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Member Blog: What To Know About Cannabis Business Valuations

By Melissa Diaz, CFO, Rebel Rock

The rapid growth and ever-evolving nature of the cannabis industry has resulted in wild and hyperinflated business valuations, making it extremely difficult for companies to zero in on a fair valuation as they seek to acquire or be acquired in the up-and-coming field. 

What can cannabis companies do to counter overinflated valuations as they pursue an exit or acquisition strategy? The best approach is to better understand what investors are looking for when they evaluate a company for a potential merger and acquisition deal.

Many Ways to Determine Value

Pinpointing the value of a business is not an exact science. Investors rely on a variety of methods and evaluation techniques to help them land on a fair valuation. Let’s break down some of the most common methods.

  • Discounted Cash Flow: A Discounted Cash Flow (DCF) analysis attempts to determine a company’s value today based on projections of how much money it will generate in the future.

  • Market Transaction: This method estimates a company’s value by comparing the business to similar companies in the marketplace. This approach works really well with publicly traded companies.

  • Adjusted Net Asset Method: A company’s value is determined by analyzing the net value of its assets minus any liabilities.

  • Revenue Multiplier/EBITDA: A company’s value is determined by dividing its revenue multiplier ratio by its earnings before interest, taxes, depreciation, and amortization (EBITDA).

Unique Cannabis Challenges 

Because of the unique nature of the cannabis field, each of the above-mentioned valuation methods come with their own challenges when applied in the industry.

  • Discounted Cash Flow: Because cannabis businesses’ operating costs are so high and their margins are so slim, a DCF analysis will likely produce a more modest valuation than some of the eye-popping ones seen throughout the industry in recent years. But that doesn’t mean it’s unfair or wrong. DCF analyses take into account the current realities of U.S. tax code and the impact it has on costs and earnings.

  • Market Transaction: A market method should not be used by cannabis companies in pinning down a valuation because cannabis companies that have gone public — most notably in Canada — have not been able to sustain their sky-high IPO values, which raises concerns that they were overvalued. Also, public cannabis companies north of the border have seen their values plummet in recent months because big promises of heady market growth don’t seem to be coming to fruition.

  • Adjusted Net Asset Method: While this method can be beneficial for certain cannabis businesses with a lot of assets (cultivators, for instance) one potential downside is it assumes the value of the company is simply the value of its assets and does not take into account any potential for future earnings.

  • Revenue Multiplier/EBITDA: This is currently the most widely used valuation method in the cannabis industry and is likely going to be used in tandem with another valuation method. That’s because EBITDA eliminates the impact of tax restrictions under IRS tax code 280E. It allows investors to look at a company’s hypothetical profitability for when those tax issues are eventually resolved. Most professionals in the cannabis industry agree those tax and legal issues will be eliminated in the next five to eight years. The risk or challenge with this method, then, lies in if that timeline ends up being longer than expected.

Other Valuation Considerations

Evaluating a company’s valuation is a multifaceted approach. Investors often rely on a hybrid approach, using more than one of the standard valuation methods. But they also take into consideration other metrics that have little to do with the bottom line. Some of those include:

  • Management Team: Who’s on your board? Who are your top executives? Investors take a look at management before any other metric. Because of the industry’s legal haziness, investors want to see legitimate industry expertise on boards and management teams.

  • Brand Loyalty: Brand loyalty is big in cannabis. If buyers find a strain they really enjoy, they are more likely to try other strains from the same brand when the preferred product is out of stock. Investors will look at how companies measure brand penetration as part of their due diligence.

  • State of Financials: How quickly are you able to produce them? Is your accounting managed through a cloud-based system? Are your company’s financials messy? Unbalanced? Clear and organized financials are important, as is responding to investor requests in a timely manner. Otherwise, an investor will get the impression that you are disorganized and don’t truly understand your business — which can have a huge impact on any potential valuation.

Be Your Own Advocate

Whether a cannabis business operator is pursuing an acquisition or an exit, it’s important to understand the standard approaches investors take when evaluating such opportunities. Also, don’t be afraid to suggest a particular valuation method or approach to potential investors. Ultimately, nobody knows your business better than you — it’s vital to be your own best advocate.

Advocating for your business and having a better understanding of the valuation process will go a long way toward landing on a fair valuation for your business.

Melissa Diaz is a co-founder and CFO of Arizona-based Rebel Rock, which provides cannabis businesses across North America with specialty accounting solutions, income tax services (U.S. only), CFO and controller services, and business system implementation. She guides companies of all sizes through GAAP compliance, financial modeling, financial reporting and general financial accounting inquiries and functions. 

In addition to leading Rebel Rock, Melissa co-founded Rebel HR, which provides cannabis companies with technology-based HR solutions. She is also a partner in High Rock, a likeminded accounting firm focused on cloud technology integration. Melissa has additional experience as a financial statement auditor with a large international accounting firm, providing audit services for domestic and international businesses. Further, Melissa has experience overseeing global revenue and receivables for a Fortune 500 company. 

