When it’s time to sell your e-commerce business, you undoubtedly want to capture the highest price for it. But how do you know how to value an e-commerce business, or what a fair asking price is and where to start negotiating with potential buyers? Anyone who purchases an established business wants assurance that they’re getting their money’s worth, that the enterprise is sustainable, and has the potential to continue growing.
An e-commerce business valuation is the first step to achieving your goals for selling the company and getting a fair price. Working with a qualified business appraiser is critical to determining your company’s worth, but you should also understand the processes and factors that go into the final dollar amount. In addition to earnings and other specific financials, the value of your business hinges on certain intangibles, like your brand, niche, and operational approach.
Ultimately, any business is worth what a buyer is willing to pay. However, arming yourself with knowledge of the valuation process can help you launch discussions about the fair market value of your company and get the price you want.
The Three Main Drivers of E-commerce Business Value
Regardless of the methods used for e-commerce business valuation, it ultimately comes down to three primary drivers: transferability, scalability, and sustainability.
Transferability is the value of the business without you as the owner. In other words, if your company cannot operate successfully without your guidance or skills, it won’t be worth much to a new owner. In the case of an e-commerce business, this typically boils down to how much time the owner spends on the business each week and whether you automate or outsource tasks.
Scalability refers to the potential for growth. Site traffic metrics, earnings, and growth trends over time can all indicate whether the business is on an upward trajectory. If your business shows a consistent downward trend, doesn’t have a strategic growth plan, or doesn’t appear primed for growth, it won’t be worth as much.
Finally, sustainability refers to whether your business model can remain profitable. For example, if your business focuses on a unique product only available from a handful of suppliers, losing one or more of those suppliers could be devastating. Valuing your business requires looking at every element of how you operate, identifying the risks that could significantly affect the company, and evaluating how well you mitigate them.
The Most Common Methods for E-Commerce Business Appraisal
An e-commerce business appraisal is a detailed process that requires evaluating various factors. Appraisers can use several methodologies when valuing an online retail business, but the most common is the MDE, or multiple of discretionary earnings. This approach calculates your company’s net revenue and multiplies it by an industry multiplier.
Multiple factors determine the industry multiplier for your company; ideally, your multiplier should be between four and six. Some of the determining factors for your multiplier include:
- The number of years you’ve been in business
- Your industry
- Your competition
- Your profit margin
- The business’s growth potential
- How many hours you work on the business per week
- And more
In more practical terms, an MDE appraisal looks like this. You determine that the net review for your online business is $250,000 per year, with an industry multiplier of five. By that standard, your company is worth $1.25 million. This doesn’t mean you will get that much when you sell the company — you could earn more or less — but that is a good starting point for negotiations.
How To Determine Your Business’s Earnings
Calculating the multiplier for your company is only one part of determining an e-commerce business valuation. You also need an accurate assessment of the company’s earnings, and have a couple of ways to do that.
Seller’s Discretionary Earnings (SDE)
Most small businesses use this method to calculate net revenue. This method subtracts overhead expenses and the cost of goods (inventory) from the earnings, then adds the owner’s compensation and non-essential business expenses. Essentially, this number reveals to a potential buyer what they could earn if they run the business full time.
Earnings Before Interest, Taxation, Deprecation, and Amortization (EBITDA)
The EBITDA method is more accurate for calculating net revenue if your business earns over a million dollars annually. It’s a simple formula: add interest, income tax, depreciation, and amortization to your net income to get an overall number for net revenue. Large businesses use this method to compare their revenue to other companies in the same industry to gain a sense of their performance against the competition.
Although it’s the most common, MDE isn’t the only method for determining the value of an e-commerce business. Appraisers can also use two additional methods: discounted cash flow analysis and precedent sales.
Discounted Cash Flow Analysis
A discounted cash flow analysis estimates the future value of an investment in the business. It accounts for the time value of money or the fact that the value of an investment can change over time.
Discounted cash flow analysis determines the free cash flow of your business for the previous year by subtracting expenses from the operating cash. The appraiser uses this information to project a five-year cash flow growth rate.
This method is ideal for stable, established businesses. However, e-commerce is often unpredictable, and cash flow can vary significantly from month to month, so this method isn’t necessarily accurate as a primary method for determining the value of your business. That said, it can highlight fluctuations in free cash flow that prompt further investigation and, in some cases, a better-informed strategy or changes that improve the business’s overall success.
Precedent sales simply refers to looking at recent sales of similar businesses to get a ballpark estimate of what your company is worth. This approach is by no means an accurate e-commerce business valuation, as it doesn’t reveal all the metrics and factors that went into the final selling price. Still, gathering this information provides a valuable point of comparison, as it can reveal whether you might be over- or undervaluing your company.
