Most cannabis business owners looking to sell their businesses ask the same two opening questions:
1. “What metrics are used to determine the value of my business when a buyer is looking to make an acquisition?”
2. “What are the top three or four steps I can take to maximize that value?”
Whether your company is a laboratory, a farm, a retail business or a provider of cannabis derivatives, acquirers all value the same basic performance metrics, and these metrics are easy to identify.
Once a business owner decides it’s time to prepare for a sale, it is a relatively straightforward task to optimize the sale value of the company by focusing on improving these metrics. That said, businesses can’t be changed overnight. If you are selling your business and there are aspects of operation that need attention, you will likely need some lead time — perhaps six months or more, depending on the quality of your advisor — to get your house in order. Let’s take a closer look.
Where to Focus?
As you move toward offering your company for sale, focus on improving the productivity and performance of your business, both top line (gross revenues) and bottom line (net profit). Keep in mind that potential buyers will scrutinize your financial statements for the last three years. They will also examine “trailing 12 months” financial statements, expecting continuous financial performance over these periods of time. You will achieve the highest valuation when you show consistent year-over-year improvement. For example, a business that books $15 million in business for each of the last three years, with good net margins, may be very attractive to you, the business owner. However, the value of your company will be heightened if the business experiences consistent, predictable year-over-year growth and solid financial performance, typically measured by a year-over-year improving EBITDA (earnings before interest, tax depreciation and amortization), as well as discipline in maintaining gross profit margin and discipline in controlling expenses, like SG&A expenses — selling, general and administration.
It may come as a surprise that traditional basics used to value old-line businesses are also used in cannabis and hemp transactions, even though the cannabis industry is relatively new and coming out of the shadows of illegality. In other words, there are no special rules for cannabis and hemp companies, aside from, perhaps, a premium that might be paid for these companies because of the speed with which these markets are expanding. Nonetheless, most buyers will look for what they have always looked for: a) solid balance sheets with excellent accounts receivable (showing little or no account dating and low delinquencies); b) good cash flow; and c) high-quality earnings and a percent EBITDA that meets or exceeds industry norms. These are among the primary drivers in the valuation process, and it’s these metrics that should be your top priority when preparing your company for a potential sale.
“Well-Presented … Half Sold”
In addition to getting the financial aspects of the business in order, it is also essential that your financial performance be well-documented. Well-presented financial statements that use standardized GAAP methods of accounting go a long way to giving your buyer confidence that you are running a high-performance company. Just having your financials in order can actually raise values almost as much as solid earnings, because the buyer will think, “Heck, if they’ve got their financial statements in such good shape, I’ll bet the rest of the business is equally well cared for.”
Furthermore, as you prepare for sale, an internal SWOT analysis (strengths, weakness, opportunities and threats) can be a useful tool in determining what aspects of the business need improvement. (Within the SWOT analysis, strengths and weaknesses refer to internal factors in your company that you can control; opportunities and threats are typically outside the control of your business but directly impact your business.) In fact, a potential buyer of your business will more than likely perform their own SWOT analysis, so you can only imagine how impressive it will be if you get ahead of the curve and perform your own to show that you are working to improve the business, even as you prepare to sell it.
Timing the sale of your business is based on many factors, but two are critical. You want to sell your business when it is doing well and the industry sector is healthy. Just as an unprofitable business has little value in a good economy, a company with historically strong earnings will not achieve its highest value if it is sold when the economy is on the decline or in the tank. (If you sell as the economy starts to slow or tank, a sale can be perceived as a rush to the exits.) If your business is in a cyclical industry, or you work in a sector of the industry that is subject to changing regulations and an unpredictable tax landscape (especially true of cannabis), you have to ask yourself: Am I prepared to wait out the next downturn or to chance some unforeseen regulatory hurdles? Or should I sell now, knowing that the sale process will take around six months to a year to complete?
A solid economic environment that is at or near its peak — on its way up, not on the way down! — is an ideal time to engage a mergers-and-acquisitions advisory team to help prepare your business and put it on the market to see what valuations you could achieve.
There are external factors that are not in your control, such as the overall economy, global events and industry business cycles, and it’s probably a mark of prudence (and not stupidity) to take your exit in a safe business environment, even if you potentially leave a “little bit of money on the table.”
For example: A business worth between 5X and 8X multiple of adjusted EBITDA are typical for those in cannabis and hemp sectors for an all-cash deal (although valuations can go much higher with multi-year earnouts). However, that multiple can easily drop in a down cycle, where you would see a 5X multiple of adjusted EBITDA or lower. At 5X, you would need to increase your EBITDA by 40% just to get back to a dollar valuation equal to the 7X multiple of EBITDA in an up-market cycle. Selling today at, say, 7X, even when you suspect you could achieve a higher value, would likely be a great move in retrospect if the economy were to constrict or regulation and tax laws were to change.
This article is adopted from the book M&A Basics For Cannabis & Hemp Companies: A Company Owner’s Guide to Key Deal Elements & Common Practices of Mergers & Acquisitions, by John D. Wagner and Carl Craig, Ph.D. The book is available from Amazon. For more information, visit www.1stWestMA.com. Wagner can be reached at j.wagner@1stWestMA.com.