Strategic Value – Cannabis Businesses (7 of 8)
Welcome to the seventh blog post in 4 Corners’ Cannabis Valuations in Washington State series! Throughout this eight-post series, we’ve shared information about the local cannabis industry and walking through the key concepts and challenges of a cannabis business valuation. Today's post discusses the strategic value premise and why it may sometimes be used in a cannabis business valuation.
Thus far, this blog series has focused on the premise of fair market value, which is defined as a hypothetical transaction between a willing and able buyer and a willing and able seller. All United States income and transfer tax appraisals use this premise of value.
However, when one company acquires another company in the real world, the price to acquire the subject company may be above and beyond the fair market value.
According to valuation expert Chris Mercer, “Strategic buyers can (and do) pay more for companies than financial buyers because they expect to realize synergies from acquisitions (e.g., perhaps through eliminating duplicate expenses or achieving cross-selling benefits) that increase future cash flows.”[1]
The principle of strategic control value is that the value of equity is more valuable to a specific buyer than to a typical financial investor. In the cannabis industry, we’ve seen growers in other states interested in acquiring dispensaries to ensure shelf space. A grower might pay more for a dispensary than a typical investor because of the expected benefit to its grow operation.
As another example, Anheuser-Busch acquired 10 Barrel Brewing (headquartered in Bend, OR) in November 2014. The deal price was never revealed but it was most likely a strategic acquisition. 10 Barrel’s revenues and earnings alone likely didn’t warrant a high acquisition price. Instead, Anheuser-Busch is relying on its own vast distribution network to enhance the value of 10 Barrel. Because of this existing network, Anheuser-Busch was likely willing to pay a higher price than other buyers.
Chris Mercer outlines that when performing a valuation for strategic value purposes (and not fair market value) the valuation expert should make adjustments to the subject company’s existing cash flow stream to account for “improvements” that a strategic buyer could make to the business. Those improvements include:[2]
Improvements that a typical buyer might expect to make by running the company better.
Expected synergies (generally related to cost reductions) that could be realized by the specific buyer.
Expected strategic benefits (from selling more of the acquirer’s products through the target’s existing distribution channels).
It is difficult to perform a valuation using the premise of strategic value because it requires many assumptions. To perform a strategic valuation, a valuation analyst should identify a strategic buyer or buyers. Working with company management, valuation analysts can project or forecast future synergies and operational improvements. A strategic valuation will then use these increased cash flows to calculate an estimated value.
Some synergistic acquisitions may continue to take place in the Washington cannabis market. Large companies pay high prices for the businesses that have achieved brand recognition and loyalty.
It is important to know the difference between fair market value and strategic value. Depending on the valuation purpose, a fair market value may not be helpful to your business goals. 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 final blog post in this series, covering financial forensics, disputes, and litigation in the cannabis industry.
You can find previous installments of the Cannabis Valuations in Washington State series at the links below:
[1] Chris Mercer, Business Valuation – An Integrated Theory; Pg. 69-70
[2] Chris Mercer, Business Valuation – An Integrated Theory; Pg. 83-84