Dispensary Valuations: How to Value a Cannabis Dispensary
In this ever-changing industry, cannabis dispensary owners should know how much their businesses are worth. This knowledge allows owners to entertain acquisition offers from investors and offer shares of ownership – or equity – to prospective buyers.
Any serious buyer or investor will naturally want to know how much a potential acquisition will cost. If they believe they can make the business worth more in the long run, they may offer less up-front cash in exchange for greater equity in the business.
Experts predict the legal cannabis market will enjoy a spectacular compound annual growth rate (CAGR) of 34.6% by 2025. Because running a business is a long-term commitment, any transaction of this kind should take into account the expected future value of the business within the context of the industry at large.
But the rapidly-growing cannabis industry presents a number of challenges to the usual process of business valuation. Regulatory concerns, legislative uncertainty, and institutional under-appreciation make the process of cannabis dispensary valuation more delicate than that of most other industries.
This is how businesses like Seattle’s Uncle Ike’s can go on the market with a $50 million valuation. But that is a tiny sum compared to Canopy’s $3.4 billion acquisition of Acreage Holdings – which includes $300 million in cash.
There are several ways dispensary owners and buyers calculate these sums. The method you choose may present a chance to establish favorable terms.
3 Ways to Value a Cannabis Dispensary Business
There are three main ways in which investors and cannabis dispensary owners can establish the value of a business. Each method has its own set of pros and cons, but one stands out as being the most accurate and realistic for entrepreneurs in today’s legal cannabis environment.
1. Income Valuation
Income valuation is the simplest way to value a business. With this method, the business is worth the amount of income it generates. If a company earns $1 million per year, every year, then its owner only needs to determine how many years’ worth of income it should sell for. With a weighted average of yearly income, it’s easy to estimate the cannabis business’s valuation.
The problem with this approach is that it does not take external factors into account. Because the cannabis industry is growing every year, last year’s income is not necessarily a good indicator of a dispensary’s value today – or even next year.
Additionally, this dispensary valuation method doesn’t take into account the income-generating potential of new leadership. Experienced cannabis professionals and large-scale national cannabis brands may be able to vastly improve the profitability of a small cannabis business in a growing market. Under these conditions, an equity-based transaction is generally more advantageous for the seller.
2. Asset Valuation
Asset valuation determines the value of a business based on what it owns. This is a common strategy for business owners who are quitting an industry. A cannabis company with a bad reputation, poor sales, or a revoked license may fall into this category, which generally offers the lowest price.
For the average retail cannabis dispensary, this valuation represents the sale of all inventory and dispensary property. It may provide worthwhile terms to cultivators and processors, but only if serious problems make the prospect of new leadership guiding the company to growth and profitability unlikely.
3. Market Valuation
Market valuation offers the best chance for dispensary buyers and sellers to conduct a mutually beneficial transaction. It addresses the value of the dispensary within the context of the industry and the potential for growth within it.
In the cannabis industry, speculative market valuation has become the norm as cannabis companies earn valuations far in excess of what they sell. This method requires expert consultation from reputable valuation providers who know the industry and can reasonably predict its performance on a state-by-state basis.
Market valuation is not without its share of risks. Experienced institutional buyers can interpret market data to manipulate sellers into less-than-favorable terms. Restrictive regulation and legislative gridlock can have an enormous effect on the valuation of cannabis businesses in a state.
There are also risks to market valuation at the other end of the spectrum. In states that enjoy a functional regulatory environment that is conducive to growth, speculative investors may seek to purchase overvalued cannabis businesses according to the “greater fool” theory.
This strategy generates ever-increasing profits for institutional investors – for a short while. Eventually, the system collapses entirely and takes everyone along with it. Cannabis industry entrepreneurs should be wary of unusually high-priced valuation patterns.
Licensing is another crucial element of the market valuation equation. Most states only issue a fixed number of cannabis licenses. The practical result of this approach puts a premium on the market valuation of license holders’ businesses. If license holders choose not to sell, buyers have no other option for accessing the cannabis market in that region.
Throughout the nationwide cannabis industry, MedMen is known for acquiring dispensary businesses in newly regulated states in order to acquire their licenses. The firm has shown its readiness to invest tens of millions of dollars to open markets it would not otherwise be able to penetrate.
Leverage Equity to Your Advantage
For cannabis dispensary owners interested in selling their business, weighing the potential benefits of cash vs. equity is considerably challenging. On the one hand, there are few things more appealing and secure than a large amount of up-front cash. But an equity-based transaction can result in far greater profits in the long-term.
Consider the difference between these two offers:
- An experienced cannabis investor offers an equity deal of $200,000 for a 25% stake in the dispensary.
- A less experienced investor offers $200,000 for a 20% stake in the dispensary.
The first offer results in a total valuation of $800,000, while the second produces a $1 million valuation. However, a more experienced investor may be able to vastly increase the total value of the business over time.
For the seller, a 20% stake in a business with skilled leadership can result in far greater profits than a 25% stake in a business in less capable hands. Sellers have a powerful incentive to diligently research potential buyers, and buyers have an equally powerful incentive to earn sellers’ trust by demonstrating a high degree of professionalism and experience.
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