Selling Your Cannabis Business? Here’s What You Need to Know.

John D. Wagner
9 min read

This story originally appeared on Marijuana Venture

Source:  https://www.greenentrepreneur.com/article/337784
Is your business special? Sure it is! Just like a homeowner who puts his or her house on the market and expects that it will achieve a premium value because it is “special,” almost every business owner thinks their business should achieve a multiple of value in excess of the averages being paid. That’s not necessarily a bad position to hold; it shows that you, the owner, take great pride in what you’ve achieved over many years of hard work building up the business. That said, in preparation for the sale of your business, it is important to understand the valuation process and have a realistic expectation of the valuation range.

Valuations

What’s realistic? You can readily secure a valuation range from the investment banking firm representing you in the sale of your company. (The investment banker may also be referred to as a “broker,” an “IB,” a “sell-side rep,” or an “M&A advisory.”) But that investment banking firm really should understand the idiosyncrasies of the cannabis-related business sectors. It’s important that your investment banker demonstrates that expertise, along with the normal and traditional practices required to get any deal done. For instance, when researching valuations, if your investment banker pulls down values for pharmaceutical testing labs, when he should have looked specifically at cannabis testing labs, that error could result in you leaving a substantial sum of money on the table. That’s because these two types of companies may be selling at different multiples of earnings. Even small errors in valuation estimates can have dramatic effects on the company value obtained in a sale.

There are databases available to investment bankers and brokers that show the actual valuations of businesses similar to yours that have recently sold. Since M&A activity in the cannabis business is relatively new, note that your M&A advisor may have to triangulate deals done in closely related industries until the valuation data builds up.

Knowing the average valuation range being paid for businesses like yours is a critical initial step, but it represents an average and not necessarily what you will get in terms of valuation for your business. Whether you receive offers above or below the average valuation range will all depend on factors beyond just the financial performance of your business.

Here’s a list of some of these factors:

  • Market strength at the time of sale: Is your sub-sector within the cannabis market strong? Are the long- and short-term prospects for your sub-sector strong? That will have a direct impact on the valuations paid for your business. Make no mistake, the acquirer’s analysts will spare little expense to precisely determine those prospects. Other factors that affect valuations include interest rates, material costs, the cost of labor, the cost of health care and pension programs and even the cost of fuel or utilities.
  • Strength of the management team: A buyer of your business will very likely want to keep the team in place that made the company as strong as it is today. If you have a strong “bench” of management talent, and they’re willing to stay with the company after the sale, that will heighten the value of your business. If you have a leadership team that is going to vacate their offices as soon as the transaction is complete, that will devalue your business, at least equal to the replacement costs of that missing talent. Good management, solid succession planning and leadership continuity invariably lead to a higher price paid for your company.
  • Market position and competitive landscape: If your business is in a crowded market and you are fiercely competing for new clients — and/or fiercely competing to keep legacy clients — this will cause a downward pressure on your valuation. A buyer will look at where you are in the competitive landscape and determine your relative strengths against other businesses in your region or those that compete with you. A solid market position or a dominant presence in a competitive landscape will help you achieve the highest value possible.
  • Product mix and services: If your product or services mix is overly concentrated in one area, that lack of diversity may not attract a shrewd buyer. Buyers like to see a balanced mix of products and services to show that the company is diversified, thereby lowering risks. If you have a good mix, it demonstrates that you have managed your company well and this should be reflected in a high valuation.
  • Customer concentration: If you have one customer who accounts for more than 10% of your business, or one customer whose loss would affect earnings in a meaningful and negative way, a buyer will devalue your business accordingly. A diverse customer base is essential to a good valuation.
  • Asset quality: The quality of the assets being sold will impact the multiple on your earnings. A company that has driven up its earnings by foregoing maintenance (on building, land or equipment), shorting inventory or undermining the strength of its management team with non-market-rate salaries is not going to be as attractive as a company that takes care of its equipment, its inventory and its employees.
  • Quality of earnings: Are your earnings sustainable? Is a meaningful amount of your business predictably repeating? Or was a great recent year a “sugar high” of earnings, which is unlikely to repeat? Non-repeating business is more expensive to obtain than repeat business, and that’s something that will be examined in detail by a buyer.

The M&A Process

Selling your business is a one-time event and one of the most important business decisions that you will make. The execution of the sale of your business must be done with the utmost professionalism if you are to optimize its value. That process typically starts with an M&A advisory firm preparing an “informational memorandum” that builds a narrative around your business and explains the various financial declarations that it contains. (The informational memorandum is also called an “IM.” Some people call it an OM for offering memorandum, while others call it a “deal book.”)

In addition to presenting and describing your financials, leadership profiles and competitive landscape, among other aspects of your business, the informational memorandum should tell a powerful story about your company, its history and its culture. Done well, the informational memorandum should not only be well written, but look good graphically as well.

As the preparation process is completed and outreach is made to the broadest possible community of buyers, the M&A advisory firm should extract a premium valuation (with acceptable terms and conditions) through a controlled auction to a group of serious and pre-qualified buyers. Under this controlled auction approach, in a process entirely managed by your M&A advisory firm, buyers privately bid against one another for your business, while you decide what is the best offer, based on your sales objective.

Your M&A advisory firm should identify all potential qualified acquirers (or targets) who may have an interest in acquiring your business. It is not unusual for the list of potential targets to number in the hundreds or even thousands. There are databases that tell which strategic and financials buyers have been active in your sector, and your M&A advisor should have access to these resources.

In addition to the informational memorandum, your M&A advisory firm should prepare a one-page “teaser” that is initially sent to each of the targets. The teaser summarizes your business and lists recent financial performance without actually naming your business. Many targets will try to guess who you are, but the teaser is designed to reveal basic financial performance and the industry sector, hoping to get targets interested in seeing the full informational memorandum.

Confidentiality agreements are sent along with the “teaser” by the M&A advisory firm. No informational memorandums should be sent until the confidentiality agreements are signed. Note that, as a seller, you have veto power over who gets to see the teaser. So carefully review the outreach list ahead of time. Once everything is in place, outreach is made, usually via email, and your business goes to market.

Getting Started

Surrounding yourself with a strong advisory team to manage the sales process is critical to achieving your sales objective, and that team allows you to run your business during the sales process. In addition to an accountant who can generate the reports and financial documentation required of a sale, here are two key components to put in place as you go to market:

  • An M&A advisory firm (your investment banker) that really understands your business and the cannabis market. The M&A advisory firm should have the staff to prepare and execute the methodology and steps that have been described. M&A advisory is not done well by a one-person operation. Look for a firm that has executed a substantial number of high-value deals, in and out of cannabis.
  • A transaction attorney who specializes in M&A transactions and can handle the letters of intent and sales agreements (also known as the asset purchase agreement or definitive purchase agreement) once you decide on the winning acquirer. An attorney with specialized knowledge of the cannabis businesses is essential, given today’s highly regulatory environment, and how regulations can vary state by state. Do not use the lawyer who drafted your will or reviewed your real estate lease. The legal practice of M&A transactions is a specialty practice.

There is no more exciting time in the life of the business owner than when he or she can sell a business for meaningful profit after many years of building the business value. The cost of hiring an M&A advisor is a small price to pay to prepare your business for sale, to make it as attractive as possible to a potential buyer, to maximize the value obtained and to allow you to run your business successfully during the process.

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