How to Value a Tech or Internet Company
It has become easier than ever for a budding entrepreneur to launch an online business without all of the hassles and expenses associated with traditional Brick & Mortar businesses. They can save themselves the cost of opening a retail storefront, paying a lease, securing the necessary permits, and in some cases, hiring employees. Many eCommerce Brand owners are able to operate out of a laptop in their home (or on a vacation) with their products are housed in a 3PL, and in some cases, with the use of virtual assistants from foreign countries. And if they primarily sell Amazon FBA, the process is even more streamlined because Amazon stores the product, picks it, pack it and ships it … and handles all customer service issues associate with delivery. No need to buy a warehouse, hire warehouse employees or deal with any of the time waste that usually comes with running a warehouse.
With very low overhead and the ability to boost traffic through search engine marketing, an online business has the potential to attract a massive customer base and begin making sales quickly after the startup stage. Within a few years, a brand owner can find herself with a loyal customer base, a fast-rising Repeat Customer Rate, and increasing profitability. Many clients come to us in as short as 2 years from startup due to their massive growth in sales and a need to exit due to the fact that it simply is growing to be too large for them to handle.
With so many digital companies thriving, it’s common to find business owners that are eager to sell their company, but they oftentimes don’t know where to start – that is where we come in! With the largest database of SMB & Lower Middle Market transactions for the digital space, who better to analyze how the market is reacting to particular sectors and verticals?
Prior to going to market, and among other things necessary for such preparation, we need to develop an Enterprise Value (EV) Range for the business. An EV range is the target valuation range that we give a business based on a large number of factors. We use an in-house, proprietary system for valuing SMB & Lower Middle Market Tech Companies that take their specific business into account – we don’t use textbooks or outside resources for our valuations because we don’t believe they properly represent the true market value of a company. We are in a unique position to offer insight into a company’s valuation that very few others can – certainly a valuation company couldn’t provide an accurate reflection of a company like we can – they don’t sell companies and they don’t have a database that properly reflects what digital companies in our sector are selling for – and to go one step further – they have no idea what earnings profile was used to get you there. Historical, Average, TTM, or Projections.
The reason for our reluctance to use valuation tools, codes and other third party valuation strategies is due to the fact that a digital company can have a broad range of values depending on the sector it sits in, the demand in the sector, the company’s trajectory, it’s individual KPIs, the founder(s) and their technology background (and whether they are going to continue on with the business after a sale), the shareholders’ willingness to retain equity, and so much more. In all, we have over 250 factors that we look at when valuing a company – and these aren’t just checkboxes – these are meaningful factors that truly will matter during the offer stage of the process.
So, where to begin?
As we noted above, every business has an EV Range – not a set value. We aren’t selling a home or a car – we’re selling an asset in a high growth sector (the digital space) where many buyers will value this business differently than many others, so for that reason you must look at things in terms of a range. Ultimately, the value of a company is determined by market participants, each of whom will potentially see the value of the company differently based on a number of factors. For a buyer specifically, some of those factors include any synergies that might be present with the buyer’s current business operations, the buyer’s experience in the space, the buyer’s network to grow the business, among many other factors.
Financial Analysis
For us every deal starts with an analysis of the company’s financial records. Depending on the nature of the business, the industry that it operates in, its growth trends, the age of the business and the appeal or uniqueness of their products, there are different methods that can be used in the valuation process for eCommerce and other Digital Assets. Some of the most important factors include:
- Financial history (2-3 years of historical data is helpful)
- Projections (1-2 years ahead)
- Updated Numbers through the month prior to going to market
- Tax Returns (for SMB Companies)
- Historical (and a Current) Balance Sheets
Once these financial records are reviewed by our internal team, we then work with clients to ensure that they are presented by the client and its accounting team in a market-friendly manner. Additionally, if there are discretionary items on the Income Statement that could potentially be added back, we work with clients to ensure that everything is added back for the go-to-market deal package. While the financial analysis of a company is the first stage, it’s also the most important stage because this is what matters first and foremost to the vast majority of buyers – buyers invest in companies to make a large return on that investment.
Operational Analysis
As any business owner knows, there is so much more to a company than just its financial results. While the latter provides evidence to help prove the company’s strength in the marketplace, there are many more factors that influence the value of a company that have no relation to the sales or profits of the company, but are more acutely identified as Key Performance Indicators (KPI).
