The most important part of purchasing in the E-Commerce sector (including businesses that primarily operate on marketplaces like Amazon.com) is to understand the nature of the beast. This is not even vaguely similar to pursuing a Bricks and Mortar business. This is a coveted space that draws a lot of attention from the best of the best from the Buyer side. The internet is constantly growing and is poised to continue to do so. As a new generation of retail consumers emerges, Internet businesses are replacing an older generation of consumers that is more hesitant when it comes to shopping on the internet. The new generation is tech savvy and very comfortable with all aspects of using the Internet for everything they do, especially purchasing. This is creating a dynamic front for those generating income on the internet.
If you combine the growth element of this sector with the fact that most of these companies are relatively easy to relocate, the Buyer pool can come from all continental states creating a glut of Buyers versus a dearth of Sellers. This being said, as a Buyer of these companies, you must be decisive and aggressive in your pursuit. While you are kicking tires, others are drawing up offers. The multiples will be higher due to the dynamics.
As experts in this sector we can isolate the factors that create a stronger buying scenario and also give you an insight into any factors that may create a higher than normal risk such as fluctuating or obsolete inventory levels or an abnormal CapEx requirement. We will advise you on all aspects. Keeping this in mind, we only accept engagement agreements on companies that we feel strongly we can sell. The strike price, in some cases, may be a bit above fair market value, but it is rarely outlandish. There are prevailing indicators that will create a higher perceived value among specific groups and this is accounted for in determining the valuation.
Let’s talk about what you need to consider as a Buyer:
First let’s look at Value. The rule of thumb is that the multiple will be around three times earnings. This is a good place to start, but if sales are growing at a double digit pace, this will drive the multiple up. If the earnings are steady, this multiple is acceptable, but it will cap at 3 times. If the earnings are declining, the multiple will very likely drop below this reference point. In creating a fair market value for a company you must look at inventory as well. This issue is a slippery slope. Common sense says that if the company has $500,000 in inventory it should be added to the 3 times multiple. This is definitely not the case. Anybody that tells you otherwise has very little experience in seeing business deals close. Banks will value the company based on cash flow. Independent valuations that are a necessary part of bank financing will not increase the value at all. However, no Seller is going to agree that his inventory does not increase the value and there is logic in his stance. The issue to be careful of whether the inventory needs to increase at a value that exceeds the annual percentage increases in the revenues. If this is the case, you are creating an artificially high Sellers Discretionary Cash Flow and this needs to be factored into the overall value.
Next let’s explore the Inventory versus Drop Ship Business Model. Many Buyers think that drop shipping is a negative model that takes away value. This is an understandable thought process, but perhaps a bit indefensible. The wholesalers’ and manufacturers are allowing this less frequently now and grandfathering those in who are already in the system. The ability to control inventory without getting stuck with older obsolete inventory is very big cash flow advantage. The cash flow derived from a drop ship business is a pure cash flow structure that does not have lingering doubts generated by possible obsolete inventory. Additionally, employee requirements are less and allow for a more streamlined management system with fewer management issues. On the other side of the coin is the Inventory Model. The advantages are the lack of a drop ship fees which allows for higher margins, and higher level of a competitive edge. This can be important in generating top line revenues. In the end, the consumer is becoming more sophisticated in finding the best value. This edge is slightly negated by the necessity of managing your inventory. This is a challenge for all retailers including the largest companies in the world. If the ability to accrue free and clear cash flow is impacted by tough to manage inventory levels, any advantage is quickly dissipated.
The Sector you are in can make a difference. We have heard theories that are all over the board in regards to this issue. Niche, hardly heard of, sectors can be very powerful, but be careful of the element of fads or products that can come and go. Mainstream commodity sectors are probably the most stable, but are also the most competitive. Make sure there is an ample array of suppliers to accommodate your needs, or you can experience a lot of headaches.
The Location is not critical, but can be strategic. If you have the ability to grow your company, then the shipping charges can represent a large line item on the P & L. Depending on the geographical splash of the products, centralized locations can be beneficial or in some instances the issue of relocation will come up. Whether it is appropriate to have multiple locations or choose a centralized one. It is a consideration.