Market Approach – Marijuana Business

By: Eli Neal

Business Valuation – The Marijuana Chronicles #4

If you have missed any of our previous blog posts on valuing marijuana businesses, you can find those blog posts here”

  1. An Introduction to the Oregon Marijuana Industry,
  2. How to Perform a Business Valuation of a Marijuana Business, and
  3. Adjusted Net Asset Approach – Marijuana Business.

The next business valuation approach that we’ll discuss in the context of marijuana businesses is the Market Approach.

The Market Approach is a methodology premised on the theory that a business can be valued with reference to transactions involving comparable companies in an open and unrestricted market. The challenge in valuing a business using this approach, and particularly when valuing a small or unusual operating entity, is finding true market comparables. It is unlikely that any two businesses or ownership interests will be alike in all regards.

The two most commonly used variations of the Market Approach are the Guideline Public Company Method and the Guideline Acquisition Method.

Under the Guideline Public Company Method, the business valuation expert calculates the market value of equity using the current price per share and number of shares outstanding of public companies comparable to the valuation subject company. Then, a multiplier is calculated based on earnings, assets, cash flow, or, in some instances, revenue. Valuation experts should apply adjustments to the calculated multiples to account for differences between the Subject Company and guideline companies. These multiples can then be applied to the equivalent measures for the subject company to determine value.

Initially, I thought this it was unlikely there would be any public marijuana companies actively traded on the open market, given the illegality of the drug at a federal level. I was wrong.

The following were just a few of the publicly traded companies mentioned in a Fox Business article:

  • Insys Therapeutics (INSY) gained approval for a cannabinoid drug – Syndros
  • Aurora Cannabis (ACB) produces and sells medical cannabis
  • GW Pharmaceuticals (GWPH) is a biopharmaceutical company focused on cannabinoid products in a range of disease areas

The list goes on. That being said, I would be cautious using public marijuana companies within a business valuation of a marijuana company. First, a valuation expert needs to find a public company (or even better, multiple public companies) that is comparable to the subject company.  That alone is often difficult.

Next, the Guideline Public Company Method relies on the theory of an open and unrestricted market that is perfectly competitive. With so much uncertainty around the marijuana industry, market reactions can (and are) all over the map and market prices have been incredibly volatile.  A business valuation analyst could look for peaks in consumer confidence about marijuana to obtain a high value or lows in consumer confidence to obtain a low value. I would suggest being very careful when employing this method and clearly disclosing the rationale for the public companies selected and the market price used in a valuation report. Even then, at Cogence Group, we’d likely shy away from this valuation approach due to the volatility in the public market.

The other Market Approach, the Guideline Acquisition Method, relies on similar metrics to derive valuation multiples but relies on actual prices paid for businesses in recent transactions as opposed to market trading prices for shares of public companies.

At the time of this posting, there is a lack of actual reported transactions of marijuana businesses providing the data points necessary to apply a value to the subject company. The industry is young and there just aren’t many data points from which to draw conclusions. Further, a NAICS or SIC code dedicated to the marijuana industry does not currently exist, making searches for marijuana transactions difficult in the existing business valuation databases such as Pratt’s Stats or Biz Comps. We’ve even heard that some companies are shying away from listing marijuana anywhere on its tax return to avoid undue attention from the federal tax authorities. The combination of these factors makes finding transactions of marijuana companies for comparison difficult.

To further complicate matters for the Guideline Acquisition Method, the transactions completed to date have occurred at the infancy of an emerging multi-billion-dollar industry. A business valuation expert would need to sort through the impact of comparing his or her subject company to a company acquired during “the big bang” of the legal cannabis industry. It’s an unstable period and even if appropriate comparable acquisitions can be found, a valuation expert would have to think about whether any adjustments would be necessary to account for industry fervor and possible strategic acquisitions that may not relate to his or her own subject company.

At this point, the data is likely insufficient to compile a Market Approach valuation for a marijuana business that inspires confidence. However, valuation experts are working hard to compile a database of marijuana business acquisitions which would allow the Market Approach to be used and relied upon in future business valuations.

These are just a few thoughts on the Market Approach and how it relates to 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.

The next blog post will cover the Income Approach in the context of marijuana businesses.