If a buyer comes along and expresses interest in buying your ecommerce business and you’re interested in selling it, what do you say? How do you analyze the offer they give you, and what do you sell it for?
These questions are difficult when you’ve been the one working on this business, losing sleep just to get it where it is, and now somebody else wants to take it over. It’s extremely hard to put a price on all that hard work. The best thing to do is to disregard the emotional connection and try to look at it from a logical/numbers point of view.
When a buyer approaches an ecommerce business, they are looking for the rate of return on their investment. When will they get their money back? That’s the big question they are asking overall. It comes down to the business’s profit. What is the profit per year, and how many years will it take to get my investment back? Anyone in that position should be asking those same questions.
Let’s do a quick calculation to that: Your business brought in 220k in revenue last year and you can prove it. Now, the profit for that year was 50k after the expenses are removed. The value of your business would be 50k x how many years the buyer is willing to wait to get their investment back.
The industry average for an e-commerce businesses is 2.62 times your annual net profit:
2.62 x 50k = 75k is the worth of your e-commerce business in this scenario. However, let’s look at what the numbers tend to look more like:
Year 1 – Sales of $220,000 and profit of $50,000
- Year 2– Sales of $805,000 and profit of $140,000
- Year 3– Sales of $1,500,000 and profit of $250,000
- Year 4– Sales of $2,200,000 and profit of $450,000
Based on the data we can make the following assumptions about the value of the business at each year.
Year 1 – Profit of $50,000 @ 1.5X multiple = $75,000
- Year 2– Profit of $140,000 @ 2.3X multiple = $322,000 valuation
- Year 3– Profit of $250,000 @ 3.1X multiple = $775,000 valuation
- Year 4– Profit of $450,000 @3.7 X Multiple = $1.67m valuation
Now, the above example is a simple formula and it tends to be a little more complicated than just that, but it should give you a good middle ground to start from. Other factors that come into play are: the size of your business, how automated it is, it’s profit growth or decline, the diversification of your customer acquisition, the market(s), the product(s), brand, intellectual property, competitors and the overall business model, just to name a few.
Traditional businesses will break their valuation methods down into 3 main factors:
- Asset Methodology – Values the business based on the value of the assets that the company owns (e.g. plant and equipment)
- Future Earnings Methodology – an estimation of the money you would receive from the investment in the future discounting the time value of money
- Comparable Sales Methodology – what have similar businesses sold for and how does that compare to this business
E-commerce businesses are a bit different than traditional business due to their high reliance on goodwill. Where traditional would normally use a discounted cash flow valuation methodology, ecommerce businesses work better with a valuation method based on a multiple of earnings which comes from the Future Earnings category listed above.
Why we use that multiple for average?
Like we mentioned, 2.62 is the average multiple for e-commerce businesses we sold in 2013.
After analyzing 151 e-commerce business transactions in 2013 (shown in image), we can see that the most frequent sales price from our dataset was $200,000 from a total value of all the businesses analyzed of $77 million.
Drop-ship sites vs. owning your own products
Finally, we did analysis on the difference between ecommerce businesses (that own their own products) vs. dropship ecommerce businesses. The red column represents purely drop ship businesses. Generally, drop-ship only style businesses sell for a lower price than traditional ecommerce businesses for the following reasons:
- Easy Business Model Replication – Very little barrier to entry for someone to create their own
- Proprietary of defensible products – There is no intellectual propriety to prevent competitors for copying
- Smaller Margins – They have no way to increase margins other than to negotiate with drop-shippers
- Little chance to discount
- Paid advertising is difficult because of competition
Another item to note from our diagram is how the valuation multiple increases over time. As the business becomes more mature, the amount paid for the business also increases.
The size of your business as a lot to do with the valuation of your business as well:
Smaller Businesses – Your business makes $100-$4,000 in monthly profit than its sale price would be: 100k or less
Medium Businesses – 5k-200k per month or 50k-2M a year in profit. Sale Price: 100k-5 Million
Large Businesses – 2M or more in net profit or EBIDTA per year – Sale Price: 5M+
The valuation multiples tend to get higher as the business gets larger because buyers are more willing to pay a higher multiple for a business that has proven its ability to grow and sustain and the new owners have more to work with as they attempt to accelerate the business growth.
As always the case, if you need help with understanding your company’s valuation beyond the information in this article, Digital Exits provides those answers.