Adjusted Net Asset Approach for Marijuana Businesses

Business Valuation – The Marijuana Chronicles #3

Written by: Eli C. Neal, CPA, ABV, CFF

The Adjusted Net Asset Approach is a valuation methodology that estimates the fair market value of a company by subtracting the total liabilities from the total assets of the firm, 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.

There are two methods under the Adjusted Net Asset Approach are the Net Liquidation Method and the Value-In-Use method.

The Net Liquidation Value Method is appropriate to use when valuing businesses that are unprofitable and where the best value that could be obtained would be through an orderly realization of the underlying assets.

Under the Value-In-Use Method, all assets and liabilities must be stated, or restated, at their fair market or “economic” value. This method is most appropriate when the company is a going concern, has significant tangible assets, has little or no identifiable intangible assets, and/or is in an industry where businesses are commonly valued with respect to assets.

The Adjusted Net Asset Approach typically provides a “floor” of value as it does not account for intangible assets generated by the business or additional profits created by the business.

Within the marijuana business, we would expect that the asset approach might be used to value the following companies:

• Property-holding companies that lease to marijuana businesses;

• Cultivators / growers of marijuana; and

• Any marijuana businesses operating at a loss with the expectation of losses continuing into the future.

Oftentimes, property-holding companies that lease space to operating businesses would realize more value from the sale of property than by collecting the cash flows from future lease payments. This is the effect when high property values exist relative to low monthly lease payments. In other words, the property may not be utilized to its highest and best use when leased to an operating business.  If this is the case, we typically would employ the Adjusted Net Asset approach for these types of real estate holding businesses. However, if a marijuana grower in southern Oregon is utilizing land that would not otherwise be used in a commercial way to generate income, the lease payments received may represent the property’s highest and best use.  In this situation, we may consider valuing the real estate holding entity using an Income Approach instead of the Adjusted Net Asset Approach.

Marijuana cultivators and growers have the most capital intensive function along the marijuana supply chain. The equipment needed to grow marijuana at legal standards typically includes intelligent grow lights, exhaust fans, air conditioning and temperature control, CO2 emitting devices, and possibly hydroponic systems. In summary, growing marijuana can amount to huge equipment costs and valuable facilities in the right hands, even without demonstrating profitability.

Effective October 1, 2016, stringent pesticide testing protocols were imposed upon marijuana growers by the State of Oregon. Instantly, products compliant on September 30, 2016 became non-compliant the following day. According to the Portland Business Journal, products were failing for existence of pesticides and other banned substances.

On December 2, 2016, state regulators revised the testing rules enacted in October 2016 which temporarily lowered the testing burden on producers and processors. However, damage had already been inflicted on the business community. The Portland Business Journal cited that out of a survey of 72 marijuana businesses, 16 were shutting down and 11 planned to lay off between five and 25 employees due to the testing requirements.

For cultivating/growing businesses unable to meet the high testing requirements, the Adjusted Net Asset Approach would likely be a good fit for valuation. The asset mix assembled by the original owners could be attractive to companies that have been able to comply with the testing thresholds.

Similarly, recreational stores that are unable to generate positive cash flow could still have value in underlying assets. Specifically, Portland City Code 14B. 130 requires medical dispensaries and marijuana retailers to be 1,000 feet from another dispensary or retailer and 1,000 feet from a K–12 school. These locations are becoming rarer with every passing week. As a result, building leases in desirable areas are demanding a premium in the market compared to areas that would not be applicable to dispensaries and recreational stores.  At Cogence Group, we expect to see a flurry of activity in the next few years of profitable, successful marijuana retailers with brand recognition purchasing the stores of struggling retailers with the belief that they will be able to make a profit in that same location.

These are just a few examples of how the Adjusted Net Asset Approach might be employed for the valuation of a marijuana business. 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.

Stay tuned for the next blog post, which will cover the Market Approach in the context of valuing marijuana businesses.

If you missed the first two installments of our blog series, you can find them here:

Blog #1 – An Introduction to the Oregon Marijuana Industry

Blog #2 – How to Perform a Business Valuation of a Marijuana Business