Strategic Value – Marijuana Businesses
Business Valuation – The Marijuana Chronicles #7
Written by: Eli C. Neal, CPA, ABV, CFF
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So far, this blog series has focused on the premise of fair market value, which is defined as a hypothetical transaction between a willing and able buyer and a willing and able seller. All United States income and transfer tax appraisals use this premise of value.
However, when one company acquires another company in the real world, the price to acquire the subject company may be above and beyond the fair market value.
According to valuation expert Chris Mercer, “strategic buyers can (and do) pay more for companies than financial buyers because they expect to realize synergies from acquisitions (e.g., perhaps through eliminating duplicate expenses or achieving cross-selling benefits) that increase future cash flows.”[1]
The principle of strategic control value is that the value of equity is more valuable to a specific buyer than to a typical financial investor. In the cannabis industry, we’ve seen many growers interested in acquiring dispensaries to ensure shelf space. A grower might pay more for a dispensary than a typical investor because of the benefit to its grow operation.
As another example, Anheuser-Busch acquired 10 Barrel Brewing in November 2014. The deal price was never revealed but it was most likely a strategic acquisition. 10 Barrel’s revenues and earnings alone likely didn’t warrant a high acquisition price. Instead, Anheuser-Busch is relying on its own vast distribution network to enhance the value of 10 Barrel. Because of this existing network, Anheuser-Busch was willing to pay a higher price than other buyers.
Chris Mercer outlines that when performing a valuation for strategic value purposes (and not fair market value) the valuation expert should make adjustments to the subject company’s existing cash flow stream to account for “improvements” that a strategic buyer could make to the business. Those improvements include:[2]
Improvements that a typical buyer might expect to make by running the company better.
Expected synergies (generally related to cost reductions) that could be realized by the specific buyer.
Expected strategic benefits (from selling more of the acquirer’s products through the target’s existing distribution channels).
It is difficult to perform a valuation using the premise of strategic value because it requires many assumptions. To perform a strategic valuation, a valuation analyst should identify a strategic buyer or buyers. Working with company management, valuation analysts can project or forecast future synergies and operational improvements. A strategic valuation will then use these increased cash flows to calculate a value.
We expect that synergistic acquisitions will take place in the Oregon cannabis market. Large companies will likely pay high prices in the future for the early winners that have achieved brand recognition and loyalty.
It is important to know the difference between fair market value and strategic value. Depending on the valuation purpose, a fair market value may not be helpful to your business goals. If you’d like to know more, give us a call at 503-467-7903 and we’d be happy to have a conversation with you.
[1] Chris Mercer, Business Valuation – An Integrated Theory; Pg. 69-70
[2] Chris Mercer, Business Valuation – An Integrated Theory; Pg. 83-84