I recently valued an Internet business that had a good looking website and all the desirable social media hooks with respectable follower and fan counts. The site has been in business for many years and the owner loved and nurtured his business. Though revenue had remained steady over the years, the margins of the product he sold were low and so, therefore, were his earnings. He was disappointed when I valued his business because he thought it was worth a lot more.
Compare that with another ecommerce owner, whose business was only few years old. He was still trying to figure out social media and his website needed updates. But he sold customized jewelry at a high margin that was inexpensive to produce and popular among teenagers. He was pleasantly surprised to see my valuation for his business.
How did I estimate the fair market value of each business? By using a multiple of net cash flow. This is the most important number to know when calculating the value of your business. The correct accounting term for this number is “EBITDA” – Earnings Before Interest Taxes Depreciation and Amortization. Over the years of selling ecommerce businesses, I have dealt with many interesting scenarios involving this number. Here are four examples.
- Owner-operator scenario that results in higher EBITDA. Say you have been running your business as an owner-operator and your spouse is on the payroll and you have (dishonestly) expensed your personal car and home bathroom renovation as a “website redesign.” On paper, your business generates $400,000 in EBITDA. But when you add those fictitious expenses back in, the actual EBITDA jumps to $600,000. With a multiple of 3 to 5, your business would be worth $1.8 to $3 million. (See “eCommerce Business Valuation,” my post from 2011, for an explanation of the different expenses that can be added to arrive at an accurate EBITDA.)
- Owner-operator scenario that results in lower EBITDA. Assume your spouse and daughter work in your business full time and you do not record any payroll expense for them. A prospective buyer would likely argue that it would have to hire employees for the duties of your spouse and daughter. A buyer would likely subtract that anticipated payroll expense from your calculated EBITDA.
- Past years’ performance lowers average EBITDA. Say your business recorded EBITDA of $300,000 in 2013. You may assume your valuation is 3 times EBITDA, or $900,000. But, a potential buyer may require financial statements for several years, not just 2013. Moreover, the buyer may require updated 2014 monthly financials from January to March. Depending on the EBITDA for the years prior to 2013 and for the partial year of 2014, the offer from a buyer may be lower or higher than $900,000.
- Capital expenses and improvements did not pay off. Perhaps you spent too much on search engine optimization in 2013 that didn’t result in additional revenue, or you paid heavily to revamp your website to make it responsive. You could argue that the SEO expense was a mistake, and responsive web design was a one-time expenditure that will not be repeated. A buyer would likely agree with not counting the SEO effort as an expense. But a savvy buyer could say website redesign is needed, say, once every three years. The buyer could ask you to count one-third of the redesign expense in your most recent EBITDA.
At the end of the day, you are the owner. You can determine whether to accept an offer. Your business is worth different amounts to different buyers. Remember, no offer is a bad offer until you have a better one.
Have you encountered an unusual EBITDA scenario? Please let us know in the comments below.