What to Look For in Valuing a Cannabis Dispensary

Through years of valuation experience with all types of businesses, it's clear that each company is unique and should have an interview questionnaire that targets your client.

January 23, 2020

Through years of valuation experience with all types of businesses, it's clear that each company is unique and should have an interview questionnaire that targets your client, whether it be a cannabis cultivation facility, a dispensary or any other cannabis plant-touching business.

The Interview Process

When an individual customer goes into a dispensary, he or she is looking for advice as to what strain would be good for either a medical ailment or for particular recreational uses. Therefore, it is imperative that budtenders have an extensive knowledge of each product in their inventory. 

The key to good sales in a dispensary are the people behind the counter.  When shoppers go into a grocery store, they usually know what fruit or vegetables they are going to buy. This is not necessarily true of a dispensary, where people, whether it be first-time buyers or experienced users of cannabis, need to find out what strain is best for their particular medical needs.

Dispensaries are retailers that need to provide consumers a compelling reason to visit and return for exceptional service, quality product selection, convenience and, of course, low prices. In other words, the people with the most hands-on experience in actual day-to-day operations need extensive interviewing to see if these qualities exist in the dispensaries. Do not rely solely on the owner’s propositions  that they do exist. Find out for yourself.

While in the dispensary performing your interview, look around and see how many lines of products are available within the dispensary. It has been proven that diversification of product lines is one of the keys to profitability. Cannabis product manufacturers offering goods across multiple categories reached higher profits than those focused on a single category.

Having diversification within a dispensary offers a key advantage in the marketplace.  Companies can leverage their name in one sector to more easily gain valuable shelf space in another category.

When looking at the layout of the dispensary, see if the cannabis-touching part of the business is segregated from the security room, the holding lounge, etc. This is an important feature because the dispensary must report all its revenues, and wouldn’t it be wonderful if the dispensary had clear lines between products that are plant-touching and products that are not? 

We are always faced with IRS Code 280E and the ramifications of losing expense discounts because of the issue of not being able to deduct all business expenses; therefore, it is wise to prepare for this. The layout of the dispensary is very important. In fact, the dispensary owner should consider having his dispensary separated and organized into two businesses, one plant-touching and the other non-plant-touching. This way he or she will have two separate revenue streams: one from the plant touching and the other non-plant touching, i.e. the intellectual property portfolio. This practice will help minimize the tax effect of 280E and if the owner needs more information on how to prepare his business for countering 280E he needs hire a professional cannabis expert, especially as it applies to federal taxation, plus put together a cannabis team to protect the business from potential IRS audits.

Forming a Cannabis Team 

Among professionals, a Certified Public Accountant (CPA) may shy away from plant-touching cannabis touching businesses because of the threat of the IRS claiming there is a chain of money-laundering activity associated with those business.  Unfortunately, the IRS doesn’t show favoritism whether you are a CPA or bookkeeper; anybody that is associated with a cannabis-touching business must take safeguards to protect their license or livelihood. 

I would recommend to anybody in the cannabis business to have their books and records filed in a very meticulous, organized manner...

- William Fowler

As a valuator, one must look for all values that can be gleaned from the detailed interview questionnaire regarding financial information. For example, there should be questions as to how much of their operation is devoted to cost of sales. These are very critical questions because all federal tax as it pertains to cannabis-touching businesses must report an accurate cost of sales expense which will determine the gross profits the business will be taxed upon.

It is important for the dispensary owner to become knowledgeable about 280E and realize that his or her business is not taxed on income before tax; rather, it is taxed on gross profits, hence the importance of the deriving an accurate cost of goods sold. The valuator, in order to perform an accurate appraisal, must have confidence in the numbers presented by the dispensary owner—otherwise all efforts are for nil.

Obtain a Separate Appraisal on the IP Portfolio

There can be the possibility of unseen assets that must be discovered in the interview process. These assets can include IP. Examples of these are trademarks, plant patents, business method patents, trade secrets, etc.

An IP question that would make sense in the interview process is how much does the IP revenue steam account for the overall sales? This is a very important since these revenues will not be subject to 280E taxation and the IP portion of the business will be outside the range of bankruptcy court, should this business fail. One must remember that any cannabis-touching business that does fail will be unsuccessful in bankruptcy court because federal laws prohibit those businesses from filing in U.S. bankruptcy court.

Licenses, Special Permits and Taxes

The state license for this dispensary, of course, will add value and this must also be considered. Question the owner as to what hurdles he or she had to go through to fulfill the state licensing requirements. This question will give valuable information because he might have had to spend capital in improvement of the dispensary, adding wheelchair accesses, complying with all local laws, etc. By gauging the cost and effort to obtain the license is very valuable and could possibly have a lengthy discussion about the capital invested and effort written into the valuation report and highlighted as a significant part of the overall value. The valuator would need to actually see the licenses as voiced by the owner and verified in print; whereas, the valuator should have a statement in the engagement letter from the owner that state and local licenses are current.

The valuator must question the owner of what taxes the business is paying for county, city, retail and see if the local taxes are based on square footage, possibly an absolute amount on sales, or is it a percentage of sales? These questions are pertinent in order to actually come to a reliable after-tax net income which the valuator will need in order to calculate a reliable value conclusion.

Cannabis valuators must always keep in mind that IRS Code 280E and the federal tax rate apply to gross profits, so traditional approaches in valuation must be carefully thought out,  whether it is a cost, market or income approach.

Cost of Goods Sold Review, Ledgers, Bookkeeping

Whenever a valuator is looking to appraise a cash business, such as a cannabis-touching business, then the valuator must impress on the owner that the Cost of Goods Sold ledger should reconcile with all other ledgers of accounts. I would recommend to anybody in the cannabis business to have their books and records filed in a very meticulous, organized manner, so if there is an IRS audit, the paper trail will be consistent, reliable, and less chance of penalties, fines, or interest payable to Uncle Sam.

Interview Efforts Will Pay Off

All the interview efforts, by the experienced valuator will provide a verifiable valuation report, that will reflect what has been gleaned from an extensive, though, interview whereas no missing values are overlooked.