Listen To Our Most Recent Podcast Episodes As Soon As They're Live: Here!

Sell an Online Business- Valuation Basics

Posted by Chris Kern in Articles
Share:

Sell an Online Business – Valuation Basics

 

 

The typical process of selling a business usually begins with a valuation of the company. Having clean financials is essential for the right valuation. Your valuation will dictate many different aspects of the business sale. It is impossible to begin the free business valuation process offered by many online business brokers, however, if you do not have clean financials. Let us explore the business valuation basics below.

Understanding Online Business Models

With the technology evolving and more people spending time online than ever before, businesses have also evolved to sell using the digital platform. Online business models refer to companies that generate sales digitally. 

With online business models, everything happens online – marketing, sales, value delivery, and payment. Basically, all the operations happen without face-to-face interaction. More common examples of online business models include the following:

  • E-Commerce (Amazon, Shopify)
     
  • Subscriptions (Content such as Spotify or Netflix, Software as a Service such as Microsoft)
     
  • Affiliate Marketing
     
  • Digital Media or Digital Products
     
  • Freemium (Zoom or LinkedIn that requires a fee for premium access)

To adapt to the online market conditions, many businesses use a combination of the above models to maximize their profit.

Basic Business Valuation

The basic business valuation methods for online businesses are the same as for brick-and-mortar businesses – they require a careful assessment of the financial performance, risk factors, growth prospects, market indicators, and other factors that could affect the valuation.

In the valuation, the following approaches are used:

1. Business Model Understanding

Several businesses operate using different types of business models. For online businesses, the following models are adapted:

  • Subscriptions
  • Software as a Service (SAAS)
  • E-Commerce
  • Affiliate Marketing

2. Financial Data Gathering

Financial Reports are highly important in the use of valuation approaches. This sets the groundwork for the valuation and the basis for computing the worth of the business accurately. The reports needed in the computation of the valuation are the following:

  • Balance Sheet (Company Assets, Liabilities, Owner’s Equity)
  • Income Statement (Revenue, Expenses, Net Profit)
  • Cash Flow Statement (Cash Inflows and Cash Outflows)

3. Customer Metrics

The survival of online businesses depends on the traffic it gets. With high traffic and engagement, sales have the potential to increase. Another metric used is the CAC (Customer Acquisition Cost) which measures how much in total a company spends to get new business customers.

4. Intangible Assets Valuation

It may be difficult to quantify intangible assets as opposed to physical assets that have historical values but they must be included in the valuation nonetheless. These include the value of content, technology, software, domain name, and reputation of the brand.

5. Business Financial Performance

Key financial metrics will be included in the valuation such as historical financial reports, projected financial statements, and EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization). 

6. Market Position and Growth Potential (Market Approach)

Unique businesses have more growth potential in the market and as a result, they also get a considerable market share. The growth rate of unique businesses naturally does well in their niches.

7. Valuation Approaches (Methods of Valuation)

There are three different approaches used depending on the business model adopted by the company and they include the following:

  • Income Approach (the ability of the company to generate future cash flows, measured using the Discounted Cash Flow method)
     
  • Market Approach (comparable companies that have recently sold become the benchmark for valuation)
     
  • Asset Based Valuation (the business is worth its net assets here which is the company’s total assets minus the total liabilities)

The basics of valuation mentioned above serve as guidelines in business valuation. Experts use the best approach depending on the type of business to be sold.

Key Metrics for Valuing an Online Business

The basic business valuation model dictates the use of important metrics in valuing the worth of the business such as the following metrics:

Financial

  • Gross Revenue – computed as total revenue before any of the expenses are subtracted. This is the metric used to calculate the size and presence of the business in the market.
  • Profit Margin – metrics used here are the Gross Margin (Total sales less Cost of Goods Sold divided by total revenue) and Net Margin (Net Profit divided by total revenue).
  • Net Profit – measures the overall profitability of the business, computed as total sales less expenses, interests, and taxes.
  • EBITDA – commonly used in business valuation and reflects the operational efficiency of the company. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. 

