Practical Ecommerce

eCommerce Business Valuation

eCommerce entrepreneurs often ask me what profit multiple they should use to calculate their business value. Profit multiples are a valuable tool to find a direction or a range of selling price but you can’t rely on them to determine exact value of your business. You will regret if you simply use rules of thumb profit multiple to calculate the selling price for your eCommerce business. If I get a call from an internet entrepreneur asking me how much he can sell his business for if he was making a net profit of $X a year, I would not be comfortable giving him a valuation without having a discussion and getting more information about the business and how net profit was calculated.

Before you begin to apply any rule of thumb to calculate the value of your company, you must first look at the viability of your ecommerce business in the future. You were doing great when you started your business 6 years ago because no one else was selling the products you sold. You were unique and it was easy for your customers to find you in search engine results. Not so lately. For past couple of years, hundreds of internet stores have mushroomed that sell the same products that you do and at prices that are unbelievably low. You are forced to lower your margins to survive and as a result your business is trending down. It is getting more and more difficult to get noticed in a crowded internet space with large online retailers like Aamazons and eBays of the world. If you feel this applies to you, you are not alone. Three in every five web based business I review are affected one way or the other due to dwindling economy and increasing competition. Financials are a representation of the past and only give a possible indication of the future. Your business must have some uniqueness to it so it can survive successfully in a highly competitive internet space. Your revenue and profit numbers over the years tells a lot about viability of your business and buyer look at them first to filter those that do not fit their expectations.

When using rules of thumb to arrive at value of your company, it is important to arrive at an accurate profit number, also known as Sellers Discretionary Earnings (SDE). Usually this number is arrived at by adding business’ taxable income ( EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization ) plus the owner’s benefits and discretionary expenses charged to their business (owner’s salary, write off of a company car, health insurance, country club membership, boat, contributions, any personal expenses hidden under various expense account etc.) – the resulting number is typically very much larger than the company’s taxable income or net profit shown on a P & L. Any non-recurring one time expense can also generally be added back. In addition, if you have any income that is not reported on your P & L statement should also be added back (e.g. payments made by check or money order that you forgot to include in your P & L). This SDE, when multiplied with industry specific rules of thumb multiple will give you a selling price that you adjust based on number of other factors discussed below.

Another observation – If you are in early years of growth and you have increasing revenue year to year but you are investing all of your profit back into your business to grow it, you may not show positive bottom line but your business may be the best investment buyer can make. That is why such one-time expenses done to grow the business (e.g. purchase of an order fulfillment or inventory management software) can be added back with appropriate explanation. Many “first-time” business buyers who are in the market to buy internet businesses are sometimes too much possessed with the net profit number and you can’t always assume that they will appreciate the difference between operating expense and such one time expense.

Most businesses are valued at a multiple of SDE and adjusted up or down based on factors that affect the value. This is more an art than a science and this is where you need help from an experienced intermediary. Examples of factors that bring business value up are increasing sales/revenue, profitability, repeat customers, having B2B and B2C clients, solid natural search engine ranking and page rank, strong face book and twitter following and referrals, higher back links, strong market position, existing long term contracts, seller’s willingness to finance some portion of the purchase price (shows seller confidence) and upside potential for business. Businesses that can be run without too much involvement from the owner also demand higher price. Some buyers also have preference for drop ship business because they don’t like to manage inventory. Factors that bring business value down are declining revenue and/or profitability, increasing competition, declining Google analytics (i.e. unique visitors, lower conversion rate) lack of longer history (i.e. newer business) , increasing Google Adwords expenses to maintain the revenue, lack of natural search rankings, lack of owner financing and lack of well maintained books etc.

Before sharing multiples of SDE that applies to eCommerce businesses, I would like to emphasize that it is important to note that size matters. Amazon stocks (NASDAQ: AMZN) trade at 86 times the earnings – will you be able to sell your business at that multiple? You know the answer and answer is “No”. So, how much does a size of a company affect its valuation? “Significantly” – as it turns out. Larger companies have strong brand name, higher liquidity and are considered less risky. It is easy for them to obtain financing and they enjoy higher multiples. Using data from a study of thousands of small business sales across different industries: average SDE multiple for companies up to 1 million in revenue was 2.2, and for companies with revenue between 1 and 5 million was 2.9.

As it turns out, data for internet business sales is not all that different from the overall “main street” businesses. From a comparison of 2009 internet biz sold data we have, for businesses with SDE of 200K or more were sold at an average multiple of 2.18 with a mode of 2.9. That number for businesses with SDE between 100K and 200K was 2 with a mode of 2.65 (The mode of a set of data is the value in the set that occurs most often). Since some businesses were sold at exceptionally low ratio bringing the average down, mode is a number I would use as a starting point and adjust it upward or downward based on factors discussed earlier.

