The old saying goes that something is worth whatever someone is willing to pay for it.
As an e-commerce business owner, you have probably always been curious as to what your business is worth. Also, there will come a time when you consider selling your eCommerce business and the first thing you need to know is its value.
Here, we’d like to give you a sense of how an e-commerce business can be objectively evaluated.
Valuation Method
Most valuations of an e-commerce business look at the historical earnings—the net profit of the business for at least the last twelve months—and apply a multiplier (typically between 1.5 and 3.5, though some calculations put the multiplier as high as 5) to arrive at the company’s valuation.
Let’s quickly look at this in action. Assume there is an e-commerce business that has made £100,000 net profit in the last 12 months and has been given a multiple of 2.75x based on many factors. With this information, we can calculate the value of the business, which would come out to be worth £275,000. This gives an example of how a multiple is used to reach the valuation for the business.
Some of the most important factors are revenue growth, consistency, scalability and the amount of work required to operate the business. Somewhat simplistically, the more favorable factors presented, the higher the multiplier and, hence, the higher the valuation.
Discounted Cash Flow Analysis, (DCF)
Essentially this is an estimate of future return on investment, adjusted for the time value of money (i.e., £100 received today is worth more than £100 a year from now because today’s £100 invested at, say, a 10 percent rate is worth £110 a year from now). Basically, DCF calculates the last year’s free cash flow (FCF) by subtracting capital expenditures from the period’s operating cash flow.
Due to the wide variance in monthly cash flow typical of e-commerce ventures and the volatile nature of e-commerce markets in general, DCF is not well-suited as the primary method to value an e-commerce business.
for example, show a significantly improved FCF in the current year over last year, prompting an investigation into its cause and likelihood of continuing.
Precedent Sales
While also not a primary valuation method, the acquisition price of similar companies in similar markets can provide some useful points of reference. It is therefore important to identify the metrics used for the transaction to come up with an accurate comparison. Even then, this is more of a "reality-check" than what ultimately determines an e-commerce company’s valuation.
Valuation Factors
Traffic:
Traffic is the heart of any e-commerce businesses. Without traffic, an e-commerce business would be worthless because you wouldn’t be able to make any sales. For that exact reason, traffic plays a key role in the valuation process.
For example, a store might get 500 visitors from a viral Facebook post, but if that doesn’t lead to any sales the traffic was all for nothing. For this reason, traffic stats can sometimes be misleading in the valuation process and requires sufficient research to determine the quality of the traffic.
For example, if Google organic traffic has a RPU of £.50 and Pinterest has a RPU of £.03 it’s easy to tell which traffic source is better and of higher quality.
When it comes to traffic the higher quality and more diversified it is, the higher the entire e-commerce business will be valued.
Financials and Operations:
E-commerce is a business like any other, so of course you want to know the usual financials such as gross revenues and net income, profitability, costs of inventory and operating expenses, among other standard measurements. Other operational factors to consider include:
- Product concentration - To what degree do revenues depend on certain products? Are there too many products that account for insignificant percentages of total revenues?
- Underlying cost structure - Can this be easily transferred to new ownership and replicated?
- Supplier Agreements – Are the current suppliers willing to stay on board with the new owner?
- Scalability - Can current operations ramp up and expand under new ownership without incurring prohibitive costs?
- Assets - Is there physical property that has value to new ownership? What is the book value of the business if everything was sold?
- Payroll - Are current staffing levels sufficient, how are they managed, are salaries competitive to retain essential talent, and will talent likely stay if ownership changes?
- Trademarks and Licenses - Are there any proprietary products or processes that provide unique competitive advantage?
- Liabilities - What debts does the company have, what is its credit history, has the company every had difficulty meeting its debt obligations?
- Future commitment - What is the minimum time and expense that a potential owner must be willing to commit to run the business?
Customer Base/Market Niche:
An active customer base will increase the value of any e-commerce business. An active customer base is one that has repeat customers and people that keep coming back to make purchases. This is a sign of a business that produces great products and has built solid relationships with their customers.
On the other hand, an e-commerce business that sells to a customer once and then never hears from them again is not going to be valued as highly. Here are some other factors to consider:
- How does the e-commerce business acquire customers, and what are the costs of customer acquisition?
- Number of competitors for the particular market niche(s)
- Existence of an established mailing list
- Churn rate
Brand Differentiator:
An e-commerce site with an established and well-recognized brand identity is worth more than a business in the beginning stages of establishing a brand.
Owner Involvement: This could be the factor that could make or break a deal for any e-commerce valuation. To what extent can the website business continue to operate successfully without the current owner at the helm, either because of the owner’s technical knowledge, relationships with customers and employees, and/or reputation in the industry?
