Valuations for the Cannabis Industry

August 30, 2021

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In this episode of CannaCast Eric Altstadter speaks with Hubert Klein, Partner and Practice Leader for EisnerAmper’s New Jersey Financial Advisory Services group, about the complexities of doing valuations for the cannabis industry.


Transcript

Eric Altstadter: Thanks for tuning into this episode of CannaCast. I'm your host, Eric Altstadter, EisnerAmper's National Cannabis and Hemp Practice leader. Please welcome Hubert Klein. Hubert is one of my partners in Eisner Advisory Group, LLC, and the leader of our forensic litigation and valuation services team.

Hubert is frequently called upon as a technical resource in various litigation and valuation matters his consulted and provided services and matters including complex damages, business valuations, due diligence analysis, fraud and forensic investigations, lost profit calculations, shareholder disputes, reasonable compensation and benefits analysis, insurance claims analysis, bankruptcy, and matrimonial proceedings, and of late he is spending a significant amount of time working for the cannabis industry. Thank you for joining me, Hubert.
Hubert Klein: Eric, thank you for having me today. Pleasure to be here.

EA: Hubert, under what circumstances would a cannabis company need evaluation?
HK: Cannabis businesses need valuations for a whole host of areas. For looking to bring in investors, looking to bring in new shareholders, looking to have shareholders transition out, for financing purposes, for financial statement purposes, and the run of the mill things that we see all other businesses need valuation. Estate and gift tax planning. People are using this as a part of their portfolio today and working to do gifts or have estate work that if somebody owns an interest they need valuation. We do see them now coming into family law proceedings, where people want interest in cannabis businesses or are having the separation of their marriage and have to split up their assets. There's need for valuations there. And there's a big need after today in what I call the big three, patents, trademarks, and copyrights, because a lot of things in the cannabis industry today, there's patented products because people are making the super THC products into sports drinks and all this other stuff.

There's trademarks for logos and designs that you're going to see things revolving around that, that companies are going to be buying that, as well as the copyrights for people who own intellectual property in the space. So there's a whole host of reasons, just the same as all other businesses.
EA:Are there unique issues that people who will use or rely on valuations in the cannabis industry need to be aware of?
HK: There's many reasons and unique issues. The big one is the 280E limitation. The tax rates that cannabis businesses pay versus a regular business with similar income and expenses and net profit are going to be drastically different because of the disallowance of a lot of the deductions. There's also a change or a law that requires them to account their inventory differently than a lot of other businesses will. For people are out there who remember the old 263A days of accounting for inventory. There's a provision in there for the cannabis industry that the IRS has come down with too.

So the tax rate is one major one, but also the risk factors, a business operating in the cannabis industry today has a lot of additional risk factors that a normal operating business might not, such as licensing requirements, limitations of licenses, and also their availability to ship their product interstate if they're doing interstate work.

So there's a lot of risk considerations that people have to take into account that you won't see with normal business, you can operate interstate.
EA: Are there different ways of valuing businesses and do they apply to the cannabis industry?hk: Yes, there's three different approaches to valuation, and under each approach there's multiple methods, but the important thing to note is that similar business valuation theory and approaches are applied to the cannabis industry as they are other industries. It's just understanding those unique factors that we just talked about that kind of drive how it works and how it goes. The three approaches are, there's an asset approach, there's a market approach, and then there's an income approach.

The asset approach is kind of like if you took your 75 Camaro and it totaled, you want to buy another 75 Camaro. What would it be in a marketplace? Could you go find it? It's a way of valuing things, but not really applicable to the cannabis industry, but might apply to people who are talking about inventory of a certain nature and needing to replace it.

A market approach is based on market data and there's two ways, there's public company information. And then there's private company transaction information, both of which are really, really lacking right now because of the infancy of the industry. But there is some data out there. There's some public companies within the U.S. and there's a bunch in Canada, so there is some data, but the uniqueness is you need to know what those companies are actually doing and pull their filings if you're looking at a large company in the U.S. In the bioscience space developing product versus a company in the growing space in Canada. If they're not in the same space, the information isn't relatable.

And then the third approach would be looking at the income approach, looking at historical information for capitalizing earnings or looking at projections for discounting of future cashflow stream. So you'd have those three approaches and under them you'd have multiple methods.
EA: What are the hot areas of valuation today in general, and in the cannabis industry specifically?
HK: Well in the cannabis industry, we're seeing a lot where people are looking to get into it, a lot of entrepreneurs. I kind of liken this to the late eighties, go-go nineties. You had all these tech companies come out of nowhere, and the next thing you know, everybody rushed to put their money into it. So I think one of the hot areas is people are looking for users as an outlet to put their funds and do you value the money that's coming in? How much am I buying? What am I buying? So, that's an area where I see there's a lot of growth going forward.

People with a lot of disposable cash are looking to invest into this new sector because they believe in upside potential. So that's one hot one for existing cannabis businesses. I think we're going to see a lot of estate and gift tax planning this year revolving around gifting because of potential change in gift tax law.
EA:In addition to business valuations, are there any areas in cannabis that you see that may require special skills?
HK:Yes. The skills that we have as accountants are applicable to a lot of the businesses we work on. I think the skills, aren't really a specialty area, it's the knowledge. You need to acquire that knowledge, and that's a skill you need to employ.

There's a whole host of websites and blogs and organizations, get involved and learn about the industry so you know what you're valuing. I did a presentation actually before this podcast and I was talking about how diverse the industry is. You have growers, you have people in the science side, you have the medical dispensary, the retail dispensary's, you need to know about how those businesses operate in the areas where they operate, what are their licensing requirements? What are their restrictions? Because you can't just blindly say, "I'm going to value a medical dispensary the same way I'm going to value a retail dispensary."

So you can acquire that knowledge and that's getting involved and learning, and there are many resources out there.
EA:Should cannabis companies seek out to perform a business valuation for their business?
HK: They should seek out a qualified professional appraiser to value their business, such as Eisner Advisory Group, a group like ours, where we have a specialized team of people and we're not just focused on valuation, we're focused on the industry. And I think you get more bang for your buck and the resources when the higher group is dedicated to understanding the cannabis industry, and not just people doing it as one-offs, but they're out there. Just make sure you have someone who's qualified and knowledgeable about the industry.
EA:Do you have any closing thoughts on the future valuations in the cannabis industry and valuations in general?
HK:Well, the cannabis industry, I think there's an upward trajectory for the next few years. The growth models in IBISWorld, which is a data site where I pull information from, is talking about double digit growth from now through 2026. And that's just based on the current legal and regulatory environment. I think the sky's the limit if the FDA and the federal government gets on board within the states, and that's just within the states, I think there's a lot of international opportunity as well. Canada is further along the road than we are. And Europe is opening up to this idea, and so is the Asian market, so there's a lot of growth.

As far as valuation industry in general, it's been a pretty stable business and industry. And in years like this where there's talk of tax law changes in state and gift tax changes, or people have money and are looking to invest, the need for valuation is growing.
EA:Thank you, Hubert. And thanks for listening to CannaCast as part of EisnerAmper podcast series. Please visit eisneramper.com/cannabis for more information and podcasts. Join us for our next CannaCast podcast where we'll discuss other budding issues.

About Eric Altstadter

Eric Altstadter CPA is an Audit Partner with over 30 years of experience working with public companies and privately held businesses

About Hubert Klein

Hubert Klein is a Partner and Practice Leader in the Financial Advisory Services Group with technical resources in various litigation actions. He has consulted in complex damages, business valuations and due diligence analysis.

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