As per LoopNet Inc., one of the largest companies that tracks privately held business sales transactions, Business for sale market “closed” business transactions bottomed out in the third quarter of 2010 with sellers dropping asking prices to get the deal done and has recovered to a level not seen since the Second Quarter of 2010. The median sale price for businesses sold increased 3.3 percent from the First Quarter of 2010 to the First Quarter of 2011.

As you can see, knowing the value of your company’s worth is the first step toward maximizing your sell price. What questions come to your mind when you begin to value your business?

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Comments ( 9 )

  1. Ecommerce Exit Strategies May 26, 2011 Reply

    Manny,

    Great article, Based on our in-house metrics (a combination of our deals an industry data) valuation multiples have dropped from an above 3x average in 2008 to closer to a 2.6x through 2009 and 2010.

    As you noted rules of thumb on there own are an incomplete method of valuing a business. Rules of thumb are typically a simplified Industry average and will not take into account any specifics of an opportunity. We have found that rules of thumb do offer a good starting point for conversations between business broker and business owner that can outline the tangible and intangible assets that will effect valuation and adjust the multiple. In conversations with buyer prospects, rules of thumb multiples often come up, especially if a business is priced higher than a standard multiple in which case the higher valuation can be tied to the specific assets that adjusted the multiple.

    Cash continues to be KING and SDE and EBITDA are the main value driver for the vast majority of our opportunities. We have seen an increase in the number of Industry buyers who are looking to grow through acquisition. In these types of situations web specific assets, such as search engine rankings, established Ebay or Amazon storefronts, etc may play an equal or primary role in valuation to the buy side.

    With different approaches for marketing a business for sale to private vs Industry vs Equity buyer types it is important for a business owner or business owner and broker to discuss which buyer type is the most likely. A business may have a different value to each buyer type, the difference in valuation may be substantial, understanding which type would likely be interested can reduce time on market, and possibility of leaving money on the table.

    Typically business owners know more about there current industry trends than they may initially realize so conversations about industry competitors, consolidation, and trends can lead to a well defined marketing strategy with an appropriate valuation.

    I look forward to more articles.

    Warm Regards,

    Brad Yeager
    Founder, Ecommerce Exit Strategies
    Certified Business Intermediary (CBI)
    http://www.EcomExit.com

  2. Manny Shah July 17, 2011 Reply

    Thanks Brad. I appreciate your comment and thoughtful observations.

  3. rknshah July 24, 2011 Reply

    Manny,

    Valuation of any biz is difficult as buyer will pay for future earnings while looking at past earnings. Remember the crazy valuation based on eyeballs before tech bubble got busted.Biz with stable earnings can be valued on PE or EV/EBITDA or P/BV basis however eCommerce Biz is generally start ups without long history of past earnings. I feel buyers should concentrate on many intangible aspects like human capital , Supply Chain , USP of biz model , Visibility of biz , Customer perception and tangible aspects like Enterprise Value , Past as well as projected earnings , Customers list etc. Valuation arrived by combination of various above variables will be more based on realism and not only perception.

    Look forward to your comments.

    Regards

    Rakesh Shah

  4. Manny Shah August 9, 2011 Reply

    Thanks for your comments. You raise a good point on importance of intangible factors. That is why valuation is sometimes more art than a science, explains why two same size company in a similar industry can be valued significantly differently from each other and underscore the importance of using these ratios just as a starting point.

  5. Michael Gravel August 22, 2011 Reply

    Manny,

    Excellent article with astute observations. For the past decade we have seen continued margin erosion swallow up more and more B2C eCommerce businesses. In fact we anticipate Amazon itself to experience some erosion of its margins as other major retailers such as Walmart, JC Penny, Sears etc, apply the Amazonian model to their websites. The proliferation of which will no doubt buckle the knees of many online product based businesses who simply cannot compete on both SEO and price as a result of being too far removed from the manufacturer. For example a B2C client of ours with $8 million in gross sales in the health and wellness electronic space was unable to meet prices found on Amazon for Polar heart rate monitors even though he was getting the best price possible in the USA. It is likely the product is being sold direct from a buyer who "walks up" and purchases right from the manufacturing plant itself.

    As a result we anticipate seeing more of our private equity buyers include the acquisition of a distributor, (who possibly is also selling direct online) as part of a roll up strategy. As overall sales online continue to grow, you might here of PEG firms buying the manufacturers too.

    Michael Gravel
    Managing Director
    iMerge Advisors Inc
    http://www.imergeadvisors.com

  6. Wes Grasty February 10, 2013 Reply

    Great article! I was hoping you’d give an estimate or multiplier for a drop ship only internet business. Any ideas?

  7. Chris Manley August 26, 2013 Reply

    Hello all -

    My business partner and I are seriously considering an internet retail business and we need some help. (We are real estate investors, I am always shopping online with a pretty good understanding of technology, but admittedly we are a little out of our element on the valuation/purchase) We plan to hire an attorney and a business consultant if we can find one who specifically works with online businesses. This article was a good start by the way.

