The most common question I get – what’s my business worth? – has a lot of moving parts. While lots of articles will just say “18-24 months of profit” and leave it at that, many web businesses don’t fit this metric. What if you don’t have 24 months of history, or you have very low overhead? Where does inventory fit in? Here’s an overview of some of the common factors I evaluate when I’m putting together a valuation.
How long have you been in business, and what’s your pattern of profit? Are you actually profitable?
The pattern of profit is almost as important as how much you made and how long it took you to make it. You want to see a good steady pattern of growth – if there are peaks and valleys that aren’t easily explainable (such as a holiday bump and subsequent drop-off for retail) then that makes you wonder if the overall model is really working all that well. If the below graphs represented overall profits, which one do you think you’d rather own?
A business that’s been in business longer, all things considered, is much more reassuring to buyers, but a shorter stint doesn’t necessarily mean that you can’t get a good price, or that the business you’re buying isn’t solid. It just gives you more data to work with.
And whether you can show a profit on paper.. this is often believed to be not very important by sellers, but most buyers are extremely hesitant to even look at a business that doesn’t have much in profit. I really don’t intend to crush anyone’s dreams, and I always feel bad when I have to give a valuation that isn’t very good because they decided not to worry about that pesky “making money” part of the business while it grew, but buyers want to buy something that makes money. Not just making money some of the time, or it used to make money but now doesn’t, but something that became profitable fairly quickly and has stayed that way.
That’s not to say that a business with no profit or very little profit can’t be sold. I’ve definitely done it! But you really need to have a good reason why. I need to show buyers a clear path to profitability – whether the expenses could be significantly cut, you have big deals coming up that will raise revenue, your social media stats are off the chart, you have a very unique product that is becoming more popular, and so forth. The biggest culprits I see are spending too much on advertising, buying too much inventory (or spending too much on the correct amount of inventory), and not having a good margin on each individual sale. If you don’t make any money when you sell one, you won’t make any money when you sell a thousand, since scale economies often take a lot of work for you to actually save any money that way.
What niche are you in?
Having a personal connection to the product or service the business sells is very important. For buyers, it’s often the thing that makes your business stand out from all the other listings, and buyers feel more comfortable with a preexisting base of knowledge about the area. However, some niches are better than others. That’s not to say that an unusual niche won’t find a buyer, just that it takes more time to find the right one, because not everyone will know enough about blacksmithing or CrossFit or gymnastics to feel comfortable owning a business centered on it. On the flip side, a niche that is very specific is often much easier to find customers in, so that helps the future buyer as well!
How much time does it take to run the business?
Needing very little hands-on time can be a huge boost to a business’s valuation – and having a very labor intensive business isn’t necessarily going to mean that it’s worth very little, but it may give buyers pause. Sometimes I’ll try to figure out if there are ways that labor could be cut down, outsourced, etc and include that in the valuation. You also don’t want to be significantly out of step with what buyers would expect for that kind of business – if it involves packing and shipping orders, you really shouldn’t try to tell me it only takes an hour a week.
What’s your margin?
The higher the margin, the better, but oftentimes high margin products have a lot of competitors. More expensive products with fewer sales can also be difficult, since each individual sale means a lot more. Frequently, this is an area where a new owner could probably eke out some additional profit, since a lot of business owners don’t buy as intelligently as they could. Buying in larger bulk and storing it, or putting in more legwork to get better deals, is a good strategy for the buyer if that’s something the seller hadn’t really spent much time on. Margin also goes hand in hand with the hours you put in – if you can trade some time for a better margin, that’s usually a good deal.
How many returning customers do you have? What’s the size of your email list and social media reach?
Subscription businesses usually have pretty straightforward metrics to determine what percentage of people that subscribed last month are still here this month. Anything above 90% is pretty good. But for regular ecommerce, you should be able to pull a report and tell me if you’re seeing a good number of returning customers. Not all stores sell something people want to buy over and over, but if you do, then returning customers indicate that they’re satisfied with the product and the quality for the price, which is all good news for the buyer. Returning customers mean sales that the buyer doesn’t have to work for.
The size of your email list and your social media numbers are valued the same way – they’re low hanging fruit sales. How many potential customers can you reach easily? These are people who’ve already expressed interest and are the easiest, cheapest conversions. If your email list hasn’t been utilized much, that’s not necessarily a bad thing, as long as you’ve been collecting them all along and they aren’t all years old (any email list over a year old is pretty worthless.) Social media is a really great indicator of how engaging you are with potential customers. I like to see lots of hearts, comments, follows, likes, etc because that means you’re doing something right, and buyers like to see engagement because it means any work they do is more likely to get seen and clicked on. All that makes a buyer feel more confident in their ability to get sales with your business.
How much inventory do you have?
You might think that a lot of inventory is a good thing – after all, that’s less for them to buy! But what a lot of buyers see is: why is that inventory still on hand? If you have a sub box, and you’ve bought materials for upcoming boxes, that’s terrific and buyers love it, since it saves them time and they get some space to ramp up before they have to start picking things out themselves. If your inventory is mostly made up of random extra stuff from previous boxes, or complete boxes from previous months, that’s not as valuable. Even worse if you have a retail e-commerce store and you have a lot of wide-ranging inventory that wasn’t bought recently. If you weren’t able to sell it, they probably won’t either, and thus the buyer may not even want it included in the sale if they have to pay a lot to ship or store it.
What kind of special skills are you, as an owner, bringing to the table?
Most business owners have some kind of useful skill they use to run their business, or perhaps a special connection to a community that their business serves – but if your business is actually built around that skill or community and another person would need to be basically just like you in order to run the business, that significantly diminishes the value. A graphic design business run by a graphic designer is not going to be bought by someone who is not a graphic designer, or at least not for the price you want, because they’ll have to pay someone else to do all the work that you once did. This also ties back into the labor intensiveness of the business, because you might be making great margins but only because you do all the work yourself. Outsourcing some of the work is certainly a possibility but it would cut into the margins and change the nature of the business, as well as potentially losing customers along the way who liked the old style.
While there are lots of other things that I might look at, and dozens of different questions I’ll ask during a valuation, I hope this gives you a bit of insight into what a valuation involves other than just cold, hard numbers!
Thinking of selling your web business? Contact me at [email protected]!