Adjusted Net Asset Approach for Cannabis Businesses (3 of 8)
Welcome to the third post in our Cannabis Valuations in Washington State series! Today we’ll be sharing about using the Adjusted Net Asset Approach when valuing a cannabis business.
The Adjusted Net Asset Approach is a valuation methodology that estimates the fair market value of a company by subtracting the total liabilities from the total assets of the firm, after adjusting the balance sheet to fair market value. This form of value will generally not capture the value of any intangible assets created by the business, such as goodwill.
There are two different methods under the Adjusted Net Asset Approach: the Net Liquidation Value Method and the Value-In-Use Method.
The Net Liquidation Value Method models a hypothetical liquidation of the business. It is most appropriate when valuing businesses that are unprofitable, when the best value that could be obtained would likely be through an orderly liquidation of the underlying assets.
Under the Value-In-Use Method, all assets and liabilities must be stated, or restated, at their fair market or “economic” value. This method is most appropriate when the company is a going concern, has significant tangible assets, has little or no identifiable intangible assets, and/or is in an industry where businesses are commonly valued with respect to assets.
The Adjusted Net Asset Approach typically provides a “floor” of value as it does not account for intangible assets or additional profits created by the business.
Within the cannabis industry, we expect the Asset Approach may be used to value the following types of companies:
Property-holding companies that lease to cannabis businesses;
Producers (growers/cultivators) of cannabis; and
Any cannabis-related business operating at a loss with the expectation of losses continuing into the future.
Oftentimes, property-holding companies that lease space to operating businesses would realize more value from the sale of property than by collecting the cash flows from future lease payments. This is the effect when high property values exist relative to low monthly lease payments. In other words, the property may not be utilized to its highest and best use when leased to an operating business. If this is the case, we typically would employ the Adjusted Net Asset Approach for these types of real estate holding businesses.
However, if a cannabis grower in Eastern Washington is utilizing land that would not otherwise be used in a commercial way to generate income, the lease payments received may represent the property’s highest and best use. In this situation, we may consider valuing the real estate holding entity using an Income Approach instead of the Adjusted Net Asset Approach.
Cannabis producers (cultivators and growers) have the most capital-intensive function along the cannabis supply chain. The equipment needed to grow the plants at legal standards typically includes intelligent grow lights, exhaust fans, air conditioning and temperature control, CO2 emitting devices, and possibly hydroponic systems. In summary, the equipment and facilities obtained for growing cannabis can be valuable to the right buyer, even without demonstrating profitability historically.
Similarly, recreational stores that are unable to generate positive cash flow could still have value in underlying assets, namely, the retailer license. Washington state has stopped accepting new cannabis licenses, meaning interested parties must purchase a license from an existing cannabis business. As a result, a business with an active retailer license and/or an existing building lease in a desirable area could still have some value, even if it lacks profits.
At 4 Corners, we expect to see continued merger activity over the next few years as profitable, successful cannabis retailers with brand recognition purchase the stores of struggling retailers with the belief that they will be able to make a profit in that same location.
These are just a few examples of how the Adjusted Net Asset Approach might be employed for the valuation of a cannabis business. If you own or represent a cannabis business in Seattle, Bellevue, or elsewhere in the Pacific Northwest and need a business valuation or financial expert, call 4 Corners Financial Forensics at 425.800.4896 or email us; we’ll listen to your situation and help you scope your project. We’d love to help you.
Stay tuned for the next blog post in this series, which will cover the Market Approach in the context of valuing cannabis businesses.
You can find additional installments of the Cannabis Valuations in Washington State series at the links below: