As legal marijuana markets have matured in Washington, Oregon, California and elsewhere, so too have the kinds of legal disputes involving marijuana businesses. Increasingly common are legal disputes between owners of a marijuana business that involve allegations of financial malfeasance, breach of fiduciary duty, freeze-outs, fraud, and other claims common to business litigation outside of the marijuana context. In litigation between members of a limited liability company, expulsion of the member alleged of wrongdoing is a common remedy.
A common question in such cases is how much the member’s interest in the company is worth? In other scenarios, the litigation realities may lead the members to decide that selling the company is the best move, and so a critical question is what is the business worth?
Back in 2014, we wrote about the speculative nature of valuing marijuana businesses because of the lack of market data, Marijuana Business Valuations: Still Mostly an Art, not a Science. A couple of years later, Vince Sliwoski wrote about valuation in the context of purchasing or investing in a marijuana business, Your Marijuana Business: What’s it Worth? At that time, we were aware of just one accounting firm (actually just one accountant) who claimed to have interest in marijuana businesses. In a follow-up post in 2017, Your Marijuana Business: What’s It Worth? (Part 2), Vince noted that things were changing fast and noted that Cogence Group PC and other reputable CPAs were beginning to provide valuation and other accounting services to marijuana businesses.
Today there is no shortage of firms providing valuation services to cannabis businesses. The fundamentals of valuation remain the same — our prior articles explain the common methods of valuing businesses and the pros/cons of each in the context of marijuana businesses. So I won’t repeat that overview here.
One problem that remains for strict market-based approach to valuation, i.e. looking at other actual sales of businesses, is that data can be hard to come by. Many transactions remain private and unreported on any public database. That said, there is much more information available than a few years ago including from sites like CannaMLS, 420Property, and consultants who specialize in assisting sellers and purchasers of marijuana businesses.
Valuation in the litigation context is not dramatically different than the non-litigation context. As with nearly every aspect of a limited liability company, the operating agreement is the starting point for how to value the business or a member’s interest therein. A good operating agreement will include specific provisions setting forth an agreed-upon method of valuation for the dissociation of a member – whether forced or voluntary and whether for dissolution or sale of the business. The members may agree to use a specific appraiser, or agree to methodology for selecting an appraiser or competing appraisers, as well as (critically) a provision in which the members agree to be bound by the valuation of the appraiser.
In the absence of specific provisions or where the provisions are unclear, valuation becomes a battle of experts unless the litigants can agree to jointly retain a valuation expert and agree to be bound by the expert’s determination. Experts are expensive. Along with paying the expert to analyze the company financials and prepare a report, (easily tens of thousands of dollars), litigation costs include paying your attorney and your expert to prepare for a deposition, preparing for direct examination, and preparing for cross-examination. And of course, your attorney will want to depose the other side’s expert and prepare for cross-examination. (One caveat to this is that in Oregon state court there is no expert discovery).
Although experts typically are not retained until later in litigation during the discovery process as the case gets closer to trial, it often makes sense to retain an expert early in the process. The value proposition for doing so is that an early “rough” analysis by your expert can inform whether litigation through trial makes financial sense and it can inform settlement discussions. You can also “tie up” an expert if you have a clear preference, and don’t want that person to be hired by the other side.
Ultimately, it makes little sense to spend hundreds of thousands of dollars on attorney and expert fees if the business or member’s interest is not worth significantly more than the cost of litigation. A litigant armed with a reasonable estimate of value can negotiate potential resolutions with a more clear-eyed view of what is reasonable in light of the costs of litigation.