How to Buy an Ecommerce Business

How to evaluate an ecommerce business?

Once you have located a couple of interested business buying
opportunities, it’s time to do a full-on analysis on the business.
When you are directly approaching the sellers, you will need to
get a list of questions answered by the sellers in order to do a
thorough initial analysis on the business.

Either way, make sure you get the following information:

  1. Seller interview questions and answers
  2. Google Analytics read-only access
  3. Profit and loss statement with monthly stats.

Seller interview questions and answers

You will want to know some basic information about the sellers
before you seriously consider buying a business from them.
After all, a trustworthy seller is one of the most important and
the most ignored metric in online business buying.

My suggestion is to always validate the information you get from
the seller and ask follow-up questions when you get answers.
You’re more likely to uncover hidden details and potential
opportunities in the business.

The list of questions you should ask sellers are:

1. Tell me a bit about yourself.

When you you are working directly with a seller, it is important
that you do a background check yourself. Search their name on
Google, ask for their LinkedIn profile and social media profile.
Make sure the seller is not using a fake identity. If you are working
with a seller from overseas and it’s very hard to find his or her
identity information online, stay away from such opportunity,
especially when the opportunity looks exceptionally appealing

2. Tell me about the history of this business.

When was the business founded and why? Is the current business
owner the original owner of the business? Who are the business
partners and what are their roles?

In general, ecommerce businesses with a longer history are more
attractive than younger businesses. Most ecommerce businesses
are affected by seasonality. In order to do a proper analysis on
the impact of seasonality on a business, the business has to
have at least 12 months of history. The longer history it has, the
better you can analyze its historical data and trends.
An ecommerce business with shorter than 6 months history could
be too risky to take over. It won’t have enough information on
the seasonality of the business, and it has much less predictable
metrics for you to base your valuation on.

An ecommerce business with shorter than 6 months history could
be too risky to take over. It won’t have enough information on
the seasonality of the business, and it has much less predictable
metrics for you to base your valuation on.

If you find an ecommerce business buying opportunity with less
than 6 month’s history, a very high growth rate during the first
6 months, and a relatively low purchase price, you would want
to question why the seller is selling it. Be aware of the type of
ecommerce businesses that were created for the purpose of
selling.

3. Why are you selling it?

Why the business owner wants to sell the business? If the reason
for selling is that the business has encountered adversity, the
owner might not want to tell you the real reason. You need to
dig into the business data and ask follow-up questions during
your conversation with the seller. Other reasons for selling could
be certain life or career changes, other time commitments, new
startup opportunities, or lost of interest in the businesses.

4. What other businesses do you own?

If the business owner owns multiple businesses and he or she
is only selling one of them, you need to evaluate how much this
business is related to the other businesses.

For example, if the business owner owns multiple websites or
ecommerce stores in a competing niche, be aware of the potential
competition from the seller’s other businesses after you acquire
it. If the owner cross-promotes products from the business for
sale with other businesses he or she still operates, you need to
evaluate the potential loss of customers after you take over the
business and they stop the cross-promotion effort. It’s better to
buy the entire portfolio of web businesses from the same seller
if the businesses are highly associated and the operations are
inseparable.

5. How do you operate the business?

What types of tasks do the current owners do to operate the
business? How many hours does it take the current owner each
week to perform those tasks? Are there any expenses related
to the operations?

Depending on the business model, major operational tasks in
an ecommerce business could include marketing, advertising,
customer support, supply management, inventory management
and logistics (if it’s inventory-holding ecommerce). Some
businesses have more established and automated processes
than the others. Make sure you ask how the business is currently
operated and how many hours it takes for the owner to do each
task. Also ask the owner if there are any expenses associated
with the tasks. You can find out more about common ecommerce
business expense items in the Operating Expenses section of
the guide.

When you evaluate the operations of the business, think of the
following 3 questions:

  1. Are there Standard Operating Procedures (SOPs) already
    documented and ready to be taken over? If not, this is
    something you should consider working with the business
    owner on post-closing to ensure a smooth take over.

  2. Are there any special resources required to accomplish the
    tasks? Will you be able to perform the tasks as well as the
    current business owner? For example, if the current business
    owner has a special marketing channel (free or below-themarket
    cost of access to social media influencer networks,
    ad networks, etc.) that is not transferrable with the sale of
    the business, taking over the business means losing that
    marketing channel.

  3. If some tasks are outsourced, will those contractors stay
    onboard after you take over the business? Will you be able
    to take over the business’ current contracts with its main
    partners, suppliers, etc. with the same contract terms?

Those questions can help you evaluate whether you will be able
to run the business as well as the current owner. If some part of
the operations are not transferrable to you, you need to think
about how to replace it with other resources and how much
more or less it will cost, and take that cost into account when
you do the valuation of the business.

Google Analytics Access

Ask the seller to grant you Google Analytics access so that you
can evaluate the website’s traffic.

When evaluating the traffic stats, you want to find out:

  1. Are the traffic stats authentic?
  2. What’s the traffic trend and what’s the reason behind that?
  3. Is the traffic organically sustained or does it require paid acquisition?

1. Are the traffic stats authentic?

Keep in mind that some traffic stats can be manipulated. Fake
traffic is generated by bots or softwares and can be bought from
3rd party providers. They will inflate the traffic stats before the
sellers put the sites up for sale.

The best way to identify fake traffic is to check the Audience
Overview in Google Analytics.

Audience Overview in Google Analytics

Google Analytics Audience Overview gives you a nice overview
of the site’s key performance metrics. Sites with very high or
very low Bounce Rate (>90% or < 30%), very short Avg. Session
Duration (<40 secs), low Pages/Session (<2 pages / session) are
skeptical to fake traffic or traffic from untrustworthy sources.
You can learn more about Google Analytics metrics through
Google Analytics Academy if you are not familiar with some of
the metrics I mentioned above.

Installing Google Analytics tracking code twice on a webpage
can also result in very high or very low bounce rate. You can
check that by viewing the webpage source code search for
Google Analytics tracking code, usually starts with “UA-”. If the
code appears twice on the same page, double check with the
seller to see if this is an error. Once the duplicated tracking code
is removed from the site, after 3 - 5 days you should be able to
see the bounce rate stats going back to normal.

Google Analytics installation code snippet

From the Audience Overview, you can also check the Language,
Country, City as well as Browser to help you identify fake traffic.
If the top language of the traffic doesn’t match with the top
country, or if the site is mainly selling product to US customers
while it’s Top Country is India, you should double check with the
seller to figure out why. Top Browser is usually Chrome, unless
the site is targeting a specific demographic group that prefers
other browser such as Internet Explorer. Always ask yourself
“does this make sense?” when you look at the traffic stats. This
will help you uncover traffic from untrustworthy sources.

2. What’s the traffic trend and what’s the reason behind the trend?

Users view in Google Analytics

In the Audience Overview, change the metric to “Users” where
the default is “Sessions”. Users is a better indicator of how many
unique customers visited the site.

Change the Date Range to view the traffic trend for the past 3
months, past 6 months, past 12 months and since the beginning
of the traffic history.

You can also adjust the granularity of the traffic data to see the
trend. First look at the graphic by month, then by week, by day.
If there is a traffic spike during a certain time period, you might
want to inspect that closely by narrowing down your Date Range
to that specific time period, then look at the key performance
metrics and traffic sources in Acquisition. We’ll discuss traffic
sources in more detail later on.

Notice that when you adjust the Date Range to show traffic data
from different time period, the key performance metrics like
Pages / Session, Avg. Session duration, Bounce Rate, % of New
Users could change accordingly. If you notice one of the metrics
changes dramatically during certain time period, you might want
to figure out why. For example, if Avg. Session Duration doubled
when you adjust the Date Range from past 12 months to past
3 months, it probably means during the past 3 months, users
spent a lot more time on the site on average during each visit
session. This could be due to changes of site content and design,
or due to changes of the traffic quality (perhaps more targeted
traffic). You will want to ask the seller for possible explanations.

Some ecommerce businesses are strongly impacted by
seasonality. For example, an ecommerce business selling gifts
might have much a higher traffic and sales during the holiday
seasons. If the site has over 12 months history, you can also
spot the traffic seasonality trends by comparing the same time
period across different years.

3. Is the traffic organically sustained or does it require paid acquisition?

Acquisition Overview in Google Analytics

You can go to Acquisition -> Overview to see the top customer acquisition channels.

Paid Search

This type of traffic comes from Google Pay-Per-Click (PPC)
campaigns. If a big portion of traffic to the site is through Paid
Search, make sure that all the details of the PPC campaigns are
transferred to you after the sale, so that you can analyze the
current ad campaigns and continue to manage them effectively.
If you do not know how to manage ad campaigns, you might
need to hire someone to do it for you. This should be counted
as a part of your future operating expenses.

Ask the seller to share his PPC campaign data with you if possible
so that you can analyze the ad expenses and match it with the
Profit and Loss Statement you get from the seller. Analyze the cost
per click as well as the goal conversion rate and conversion value
from Paid Search (if the seller has set up Google Analytics Goal
Tracking for checkout). If the cost per user acquisition is lower
than the earnings from that user, the ad campaign is effective.

Paid traffic is more controllable compared to other traffic sources
such as organic search traffic, because you can increase or
decrease the paid search traffic by adjusting your ad spending.
However, make sure you do proper due diligence to uncover
how much ad spending has actually occurred. Internal factors
like how you design and run your ad campaigns can influence
the paid search user acquisition cost. That’s one of the reasons
you should always get the PPC campaign data from the current
owner as a part of the asset transfer if that’s an important part
of the traffic acquisition. External factors such as competitions,
market trends, can also influence the paid search cost in the
longer term, that’s why you should also do some industry research
and PPC cost research.

Organic Search

Organic search traffic comes from search results that aren’t paid
for. You can use tools such as SEMRush to evaluate the website’s
organic search traffic quality. It gives you an overview of what
keywords the site is ranked for, and how much estimated organic
traffic is going to the site because of which keywords.

Organic search positions

Organic traffic is free, hard to fake, and it’s relatively stable and
predictable (exceptions are mentioned below). Thus, organic
traffic is usually considered as a favorable traffic source. The best
type of organic traffic is when the site ranks for many relevant
keywords and the traffic from different keywords are evenly
distributed. Imagine if a site ranks well for only one keyword that
brings in 90% of the site’s organic traffic, when a competitor
beat that ranking one day, the organic traffic to that site could
drop dramatically overnight.

Although organic traffic is relatively stable, keep in mind that
organic traffic could change suddenly when there are search
engine algorithm changes
or
penalties. A general rule of thumb
is that search engines will always prioritize high quality original
contents. If a site has consistent organic traffic history over a
long period of time, it means the site’s content is relatively riskfree
from algorithm changes. If a site uses a lot of black hat SEO,
it could be vulnerable from algorithm changes and penalties.
You should use tools such as ahrefs.com to look up the site’s
backlinks and do proper due diligence on the site’s SEO methods
when organic traffic is the main traffic source.

Referral

Referral traffic comes from other websites that link to the current
website. Click on Referral from the Acquisition Overview to
inspect the referral traffic details. Add Hostname as the Second
Dimension to inspect referral spam traffic. If the hostname
doesn’t match the website’s domain or any services relevant
to the site that has Google Analytics tracking code installed
(such as Youtube, email service provider, etc.), it’s likely referral
spam traffic. Sites with less traffic usually have a relatively
higher portion of referral spam traffic (unless the seller already
filtered out those traffic on GA). Keep in mind that it’s common
for websites to attract referral spam traffic. What you need to
do is to filter them out when you are evaluating the site’s referral
traffic, if the referral spam is a relatively large portion of the
current traffic volume.