Customer

  • Three metrics are used here such as the Customer Acquisition Cost (CAC) which is the cost to acquire new customers, Churn Rate which measures how many customers have stopped using the services, and finally, the  Customer Lifetime Value which measures customer acquisition and retention. 

User and Traffic

  • The metrics include monthly visitors, bounce rate, page views, and the average session duration per visit. 

Revenue and Growth Potential

  • Monthly Recurring Revenue – typically used by businesses that have subscription-type billings.
  • Revenue Breakdown – applied to businesses that have different revenue streams.
  • Year-on-Year Growth Rate – analysis of the annual revenue and profit growth to determine market potential and the possibility of market expansion.

Assets and Intellectual Property

  • A couple of things are measured here – the domain strength (Domain Authority), the value of content (quality and quantity), and the value of the software, technology, and patents owned by the online business.

Market Position

  • Measures the position of the business in the type of industry and niche it belongs to, how it competes in the market, the strength of its market share, and an understanding of how the business generates revenue.

Financial Ratios

  • Return on Investment (ROI) – measures an investment’s gain or loss
  • Price to Earnings Ratio – comparison of the market share against the EPS (Earnings Per Share)

The metrics serve as a guide for experts to value the business more accurately and comprehensively. With accurate documentation and a basis of financial information, the business will be valued more reasonably and correctly.

Common Valuation Methods

The basic business valuation principles include the use of the most commonly used valuation methods. Depending on the type of business, the appropriate method is also used. 

Common methods of valuation used are the following:

Discounted Cash Flow Method

If you are planning to sell your business, this type of valuation takes into account the value of future cash flows (typically estimated for 3-5 years) by discounting cash flow using the most appropriate discount rate.

Small businesses with a predictable and stable cash flow will benefit most from this method.

Capitalization of Earnings

Businesses that are stable and earn consistently use this method and the value of the business here is computed based on earnings expected by the business and the market capitalization rate reflective of the risk to the business.

Comparative Market Analysis

Businesses that possess market reports are better off using this method. The valuation is done by comparing the business to similar businesses recently sold with an adjustment made for their differences such as the size and other factors.

Through the comparison, a valuation multiple is derived.

Adjusted Book Value

This asset-based approach is calculated by computing the company’s net book value (Total Assets minus Total Liabilities) and is then adjusted to the fair market value. Businesses that have a high value of physical or tangible assets use this valuation method.

Liquidation Value

If a business is being sold because it is losing or about to close, the liquidation value is computed. This is based on the total selling price of the assets sold minus all the liabilities paid off.

Rule of Thumb Method

When a business owner has not yet decided on selling the business, the value of the business is computed based on a rule of thumb, a computation that is based on common industry multiples that are derived from historical data.

To determine what the right valuation method to use is right for you, first, determine why you need the valuation, what data is available to you, and the nature of your business (service-based, real estate, online business, etc).

Basics of Business Valuation

The basic business valuations are critical for online businesses on the verge of selling the company. Through the valuation methods used, a company will be able to benefit from it, and among them, are the following:

  • Making Informed Financial and Non-Financial Decisions
  • Aids in the Buying and Selling of the Business
  • Serves as Negotiation Leverage
  • Provides Risk Management
  • Ensures Compliance with Regulatory Requirements

When a business owner has a clear understanding of how the business is valued, he or she will be able to ascertain how the sale of the business is going to operate and what the end goal of the sale is.

Working With Professional Valuators

Probably the most important aspect of the entire business valuation process is the relationship that a business owner will have with professional valuators. They apply a basic method of business valuation but what dictates the success of the valuation is how you can communicate what you need and what your goal is.

You must be able to screen and select the valuator who can deliver the result that you need. Once you have established your objectives and selected the valuator, prepare all the needed documents and work closely during the valuation process. 

Review the findings of the valuation and communicate your observations and recommendations.

800-251-1559