Whether you’re looking to sell your ecommerce business or are interested in buying an online business, the question of its value will be of equal significance. And yet, ascertaining a realistic value for an online business – which may well have very few, if any, tangible assets – can sometimes seem about as scientific as sticking a finger in the air.
So how do you value an internet business?
Look at any listing for the sale of an online business and you will inevitably encounter the enticing prospect of ‘unlimited earnings potential’. As an online business owner looking to sell, you may genuinely believe that to be the case. However, as a prospective buyer, you are more likely to be sceptical about such claims and, often, rightly so.
Nevertheless, potential can have a very real value for an online business – just as it can for a traditional bricks and mortar business. As a case in point, Twitter launched on the market valued at a whopping £11 billion – despite never having made a penny’s profit.
Valuing an Ecommerce Business
The key for ascertaining a realistic value for an online business relies on a combination of:
- careful consumer and market research and
- the application of a number of valuation factors used for more traditional businesses.
1. Consumer and Market Research
When valuing an online business, perhaps more so than with any other business, and particularly for fledgling businesses, it is essential to carry out a thorough analysis of consumer and market trends. This sector is subject to rapid continuous development and online customers are fickle.
What might be the people’s favourite one day could be history the next; it’s easy to make costly mistakes. In 2005, ITV bought the website Friends Reunited for £175m. Four years later, it was sold on to Brightsolid for just £25m. The business had been superseded by the next big thing (Facebook); its customers had moved on.
Whether you are buying or selling an internet business, you need to do your research into the markets you are, or will be, operating in.
- What are the forecast trends?
- How achievable is the predicted growth and what are the competitive threats?
- How easy will it be to convert non-paying visitors into revenue?
2. Traditional Valuation Factors
When calculating the value of an internet business, you will also need to consider more traditional factors:
(a) Asset valuation
If the internet business in question sells products, then there will be stock, equipment and premises to take into account.
Other assets of an online business, however, can be much harder to value. For example, intellectual property, reputation, customer databases, the quality of a product/service, and goodwill. What these intangible assets are worth will come down to an assessment of financial factors, such as the strength of the sales pipeline, and perceived position of the business in the marketplace.
(b) Financial performance
You will need to look at the historic performance of the business, including cashflow and net profit.
A professional accountant or broker is likely to recommend a P/E (price/earnings) ratio, whereby the business is valued at an industry-recognised multiple of the annual net profit. A successful internet business generally sells for between 2 and 3 times its annual net profit, sometimes more, sometimes less.
If the internet business in question is relatively new and has few assets, it may be valued according to a discounted cashflow method. This entails analysing the predicted future cashflow over a number of years and then discounting this to take into account both the delay the buyer will experience before realising the cash and/or the prospect that the cashflow fails to materialise.
(c) Entry cost
If your business is still relatively young and you don’t have years’ of accounts to rely on, another method of valuation might be to establish how much it would cost an individual to set up the same business from scratch including, eg, the cost of any premises, assets, stock, marketing costs and staff training costs.
However, such valuations will not take into account the time and effort invested by the seller in getting the online business off the ground and developing its potential growth.
(d) Personal circumstances
Why is the seller selling? If he or she needs a quick sale because of illness, relocation or relationship issues, this will reduce the value of the business.
And if a buyer needs to borrow a significant sum of money to fund the purchase, or is desperate to get a slice of a competitive market, this could have an impact on the value of the business too.
(e) Operational factors
Is the online business dependent on the skills and knowledge of the seller? Or does it have established systems, procedures and trained staff who can operate the business independently of the owner?
A business that can operate without the owner’s input will attract a higher value, as will a business that is scaleable.
The Golden Rule When Valuing an Online Business
As with any business, as a seller you must remember that the value of an online business is only what someone is prepared to pay for it. And, as a buyer, don’t believe everything you’re told by the seller – dig deep for the real reasons behind the sale and do your homework.
In both case, it pays to get a professional objective opinion.
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