For the digital world, here are the Top 10 Value Drivers for a Digital Company:
Traffic: Businesses have a higher value if they gain most of their traffic organically rather than through paid media. Paid media can really eat away at a company’s SG&A, but if the business is able to drive traffic organically and generally control its own destiny, then this elevates the value of the brand. Additionally, the “kind” of traffic generated by a business can be highly valuable to other companies, whether for cross selling purposes for other brands they own, ad dollar generation through ad placement strategies, the ability to control a sector by removing a competitor, and many other things.
Contracts: Whether eCommerce or SaaS or a Website Development Firm, regardless of what you offer to the market (a product or a service), the value, length and customer type of contracts associated with the sales process can be very influential in the value of a business. For instance, if you’re a B2B eCommerce Company and 50% of your sales are long term relationships with government agencies, another business with a high volume of government orders might find those contracts to be very interesting. If you’re a SaaS business with one year contracts (versus a month to month) with a low churn rate, that can make your company more valuable than others. Of course, there are many other attributes to look at as no single attribute can be the lone ranger in the valuation modeling, but generally this tends to be an important element for any business.
Recurring Revenue: Whether a company operates on a recurring revenue basis can be important to the valuation of a company and potentially alter the type of the valuation method used for the company. A Software as a Service (SaaS) company might be valued on its Annual or Monthly Recurring Revenue, rather than it’s EBITDA … especially if it’s relatively early stage and still burning cash from its initial capital raise activity. It likely does not have any earnings to multiply, but the company is more focused on growing users and/or building more features into the software, rather than profitability. The key here is whether the company can become profitable at some stage in the future once the investment needs begin to taper and/or whether marketing or M&A can be used to make the company profitable. Ultimately, investors buy companies to earn a return, but that return can come in many different forms – and might not even be associated with the profitability of the target itself – just acquiring the target alone could benefit a company’s own P/L. This is why a thorough analysis of a company’s KPIs is important – and for recurring revenue companies – other important attributes include lifetime customer value, cost of acquisition, churn rate, growth rate, user growth rate, scalability, trending, market size, and so much more.
Another example of a recurring revenue value driver can be found in DTC eCommerce companies, where certain products sold might be purchased on a regular basis by consumers. The higher the Repeat Order Rate and the higher the lifetime value of a company (relative to the Average Order Value and Customer Acquisition Cost), the higher the EV range of a company.
Concentration: Concentration is another big factor in the valuation of a company. The lower the concentration risk, the higher the EV range. Concentration can come in many forms, including, customer, sales channel, supplier and marketing method. Whatever the concentration might be (depending on the sector), that can influence the risk profile that a buyer puts on the business.
Defensive Moats: Companies have many defensive moats available to them. Generally, these are Intellectual Property rights, including patents, trademarks and copyrights. But other moats outside of IP rights can be market share control, government or other licensing, and business methodologies that are unknown in the market. Generally speaking, the more investment a company does into creating moats for their business, they lower the risk profile for a buyer, thus elevating themselves above other companies in the same sector. This can increase a company’s EV range.
Age: Longevity can be important. A company that has been around for years is far more likely to survive in the future, and it also has likely built a following, which increases its value over others that have not been around for quite as long.
Audience Engagement: A business with a large social network that is highly engaged has built a true brand. These loyal followers can be an important element to a transaction for a buyer, not just to build confidence in the consumer sentiment of a brand, but potentially to utilize for other purposes to grow. An audience of highly engaged people can be one of the more important value drivers in certain digital companies.
Customer Base: eCommerce companies with a firmly established customer base typically have higher profits, recurring revenues, and a considerably larger percentage of upsells and repeat buys, all of which makes a business considerably more valuable to a buyer. And those customers oftentimes can be targeted for additional product sales of products or services offered by the acquiring firm.
Growth: Is the company growing? Has it been growing? Is it still growing month over month? Or Year over Year? What is the projection for the future, and what are the quantifiable reasons for that growth? There are many ways to look at growth and we dissect a company’s financials to tune into the growth trends, past and future. Most buyers focus on both sides of growth (current and future).
Team: Does the company have a management team? And is it set up for growth? Will the ownership continue with the new owner? Is the owner willing to retain equity and partner with the new buyer to keep building the business? For
These are only a few of the attributes we look for in a business, but help to understand the top 10 things we begin looking at when first beginning a valuation process. By no means is this the entire list and, depending on the type of digital company we are evaluating, there can be over 100 items that need to be reviewed to properly bring out the company’s true value proposition.
