The founder of a merger and acquisitions consulting firm examines how e-retailers can know the value of their business.
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. This article is a quick synopsis on how you go about valuing an e-commerce business.
What goes into a valuation?
Traditional business valuation methods can be broken down into three main styles:
- 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
A traditional business valuer would generally use a discounted cash flow valuation methodology when valuing a business, however because e-commerce businesses are slightly different to traditional businesses, mainly due to their high reliance on goodwill, the accepted valuation method used is a multiple of earnings method and a valuation from a more specialized service is recommended.
A multiple of earnings method comes from the future earnings method category. How a multiple of earnings valuation methodology works is that the net profit of a business is determined for the last twelve months. Then a multiple of that profit is applied to determine the valuation.
And the average multiple is?
2.62, that is the average multiple that e-commerce businesses we selling for in 2013. This is the multiple of earnings that e-commerce businesses are selling for.
A multiple of 2.62 means that on average e-commerce businesses are selling for 2.62 times net profit. Now there are many factors that go into a valuation and determine whether a business is worth more or less including things like growth trends, traffic sources, business model etc.
The above image represents that results of analysing 151 e-commerce business transactions in 2013. From the data you can see that the average multiple was 2.62, the most frequent sales price from our dataset was $200,000 from a total value of all the businesses analysed of $77 million.
Let’s use the example below to explain in detail how the multiple of earnings valuation methodology works.
Let's use this example
BeardBrand is a consumer retail business that sells a range of men’s grooming products including their most popular range of beard oil products who has blogged on reddit about their journey to $100k per month in sales. The below data is an estimate of their sales and profit projections.
Year 1 – Sales of $220,678 and profit of $50,088
- Year 2 – Sales of $805,831 and profit of $140,436
- Year 3 – Sales of $1,532,685 and profit of $249,736
- Year 4 – Sales of $2,249,128 and profit of $456,089
Based on the data we analysed we can make the following assumptions about the value of the business at each year.
Year 1 – Profit of $50,088 @ 1.5X multiple = $75,000
- Year 2 – Profit of $140,436 @ 2.3X multiple = $322,000
- Year 3 – Profit of $249,736 @ 3.1X multiple = $772,000
- Year 4 – Profit of $456,089 @3.7 X Multiple = $1.68m
As you can see from the different values, logically the larger your business the higher the exit value that you can have.
How does your business compare?
The following data shows some stats based on the analysis of 150 transactions of the value of e-commerce businesses. We tabulated all the data to give a visual representation of the value of e-commerce businesses at different stages of size and growth. Smaller businesses generally sell for less based on the perceived risk and general youth of the business. And as businesses get larger and older the price paid increases.
Why drop-ship sites are less attractive to buyers
If you look at the sales multiples that different e-commerce businesses sell for in the above graph you will notice the two columns blue and red. The red column represents purely drop ship businesses. Generally on a whole drop-ship style businesses sell for a lower price than traditional ecommerce businesses.
The reason these are as follows:
- Ease of replication of the business model – Anyone can go and setup a competing business
- Proprietary of defensible products – As a drop-ship business there is nothing unique about the products that you are selling
- Slim margins
- Little chance to discount
- Paid advertising is a challenge