Melissa earned a bachelor’s degree in Accounting from University of Arizona and a master’s degree in Accounting from Arizona State University.  

Committee Blog: Transacting in Equity – The Basics

by Charlie Christopher, VP, Finance, Cirrata
NCIA’s Finance and Insurance Committee


“A prudent man must seek to satisfy himself about the means to an end.
This demands that he must revisit, again and again,
the very elemental principles of his craft independent of how others think and act.” – Tony Deden

In businesses of all sizes it is common to transact in a number of currencies other than cash. The focus of this piece is on transactions involving common equity, the most fundamental unit of business ownership. The first section establishes a framework for how to view equity as currency, and what differentiates equity from other mediums of exchange such as cash. The second section introduces the process for creating reasonable projections based on sound logic. The third section demonstrates a somewhat novel application of concepts, and provides an example of the flexibility that can be introduced into the process. The conclusion is a reminder that these concepts can easily be misused, and that nothing should replace common sense when dealing with extreme uncertainty.

The Problem

Valuing any business is hard. Valuing a start-up is even harder still, not because of process, but because of the ambiguity associated with the output. When a valuation is based on multiple layers of high variance variables then the resulting distribution of value is rightfully broad. This poses a major challenge for operators and investors trying to agree on fair terms, and it can lead to irreparable damage to a young company.

Imagine for a second that you, and everyone else, have a crystal ball that can see the future with just enough variance to keep things interesting. How would that change the way you think about your equity? Would you be offering the same equity deals to your entire team? Would you be flexible with investors interested in your business? Of course not, you would look into the future every morning, update your projections and you would transact in equity in a similar manner to how you would with cash. Even though we do not have a crystal ball in the real world, it stands that to transact in equity with absolutely no opinion of value is the equivalent to being indifferent between paying $.10 or $100,000 for the same product or service.

Equity is a form of currency. It has value. However, its value has a built-in variance that rewards beating expectations, and punishes missing expectations. This is why equity awards are typically used to incentivize contributions that can increase the odds of achieving the former. The act of issuing the reward, in theory, immediately increases the value of the firm through the alignment of incentives. The common exaltation of the aforementioned qualitative attributes of the incentive over the quantitative attributes is also why the standard practice of ignoring a non-cash expense like share-based compensation is so indefensible. The value creation may be real, but to deny that a currency has transacted to create that value is to double count the benefit to shareholders.

The Process

Valuing a business begins from the top down and ends from the bottom up. Top down refers to projections based on the broader market while bottom up refers to firm specific capabilities extrapolated into the broader market. A common mistake operators make is to build up based on capabilities with no regard for how the aggregate ecosystem will react to the sum of all fundamental behaviors in the ecosystem. Starting from the top-down with a defensible position regarding both the size of the addressable market and the number of competitors participating in the market provides parameters for the business’s potential revenue.

Arguing for market share using a top-down analysis is fundamentally flawed if it does not reflect the true capacity of the business. A bottom-up analysis reflecting firm-specific capabilities should be compared to the top-down analysis for reasonableness. Ultimately, bottom-up analysis drives operating assumptions, and operating assumptions are the inputs to nearly every valuation technique.

I subscribe to the theory that posits that the variance in all of the assumptions can be quantified using an appropriate discount rate. In other words, if I’m uncertain and find my forecasted outcome to be highly unreliable I may choose to use a much higher discount rate to calculate the present value of the business than for a business with lower variance assumptions. When valuing a start-up company, I consider the corresponding ultra-high discount rate to cloud too much insight. For start-ups I first calculate a probability of firm failure in each of the forecast years and multiply my operating assumptions by the cumulative probability of success, I then use a more reasonable discount rate as if the firm was not highly speculative. This allows start-ups in the seed stage to more easily defend increases in value before launch. For example, the filling of a major executive leadership position justifies a small reduction in the probability of failure. Thus, your first executive hire has a reason to have received a higher percentage equity award than your last hire, even though the dollar value of the award might be equal. The process facilitates fair negotiations among all shareholders who may commit under vastly different circumstances and with different information. All too often this doesn’t take place, and the animosity that can develop as a result is as real as it is avoidable.

Valuation is admittedly more art than science. Many astute readers will point out that markets don’t operate in the orderly, fundamental matter I’ve proposed. Those critics are absolutely correct. It is a fair caution that not only are the trappings of certainty intoxicating, but sometimes simply observing how others are transacting is sufficient to make decisions. The market is often wrong, but it’s also often right. Remember to update your assumptions as new information becomes available.

Charlie is a Co-Founder of Cirrata where he lends his extensive knowledge from being both an entrepreneur as well as a securities analyst. As VP of Finance, Charlie combines his skills to assist clients through the application process, ongoing operations, and exit strategies.
Prior to joining Cirrata, Charlie co-founded a luxury women’s ready-to-wear label where he oversaw two separate rounds of funding as CFO. He has consulted numerous clients in the cannabis, construction, music, financial services and software industries in which his primary focus was on information systems, optimization, cash forecasting, securities offerings, licensing and capital allocation.

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