    The business is drop-shipping an electronics product in a specific niche – open box new items – through eBay and Amazon only. No public website yet, nothing is sold through Facebook, CraigsList or anywhere else which I would like to add to the business. (I have contacts in web development and SEO who can assist me with beefing up our online and local presence)

    The business largely depends on the owner’s relationships with her specific suppliers and her sellers eBay and Amazon. I am concerned that the business is almost too good to be true considering the owner works 15-20 hours per week in the slow season and 40-50 hours per week during peak times, yet the business is incredibly profitable. After a great conversation with seller who sounds very savvy, we’re still wondering if there is a possibility that this business flops in the next 2-5 years for any reasons beyond our control. (We can technically make our investment back within 2 years by the way)

    My specific concerns are:
    - Long term viability of the business model which is dependent upon these relationships. How much should I be concerned if she has developed and nurtured them and there is currently no issue? How much do I have to worry about another competitor stepping on our toes despite us being the largest retailer doing this with them right now? Will her sale of the business to us in any way affect the relationship if we’ve transitioned smoothly?
    - Impending online retail sales tax law. Are there any studies calculating how this might affect an online business? Will customers gravitate back to brick and mortar or can we still remain competitive enough? After all it is a niche item but I want to make sure that I understand what’s on the horizon.

    As I mentioned we need a good attorney and a consultant if we are going to feel comfortable enough to purchase this business. We are in Massachusetts. Please let me know if you have any good resources who can work with us. Any insight into the questions I’ve posed would be greatly appreciated as well.

    Thanks in advance, Chris

    • Adam N. April 2, 2014 Reply

      Hey Chris – did you end up buying the business and starting your website? Give us all an update! Sounds like it was an interesting opportunity :)

  8. Manny Shah August 27, 2013 Reply

    Thank You for your question. See my comments below to some of your concerns:

    ” I am concerned that the business is almost too good to be true considering the owner works 15-20 hours per week in the slow season and 40-50 hours per week during peak times, yet the business is incredibly profitable. ”

    Above is a legitimate concern most buyers have about sellers claims. Key question is how flexible the seller is to make you feel comfortable to address your concerns. Here are five questions I would consider asking to feel comfortable about what seller is claiming:

    (1) How long is this business in play? If it is several years and growing year to year it is a healthy sign. If it is only one year old, I would dig deeper as to why does he want to sell such a profitable business.
    (2) Is he willing to validate his claims? You should begin by asking him to provide you with eBay and Amazon transaction data for past 12 month. (of course you should have some paperwork in place before seller would agree to provide you this much detail but that does not have to be legally binding to you)
    (3) Key question is to verify the cost of goods. At appropriate time (and before your commitment to purchase) is he willing to prove his COGS is what he claims it is?
    (4) You mention, it does not have positive reviews – I wonder how can someone sell on eBay and Amazon platforms without substantial positive reviews, unless of course if no one else is selling these products – which I hard to believe would be the case.

    ” My specific concerns are: Long term viability of the business model which is dependent upon these relationships. How much should I be concerned if she has developed and nurtured them and there is currently no issue? ”

    Again, this can be verified prior to you committing to buy this business. Currently you simply have to ask if all supplier relationships can be transferred with the same terms and is there any reason why you will not be able to work with all of his suppliers with the same terms he is getting. At this point, his confirmation should be enough. Before you commit to purchase a business though, this should become one of the contingencies for a closing to happen.

    “My specific concerns are: Impending online retail sales tax law. Are there any studies calculating how this might affect an online business? Will customers gravitate back to brick and mortar or can we still remain competitive enough? After all it is a niche item but I want to make sure that I understand what’s on the horizon.”

    You are asking a question which is in every new and existing ecommerce store owner’s mind. New sales tax law is actually a good thing for smaller eCommerce businesses whose revenue is less than 1 million a year. From a CNN article “It will be possible to avoid sales taxes by buying from small out-of-state retailers making less than $1 million a year and not reporting use taxes when you file taxes.” ( http://www.cnn.com/2013/05/06/tech/web/internet-sales-tax) If this store is or when it will do more than 1 million in sales, I wouldn’t worry about it now because you would have learned many more ways to compensate for it in your journey to grow your business!

    ” (We can technically make our investment back within 2 years by the way)”

    You are alluding to the asking price here. If above thing checks out for you, asking price is not unreasonable. Per my article above on eCommerce valuation, most rules still apply that I mentioned in this article. In fact this business offers you two separate revenue channels. I strongly recommend business owners to adopt to multiple sources for revenue to reduce their dependence on any single source. When you start a website as an add-on to this business, you can add both natural search and PPC as another two sources of revenue.

    Hope things work out for you. Keep us in loop !

    Manny Shah

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