Do you need professional advice to sell your business?
For anyone looking to sell a digital company, it’s always recommended that their very first step is to work with an expert that also focuses on the digital space. One who understands the importance of valuing a digital company using all of the value factors available to maximize the company’s Enterprise Value.
Brokers who handle the sale of digital companies can review a portfolio from an objective standpoint and provide an accurate figure of what the business is worth in the open market, with specific details on the company’s strengths and liabilities to justify a quoted market value. One of the important aspects of such a valuation is similar company comps … and since comparable analysis in the private markets is usually limited to the firm that is handling the valuation (since private company sale prices, deal multiples, etc. are not usually made public), it is critical that the firm doing the valuation is one with a great deal of experience selling the same types of companies. If they have less than 100 transactions in your space, you should find a better firm. Your business is likely your most important asset – failing to use the best in the industry can cost you millions.
There are additional advantages to using an experienced broker to guide the sale. A knowledgeable advisor has access to a network of qualified buyers, including some who are repeat customers. That database of buyers actively looking for a tech and internet businesses gives the seller the opportunity for a much higher success rate. If they have sold thousands of companies, they will have tens of thousands, if not millions, of buyers following them.
A qualified broker with a track record of success also understands that the Enterprise Value cannot be so high that it won’t be attractive to buyers. And since you want a pool of buyers to review a transaction to ensure you receive multiple offers, getting too aggressive on the listing price can be a big mistake.
The bottom line is that selling a Technology or Internet Business is a complicated process, particularly for a first-time seller. A seasoned broker and a highly active M&A Firm can direct the transaction from the initial consultation right through to completion of the sale and bring to this process an understanding of how to close the deal.
What does a broker bring to the eCommerce valuation?
Lassiter Mason, a veteran broker at Website Closers, noted there has always been a scientific method to determining an eCommerce company’s value, “and then you get into the art of it.” That’s where the seller and broker look beyond the financials and focus on other attributes that buyers are known to be looking for, especially strategics.
“The more unique a company’s products or services are”, he states, “the more attractive it will be for a buyer who doesn’t want to find themselves selling overly common products or services against a sea of competitors doing the same.”
Buyers also want a business that has plentiful scale options. If the business has established brand recognition, that can mean a desirably loyal and expanding customer base. A firmly established presence on social media can also be attractive. Also attractive is whether a business sells products each month or just during a special season such as the holidays, and how much time the owner needs to devote to the business each week.
In other words, a lot of different ingredients go into establishing a tech company valuation, particularly since no two tech companies are 100% the same. “That’s where a broker can help develop and bring out the value of a company, thus the “art” we use to determine a tech company valuation”, Mason said.
“I’ve talked to thousands of buyers over the years, and you get a feel for what the market will support,” he said. “If you have a pipeline of additional products or services, that’s going to increase your value. If you’ve got a portfolio of additional R&D in the works and you can hand that over to a buyer, that makes it far more attractive. There are a lot of little things that will increase your odds of getting the strike price you want.”
Carson Bomar, also a veteran broker at Website Closers, agreed that there are major advantages to tapping into their expertise. “A main driver is exposure,” he said. “We can bring more buyers to the table than you can on your own. We can get you more at the closing table than you can on your own because of that experience.”
Brokers can also protect buyers from unforeseen problems, Bomar added. “There’s a ton of logistics and hurdles that come up during this whole process,” Bomar said. “It is important to understand that deals break all the time – a strategic business advisor will either see those coming, or now how to deal with them when them come so that the deal doesn’t implode.”
“They’ll never have the reach we have as brokers,” added Website Closers broker Tom Howard. “We have more than a million buyers. There’s no way to emulate that reach. And importantly, “the fact that you’re a good seller on Amazon doesn’t mean you’re a good seller of your business.”
Get an eCommerce valuation that closes the deal.
Determining the “full picture” value of your digital business is something sellers shouldn’t attempt on their own. The expertise that a seasoned broker brings to the sale can’t be overstated. Evaluating your company’s worth is the crucial first step to take in this process, but because so many different variables are involved, it’s important to understand how to give proper weight to each valuation factor used in valuing a technology or internet business.
Being smart about the valuation process will increase the chances of a sale that you’re satisfied with, and an experienced broker is the one who can gu
