How to Buy an Ecommerce Business

Website valuation: how much to pay for an ecommerce business?

In the previous chapter, we talked about what questions to ask
to the seller during the seller interview, how to analyze Google
Analytics data and financial data. The goal is to collect as much
information as needed to get a thorough understanding of the
business and to uncover information that could be important
to you as a buyer. With the information you collected, we can
now go through the valuation method for ecommerce business.

Ecommerce business are generally sold for 10x - 24x monthly
earnings. This is a relatively large range, and there are exceptions
that were sold above or below this range, because each business
is unique and each buyer is different. Ultimately, the business
will be sold for how much the buyer is willing to pay. However,
there are some general guidelines that could help us determine
how much the business is worth to us.

As a buyer, the principle is to achieve the highest return on
investment (ROI) when we decide to spend money on a business
buying opportunity. Depending on your different goals, your
ROI could be a monetary value that is measured by how much
money you can earn in the future from the business, or it could
be non-monetary value such as the amount of learning or joy
you can gain from operating the business post acquisition. In
this chapter, we are only discussing the measurable part of
the acquisition, which is the monetary value of your return on
investment.

Keep in mind that although historical data is a good indicator to
help you value the business, you only want to pay a purchase
price that can justify how much the business can make in the
future. Since each buyer is different, their ability to generate profit
from the business after the acquisition is different too. Thus,
the same business could be valued very differently by different
buyers. The most valuable type of business buying and selling
transaction is when the buyer has better resources and ability
to bring the business to a more profitable level than the current
owner. That means the business worths more to the buyer than
it is to the seller, and that’s when a buyer and a seller can get
to an agreement on the purchase price where both parties are
going to win.

When you look at how much to pay for a business, you want to
use the historical data to reasonably predict its future earnings
as much as possible. You can look at the previous business
performance from the following aspects:

History

How old is the ecommerce business? Businesses with longer
history are usually sold for a higher multiple compared to a
similar performing business with shorter history.

As I mentioned in the previous chapter, a lot of ecommerce
businesses are impacted by seasonality, and you can only spot
the pattern if you have a longer history of operations. Businesses
with longer history usually have more data available for us to
analyze, and more previous learnings we can take away from to
help us operate in the future.

If the type of ecommerce businesses you are looking to acquire
are largely dependent on brand and word-of-mouth, a longer
operating history also means more returning loyal customers who
could potentially refer new customers to the brand in the future.

Customer Acquisition

How does the ecommerce business acquire customers? Does the
business requires a lot marketing effort and a large advertising
budget to acquire customers, or does it have more organic traffic
and word-of-mouth growth effect?

Usually a business with more organic traffic and word-of-mouth
growth is more predictable in the short term and less risky
post-acquisition when the buyer takes over the business. The
reason being that if a business requires constant marketing
and advertising effort, it is uncertain whether the new business
owner can put in as much high quality marketing and advertising
work as the previous owner did with the business. Compared
to other online business models, most ecommerce businesses
requires a decent amount of marketing and advertising effort to
keep up the customer acquisition. Since customer acquisition
is such an important part of running an eCommerce business,
how easy it is to acquire customers, either organically or through
paid marketing, should be taken into consideration during your
valuation process.

Focus on three things when you evaluate the business’s customer
acquisition: the website’s traffic profile, the business’s current
marketing and advertising practice, and the cost of customer
acquisition compared to the average profit from each customer.

Traffic Profile

Check the customer acquisition channels on Google Analytics and
ask yourself whether the current traffic level is likely to sustain
overtime. I have explained different traffic sources in details
in the previous chapter. An example of a sustainable type of
traffic source is when the ecommerce site has lots of keywords
ranking well on Google, and the organic traffic coming to the
site are relatively evenly distributed over different keywords
instead of concentrated on one or two. An unsustainable type
of traffic source would be a significant percentage of traffic
coming from one or two articles that have recently featured the
ecommerce business you want to acquire. The press coverage
could generates huge spike in the website’s traffic profile during
a short period of time, but over time less and less people will read
the article and visit the ecommerce site through the referral links.

Current Marketing and Advertising

During your seller interview, you have gathered quite a bit of
information on how the current business has been marketed and
advertised. Does the current marketing and advertising practice
require a lot of specialized knowledge or skills? For example, if
the majority of the current business’s marketing effort is focused
on constantly writing new creative content to get a lot of press
coverage and social media sharing, it might be hard for the new
owner to achieve the same level of success if the new owner is
not a marketing and PR wizard. However, if the current marketing
effort is more focused on scheduling specific social media posts
that have predictable content, putting in a certain amount of
advertising budget into a couple of simple AdWords or Facebook
Ad campaigns that have already been optimized, it will be easier
to take over and maintain the same level of customer acquisition
in the short term (although in the long term you might still need
to continue to optimize the marketing and advertising in order
to keep up with the competitions and changing market trends).

Cost of Acquisition

If paid advertising brings in the majority of the new customers,
look at how much it costs to acquire new customers by drilling
down to the ecommerce business’s advertising performance
report. If the ecommerce business has tracking pixels set up
on their ad campaigns and through their Google Analytics, the
report should be able to show you how much they have paid for
the campaign and how much order value they have generated
through the campaign. If the customer acquisition cost is too high,
an ad campaign might not be very profitable because the profit
earned from the new customers could be very close to how much
they have paid for the ads. However, if there is a large profitability
in the ad campaigns, there might be an opportunity for you to
scale up the profit by putting more money into the ad campaign.

Market Trends and Competition

The market trends and the level of competition are external
factors that impact the business’s future performance. Thus,
it plays a role in the valuation of a business. Chapter 4 in The
Ultimate Guide to Dropshipping
has discussed how to measure
the market trends and competition in details. If the ecommerce
business you’re looking at is in a highly competitive niche and
a stagnant market, it should be valued less than if it’s in a fast
growing market with less competition.

One internal factor you should evaluate is the competitive
advantage of the ecommerce business in it’s niche. Is there
a high barrier of entry in the niche the business is operating
in that can protect the business from competition? Is there
already quite a lot of brand awareness and brand value that can
effectively differentiate this business from its competitors? Does
the business have unique products or designs that are hard to
replicate? How about patents and trademarks? If the answers
are yes to some of those questions, the business is likely to be
able to protect itself from competition at least in the short term.

One last thing you need to consider in your valuation is how
much value you can add to the business and how much “lift”
you bring to the business’s current profit level. Although this
could be hard to predict, if you do see some low-hanging-fruits
for you to pick up based on your current resources and skills,
this could effectively justify a higher valuation for you, and this
might be your chance to win the business buying opportunity
over other potential buyers.

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