Factors Influencing the Value of Your Business and the Industry Multiplier
At its core, an e-commerce business valuation requires examining a few critical value indicators. Some of the key metrics in e-commerce business valuation include:
- Revenue growth
- Revenue per client
- Customer satisfaction
- Client retention rate
- Profit margin
- Customer acquisition cost
- Customer Lifetime Value Analysis
These KPIs influence the industry multiplier an appraiser uses to calculate your business value, but the process also includes looking at some other factors.
The current state of your company’s finances is a major driver in its overall value. Appraisers will examine how long you’ve been in business and the overall performance over the last three years. This analysis also requires looking at the costs and evaluating whether a new owner can replicate the cost structure and whether there are cost reductions and savings opportunities.
Some of the other factors that go into the financial analysis include the following:
- Assets and liabilities
- Ongoing market demand
- Anomalies in the financial reporting
- Supplier agreement
Website traffic is the foundation of any successful e-commerce operation, and demonstrating that your site gets plenty of high-quality traffic is an important component of your business’s value. It doesn’t matter if your site gets thousands of visitors from a referral link or viral social media post if none of those visitors actually makes a purchase. Therefore, you must demonstrate consistent, high-quality website traffic from diverse sources.
Evaluating your e-commerce business’s traffic involves looking at the following:
- Traffic trends over the previous weeks, months, and years
- Industry trends
- How much traffic comes from searches and is vulnerable to algorithm changes
- How much traffic comes from referrals and whether it’s sustainable
- Whether your site has Google penalties
How your business operates is another critical element in evaluating its value. As discussed previously, your involvement as the owner significantly affects the company’s transferability. Your technical skills, reputation, relationships with vendors and customers, and overall oversight of day-to-day operations could determine whether buyers have an interest in the enterprise.
The technical aspects of your operation are also of concern. If your company uses a well-established platform like Shopify or WooCommerce, there’s less of a technical burden on a buyer than if you utilize a custom-designed proprietary system. A custom system requires specialized knowledge and a trusted developer, representing an additional expense and burden for a buyer.
The more well-established your brand, the more your company is worth. Your brand sets you apart from the competition, establishing a loyal customer base while attracting new business. If the only thing that makes you different from your competition is the price of your products, then your business won’t be as valuable or successful as it could be.
Some of the ways an appraiser might gauge your brand value include:
- Customer reviews
- Google search rankings for your business name and product or service
- Social media chatter
Ultimately, a portion of your business’s value rests on what differentiates it from the competition.
Whether or not your business fills a niche — and how well — is another component of your e-commerce business’s value. Succeeding in a competitive area will increase its value considerably, especially if it’s growing. Appraisers consider whether the niche is growing, how hard it is to enter, and the trends or factors that have the potential to influence its growth when valuing your company.
Knowing your ideal customer and how to reach them is a key component of starting a successful business, and maintaining that in-depth understanding of your customer base is crucial to ongoing success. A solid, well-understood customer base plays a part in your company’s value, as the appraiser will look at not only your customer demographics but also how you acquire customers, how much it costs to obtain them, and their overall lifetime value.
In short, the more solid your customer base and the faster it’s growing, the more value it adds to your company — and vice versa.
Product and Market
Last but not least, your e-commerce business value depends on the products you sell. Buyers want to know your product mix and what brings in the most revenue, current and projected demand, and the sources for products.
One important part of this evaluation is a close look at the product suppliers and how they influence cost. For example, if the current owner has a special agreement with suppliers, whether or not that agreement extends to a new owner can make a significant difference to future operational costs and, subsequently, the value of the business.
Preparing for an E-Commerce Business Valuation
The best way to determine the value of your online business is to work with an appraiser or business broker who can provide an unbiased third-party review of your business. While you may be able to determine your company’s net revenue independently, establishing an accurate industry value for your company is a complex process. Unless you have the knowledge and insight to address all the relevant factors, you risk overvaluing or undervaluing your company.
When you work with an advisor or broker, you’ll need to provide paperwork that backs up your claims regarding revenue, expenses, operations, and more. The more detailed the information you provide, the more accurate the valuation. At a minimum, you should expect to deliver the following documents to the appraiser or business advisor:
- Financial statements detailing revenue and expenses
- Details about assets, including depreciation information for fixed assets
- Profit and loss statements
- Tax returns for at least three years
- Accounts payable records
- Accounts receivable records
- Payroll records and copies of employment, freelancer, and contractor contracts
- Vendor/supplier contracts
- Loan documentation
- Website traffic details, including site analytics, paid search and advertising analytics, and SEO details
- Customer demographic information
- Cash flow analysis paperwork
This is only the basic information you need to prepare for the valuation. Your appraiser may request additional information to make the most accurate estimations. Keeping detailed and verifiable records is critical to running an efficient business, so make it easy on yourself and maintain well-organized files.
