When Illinois legalized recreational marijuana on January 1, 2020, Chicago dispensaries had lines around the block. The staggering result was a marijuana shortage and $3.2 million in sales on the first day! When sales initially inflate in such a dramatic way and then flatline, it becomes challenging to value a company to investors. It becomes even more challenging when, with a small amount of market research, canna-businesses want investors right out of the gate. According to the US Small Business Administration, more than 50 percent of small businesses fail within the first five years due to insufficient capital; now add on the current legalization climate, and that percentage escalates.
When investors see a business with no sales, no revenue, and very little research conducted on the product’s market fluctuation as a whole, it becomes difficult to put a price on potential. This isn’t necessarily bad news for cannabis entrepreneurs, though, especially if a business license is already in their repertoire.
There are two ways to potentially value a cannabis company: asset-based valuation and earnings-based valuation.
Asset-based valuations give in-depth information on what kind of monetary, and intangible, standing the company currently possesses. This could include intangibles like branding, future scalability initiatives, licensure, supply chain management, and the existence of a concrete consumer base, or tangibles like machinery, brick and mortar space, surveillance systems, and ready-to-sell products. Typically, asset-based evaluations end there.
The cannabis industry varies from the norm in that a lack of market knowledge works in the canna-business owner’s favor. Getting into the industry before large profit margins dwindle is essential for high investment potential. To assist this, states that have instituted licensing initiatives for minority entrepreneurs add to intangibles. The potential for exponential growth, even based upon minimal statistics from previous state legalization reactions, is an intangible aspect of cannabis which skyrockets investment value.
As the cannabis industry becomes more tech-savvy, important intangibles present themselves as going above and beyond. An enterprising component that piques investors’ interest is enterprise resource planning (ERP). ERP systems include metrics on inventory tracking, asset management, guideline compliance, and resource allocation efforts. This technology tracks data so that human error in reporting becomes a non-issue, and the service also creates audit trails. For example, stored electrical bills can give insight into indoor grow operations; the industry standard is 1-1.5 grams of cannabis per watt.
Earning-based evaluation is difficult for canna-businesses, as banking paper trails are few and far between. Verifying funds moving in and out of a business requires hiring a CPA who can validate the accuracy of bookkeeping. Additionally, it becomes difficult to quantify competition, as metrics for similar companies, and the industry as a whole, haven’t been researched extensively. Ordinarily, earning-based valuations are centered on a base multiplier; the current net revenue of companies are systematically multiplied by either two or five. A lack of market research for cannabis translates into a lack of an established multiplier, which in turn creates uncalculatable risk factors.
This tightrope’s-width of total information demands that investors do extensive background searches of cannabis industry standards before investing a penny. Still, the potential for explosive growth exists.