Referral Sources in Google Analytics

If the site has legitimate referral traffic from article mentioning
and backlinks, make sure to check out the referral sources, read
the articles where the referral links appear and see if the content
is legitimate, and find out whether there is any expense related to
the referral traffic in case the store owner paid to get featured/
mentioned in those articles or did something in exchange. You
can do a thorough backlink check using Ahrefs.com if the sites
has a large amount of referral traffic. You can also ask the seller
to elaborate on their referral partnerships when you spot a large
amount of referral traffic coming from certain websites.

Social Media

If the site has a large chunk of traffic from social media sites such
as Facebook, Twitter or Instagram, you will want to do proper
due diligence on how the site’s current social media accounts
are operated and how much it costs to maintain the current
social media marketing strategy.

First, you want to assess the existing social media account
followers. Find the social media accounts related to the site, the
number of followers for each account, and assess how engaged
the followers are with the posts. The more engaged the followers
are, the better. Keep in mind that fake social media followers and
likes can be bought from 3rd party providers. You can usually
spot the fake followers or likes by checking the profiles of the
people who liked or commented on the posts.

Second, you want to understand how much money is being spent
on social media marketing. There are two types of social media
costs. The most common one is sponsored posts where you pay
the social media networks directly to gain targeted impressions.
You should ask the sellers whether they have done paid social
media marketing, and if so, ask them to share the advertising
reports with you so that you can check the performance. Same
with PPC campaigns; you will want to keep the ad copies, creatives
and all other settings when the seller transfers the social media
accounts to you.

The second type of paid social media advertising is when the site
owners pay social media influencers or 3rd party social media
ad networks to promote their products. In that case, they’re not
directly paying the social media networks to sponsor their posts
so it might be harder to discover. You can usually find it out by
doing a search of the site’s domain or brand name on the social
media network website to see if there are posts promoting their
products from other social media accounts. If the posts don’t look
organic, ask the seller to disclose the costs associated with the
promotion, and provide relevant invoices to prove the expenses
amount for your confirmatory due diligence.

In rare cases where the site owners have access to large social
media influencer accounts where they can promote their own
products for free, you will want to assess how much that will
cost you once you take over the business without access to
those accounts. Add the cost to the current business’s Profit
and Loss statement to evaluate the actual profit you can earn
without those non-transferrable resources.

Direct

Direct traffic usually comes from users directly typing the URL
of the site into their browser. There are other cases where the
traffic is also counted as direct traffic. This is the least controllable
traffic source and the easiest to fake. Ecommerce sites with an
established brand, great PR and word-of-mouth can get a lot of
direct traffic. If direct traffic is the main source of traffic to the
site, make sure you ask the seller enough questions to figure
out if that makes sense.

Summary

A couple of points to keep in mind when you are evaluating
the traffic profile:

  1. Focus on the traffic sources that have the most impact on the business’s bottom line. Don’t spend too much time digging into a small volume of traffic you couldn’t explain that has minimal impact on the business.

You can check Acquisition -> Overview to see the % of each traffic source:

Top Acquisition Channels in Google Analytics

In this chart, Organic Search traffic appears to have the most volume.

When you go to Acquisition -> All Traffic -> Channels, you might see something like this:

Default Channel Grouping in Google Analytics

If the current Google Analytics setting tracks eCommerce
revenue, you can see some revenue numbers attached to
each channel. As you can see, although Organic Search
has the most volume, Direct traffic source actually
generates the most revenue.

  1. If an ecommerce business has evenly distributed traffic through multiple acquisition channels, it’s usually a good sign, as the traffic is less risky compared to a site only has traffic coming from a few channels. Whether the current traffic mix makes sense depends on the business model. For example, an ecommerce business has an unique brand with lots of press coverage could have a large amount of direct and referral traffic, an ecommerce business selling less unique goods in a relatively competitive niche focusing on buying and monetizing traffic could have a large amount of paid traffic.

Profit and Loss Statement (P&L)

Ask the seller to provide you with a Trailing Twelve Months (TTM)
profit and loss statement that shows you the revenue, operating
expenses and net income per month for the past 12 months (or
more if available).

A typical P&L for small businesses have 6 sections: Revenue,
Cost of Goods Sold, Gross Profit, Operating Expenses, AddBacks,
Net Income.

