Valuation Fundamentals: What Drives The Price Beyond The Profits
When it comes to valuing your website business, there’s no shortage of advice out there, often with sites ready to spit out a golden number using a ‘proprietary’ system to assess a multiple: just plug in a few data points and a valuation can be yours in seconds. The fact of the matter is that it’s seldom that simple.
A common rule of thumb is multiplying your monthly revenue by anywhere from a 24–36 multiple. Or, if you’re looking at annual cash flow, somewhere in the ballpark of 2.5-5 times as a multiple. But this kind of simple math begs the question, why and how does a given company generate this value? A high multiple is good news for a seller, but what kind of factors drive that multiple?
While many articles discussing valuation focus primarily on the financial condition of the business, there are numerous and important supporting fundamentals that can be considered and assessed when it comes to establishing value. Some of them can even account for individuals paying above market for a given property.
So let’s take a look at these factors, since it’s essential for any online business owner – and those acquiring online businesses – to understand the unique value opportunities that online businesses represent in order to recognize them, and make the most of them.
– Domain: There was a time when understanding what makes a good domain was as simple as seeing if it was the keyword(s) with a .com at the end. That time has long passed, and assessing the value of a given domain has become as much an art as it is a science. While factors such as keyword(s), specificity, association with a product or service all come into play, more intangible aesthetic naming trends can also come into play. There was a time when taking a name and removing/swapping out just the vowels would have been unconscionable, but as more traditional domain names are gobbled up or command stratospheric prices, it can raise the value of the next tier of names.
– Strong SEO: A high – page one – search ranking has long been the holy grail for companies. Not only does it increase your visibility exponentially, it lends a tacit sense of approval from the search engine in the searchers eyes. Though it can be a challenge to get to the top, once there, it can get very hard to be unseated. You hear horror stories about companies getting booted from page one rankings after an algorithm change, but the fact of the matter is that this happens because the algorithm was changed to purge what was probably misleading or spammy tactics. In an online world defined by search, there’s no substitute for a high organic search ranking.
– Strong Traffic Data: No longer are buyers interested in just the straight numbers, since as we all know, unlike the old adage, in the world of online business numbers do lie. When it comes to traffic an important factor is how much of it originates from organic search, how much of it is PPC, and the ratio between those two. Also geographical segmentation, bounce rate, and time on site can all demonstrate the strength of weaknesses of a businesses audience.
– History: The more history your business has – particularly if that history tells a story of stable or increasing profits – the more appealing the business will be to a seller. The key factor here is that the longer the history of a business and its record keeping, the more the buyer can accurately assess and minimize risk, which investors almost always attach an extremely high financial cost to. The more potential unknowns and risk involved, the more you as a seller are going to have to discount the price to factor it in.
– Niche: Increasingly niche businesses are proving to be a veritable goldmine for new players in established industries, and investors are recognizing this. Able to move more quickly and respond to customer feedback thanks to their smaller scale, they’re creating a business appealing to a subset of extremely high value customers that larger industry titans would never bother pursuing. With typically higher per-order value, recurring purchase rates, and a tendency to become evangelists for brands, niche products and their customers represents a huge opportunity for growth across multiple established industries.
– Recurring: Online sales models with a recurring billing model – Dollar Shave Club, Birchbox – can generate higher multiples because of the sheer appeal of the business model to investors. No matter what the product is, customers sign up to pay you over time, each and every subscription period. And while like any model there is a limit to lifetime customer value, and of course customer churn, these tend to be offset by the fact that acquisition costs are one-time, and individuals that participate in subscriptions are more likely to refer friends and family: a recipe for lower per-customer cost and an increasingly high lifetime value per customer.
– Defensible/Proprietary: Although this can be a double edged sword – lawsuits are not cheap, after all – a product or process that is defensible or proprietary can create a lot of value for an investor. This is particularly true if a form of licensing is on the table, or if exclusive sales rights can be negotiated with larger online marketplaces.
– Growth Trends: This takes into consideration not only where the company is going, but where the larger market is going. Indicators across multiple factors – sales, profits, margins, and traffic – and how they trend can have an effect on valuation, though it’s often difficult to assess just how much. Many prospective buyers are loathe to pay for yet unseen or untapped potential unless the growth data strongly indicates that it will come to fruition, or if there’s a long-established history of stability already in the business.
– Vendors: Long-standing relationships with established vendors can be invaluable, especially if they can be transferred across ownership. Having to locate new vendors can be both time consuming and costly, resulting in potential downtime and inventory gaps. Generally speaking the longer the relationship with a vendor, the more amenable the terms. Being able to inherit an established relationship that’s on good terms can be very valuable to buyers because it drastically limits potential unknowns and their associated risks.
– Inventory/Shipping Model: The amount of inventory on hand, and how it gets to customers will always factor heavily into a valuation, but whether it increases it or decreases has a great deal to do with the buyer. Where one investor is looking to get into the website business, not the warehouse business, another might already have the space and infrastructure available.
Strong or positive indicators in some or all of the above factors can have a substantial effect on how a company is valued, but it is still far from an exact science. Buyers being human, they might fall in love with one specific element of a business and place an above-market value on it. Still, looking at the factors and assessing how your business matches up to them can give you a better sense of what kind of multiple you might expect, and the knowledge to make changes before an exit that can lead to an overall higher valuation. Ultimately the old – in actual fact, ancient – saying holds true, “everything is worth what it’s purchaser will pay for it”.