Experienced business advisors and appraisers know how to use this information to make accurate projections about your business and its place in the future. They understand the industry and what to look for in order to give you the most precise valuation of your company.
Not Selling? You Still Need a Business Valuation
An e-commerce business valuation is a crucial first step to selling your company, but you shouldn’t wait to assess its value until you’re ready to put your company on the market. Yes, the process can be time-consuming, but the benefits can help you grow and refine your goals for a more streamlined and profitable organization.
Determining the value of an e-commerce business can help you access loans or other funding to support the company. A comprehensive and detailed valuation provides more leverage when working with banks and investors and clearly shows where your company started and how it’s growing.
A business valuation also ensures you have accurate and up-to-date numbers for tax and legal purposes. You’ll have it readily available whenever you need to provide details about your company’s earnings.
How To Increase the Value of Your E-Commerce Business
If the results of your e-commerce business valuation aren’t what you expect, or you want to increase its value before putting it on the market, a few strategic moves can help. Moving the key metrics in e-commerce business valuation takes time, but with patience and focused effort, it’s possible to make a measurable difference in the company’s overall value.
Reduce Owner Involvement
In general, the less involvement an owner has in the company’s day-to-day operations, the more it’s worth. Owners should always look for ways to streamline operations and reduce their burden via automation and outsourcing.
Not only does this improve work/life balance and make the company more appealing to a buyer looking for a turnkey operation, but the less involved the owner, the easier it is to scale the company. After all, there are only so many hours in a day. Trying to take on too much as an owner will inevitably become unmanageable and keep you from leveraging opportunities.
Improve Customer Service
Turning your attention to customer service and finding ways to cut down on the time and labor involved without taking away from the customer experience (or even enhancing it) accomplishes several goals. First, it frees up resources for other priorities. Second, excellent customer service is one of the building blocks of a successful brand and will help attract and retain loyal customers.
You can streamline customer service activities in many ways while still giving people what they need. Some of the ideas you can implement include:
- Developing a knowledge base on your website to support self-service
- Using chatbots and live chat
- Offering social media-based customer service
- Including more self-service options, like an account history, the ability to change or update accounts, and order tracking
- Improving product descriptions to reduce customer questions and returns
Secure Supplier Relationships
Supplier relationships are integral to keeping your business running. If your suppliers only want to work with you, or the basis for your agreements and pricing is little more than a handshake, that could spell trouble for the value of your business.
Formal supplier agreements provide greater peace of mind and stability to your company. Put all agreements in writing, ideally with a clause noting that the terms carry over to new ownership. Formalizing these agreements is imperative when you only have a few supplier options; if a new owner cannot reach a deal with a critical vendor, the overall business can be devastating.
People interested in purchasing an e-commerce enterprise are, on the whole, non-technical people. They lack the technological skills to maintain a complex platform without help. If they have to hire or outsource the business’s technological components, it will take a big bite from their profit.
One step toward simplifying the technical aspects of your business is to follow coding best practices. At the core of these practices is the need to make it possible for any experienced developer to change the business back end. Updates, upgrades, and changes are inevitable, so following standard practices and annotating the code is critical.
While it’s ideal to use an established e-commerce platform, if you utilize a proprietary system, you need a reliable and knowledgeable developer (either on contract or in-house) to manage it. Otherwise, your business value could decrease because a buyer must find someone to handle the back end or move to a different platform.
Address Legal Concerns
Potential legal pitfalls can also affect the value of your business. For example, if you work with freelancers, it’s critical to explicitly state that you own the copyright on any work they create. Without this documentation, buyers may hesitate to purchase your website for fear of future legal action on the part of the creator.
Other legal issues you need to address to increase the value of your company include:
- Securing intellectual property
- Identifying the specific assets that would transfer in the sale of a business
- Securing proof of resolution of any previous legal disputes
Continue Running Your Business
Undergoing the valuation process is challenging and can take a great deal of time. However, even if you plan to sell the company, it’s important to continue running your company and taking care of the day-to-day tasks while the process is ongoing.
Until you have a signed contract and hand over the proverbial keys to the new owner, the business is your responsibility. You cannot “check out” too early, as doing so can harm the company and reduce its value. Staying on track, working toward your established goals, and maintaining the upward trajectory ensures the buyer gets the business they expect.
Get Help With Your Online Business
Whether you’re thinking about selling your thriving e-commerce company or just want to know how much your business is worth and its growth potential, Top Hat Business Brokers can help. Get in touch with us today to discuss an e-commerce business valuation and how we can assist you.