prospects are and your objective.
"You look at some activity in the marketplace on the M&A (merger and acquisition) side, and maybe the objective there is to cut the team," Miranda said. "For example, let's say the merger of Columbia Care and Cresco. Bringing these two companies together, the express purpose on some levels is to get more economies of scale and cut some of the management team, so you don't have all that overhead. You're consolidating overhead, getting more efficient on a net basis, … [and] it depends on the investor's goals."
2. Your Ego Will Hurt You
Klein said in any business, but especially in cannabis, "your ego cannot be more important than the team and strategic goals."
"The most successful entrepreneurs in the world have been able to put the best talents around them," Klein said.
Even for smaller businesses looking to sell a piece of their business or bring in a partner, if your ego is more significant than your goal, it can be difficult to raise capital, he said.
"If you find the right people to put around you, that helps create value. … That is a major driving force that investors, VCs, and other people looking to invest in a business [consider] … because that's where the confidence comes from," he said.
3. Technology Impacts Value
Hannah said technology plays a vital role in several aspects that impact overall business value, such as operations, efficiency, capabilities, and more.
"I can't even tell you how many companies we look at where they don't have any technology," Hannah said. "They are still taking their inventory with Post-It notes, and then their inventory runs out, and then there are three weeks waiting for it to order. We don't put as much value in it because now they have to integrate that value, so when we look at a company, that's really important."
4. Look At Data
Effectively harnessing data can create opportunities for your business and increase value. For example, you should consistently turn to data to understand what's going on in other markets, optimize processes, increase customer retention, and much more.
"Data is hyper important for running a business and running a business effectively because you cannot understand what is going on in other states unless you are getting data," Hannah said. "Especially if you are operating in California, there is no way for you to know what is going on in Massachusetts … or in other states. … Keep an eye on the data and what's going on around you."
5. Get In Where You Fit In
Klein said that determining where you fit in in the marketplace and then entering that sector and excelling can increase your business's value.
"Once you figure out where you want to be in the market, it doesn't matter where you are in the marketplace; you always have to strive to be the best in that marketplace. Look at what differentiates you from everyone else," Klein said.
6. Build Your Brand Portfolio
A strong brand portfolio, especially in a competitive market like cannabis, can add value to your business and help differentiate your products and services.
"For example, in California or Los Angeles … It's tough to get in dispensary doors. But if you have a well-known brand that's very respected, that the buyer consumes themselves, that the budtenders use their dollars [to buy], that speaks volumes," Miranda said.
"So, from that perspective, it's not how much topline revenue you're doing, it's not how strong your EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) margins are, it's really about what's the strength of that brand and what's the strength of that product," he said.
Looking Ahead
Looking ahead, Hannah said we are at a challenging time in the marketplace and the economy and said he does not anticipate valuations to drastically increase or change until there is regulatory change on Capitol Hill.
"I really think that we need regulatory change, and we need it descheduled," he said. "We need to change some of the laws. … If we got interstate commerce, that would be great. I think in the future it will be more regulated from a statewide perspective. … Those are the big changes, and until then, … we just have to ride out the storm."
Join us this year at the Paris Las Vegas Hotel & Casino for Cannabis Conference, the leading education and expo event for plant-touching businesses.