Revenue

The revenue stats can either be a sum of all revenue generated
from the business, or can a breakdown by different revenue
sources, distinct product categories, by customer segments,
etc., depending on how the business owner record and analyze
the revenue stats.

Cost of Goods Sold

Cost of Goods Sold section includes variable costs associated with the
products or services sold through the site.

If the business has a high Refunds and Returns rate (Returns / Product
Sales), you should be alarmed and inspect the reasons. Some
causes are easier to be fixed than the others. Low product quality,
poor product shipping and handling, misleading or wrong product
descriptions on the websites could all lead to high refunds and
returns rate.

Gross Profit

Gross Profit = Revenue - Total Cost of Goods Sold

With the Gross Profit number, you should be able to calculate the Gross Margin.

Gross Margin = Gross Profit / Revenue

Having a healthy gross margin is important for small to medium ecommerce businesses.
A high gross margin generally indicates that the business has a good brand value,
unique products or other competitive advantages that it can operate on a higher gross
margin without losing to competitors.

Operating Expenses

Operating expenses includes expenses that occur during a certain
accounting period. Depending on the business, the expense items
could vary. Most small ecommerce businesses are run by the owners
and they do not take salary from the business.

Marketing and Advertising expenses are typically a large portion of
the total operating expenses for ecommerce businesses. Make sure
you double check the Advertising expenses in the P&L and match
it with the advertising network reports such as Google AdWords
report and Facebook advertising report.

Some marketing and advertising expenses might be harder
to track down. For example, if the business owner has direct
advertising partnership, sponsorship or referral partnership with
other websites, there might not be an expense report you can
track down or match. In this case, you should closely inspect
the Google Analytics user acquisition sources, and ask the seller
whether they have paid for any of them. Sellers hiding certain
marketing and advertising expenses and leaving them out of
the P&L is one of the most common reason of dispute in online
business buying and selling.

There could also be hidden cost in marketing and advertising,
where the business owner also owns other resources they can
utilize to promote their products for free. If you do not have
similar resources, you will likely have to pay for those types of
user acquisition. One example is that the business owner also
owns a social media influencer account with 1m+ followers, where
he or she can promote products without paying for the traffic.

Higher marketing and advertising expenses can also drive up the
sales. Some sellers might deliberately increase their marketing
and advertising expenses before they put up the site for sale
to generate more interest from buyers. You can calculate the
expense ratio to avoid being misled by the absolute numbers.
Calculate the Marketing and Advertising expenses to Product
Sales ratio and inspect how that changes month over month.
The ratio could increase due to decreased market demand (such
as during slow seasons), increased competition, penalties or
policy changes from advertising networks. If you noticed a big
change in the advertising to revenue ratio, you should ask the
seller about the reasons behind it.

When you’re buying a Shopify eCommerce business, one of the
most common operating expenses is the monthly recurring
subscription fees paid to Shopify apps installed in the eCommerce
store. Make sure to double check it with the seller if that’s not
in the P&L.

Add-Backs

Since most small ecommerce businesses are operated by the
business owners, their reported earnings could be kept low for tax
purposes. We will want to see an adjusted P&L which tells you how
much Seller Discretionary Earnings the business is making in order to
fairly judge the available cash flow and returns on investment of the
business. We can do that by adding back some one-time expenses or expenses that are not
likely to occur after the change of ownerships.

Net Income

After the Add-Backs, we can get to the Net Income using Seller
Discretionary Earnings (SDE) method. This will be the number you
use to base your valuation on. We will talk more about valuation
in the following section.

The Net Income could go up and down for many different
reasons. Besides looking at the Net Income numbers and trends,
you should also look up the reasons for the trends from the
P&L - whether it’s due to the increase/decrease in revenue, or
increase/decrease in cost. External factors such as seasonalities,
competitions, changes in market trends as well as internal factors
such as changes of product suppliers or changes of operating
processes, can all contribute to the changes of Net Income.

A thorough analysis of the P&L can help you discover a lot of
information about the business, choose the right questions to
ask the sellers, and find opportunities for improvements in the
business.

Next chapter