How to Value Your E-Commerce Business
Knowing the value of your business is important as an e-commerce business owner. Not only will it help you make important decisions about the future of your online store but will also provide insights into what you need to work on (and motivate you to make the necessary changes) to help your e-commerce business fulfil its potential.
There are many factors that go into the question of how to value an e-commerce business and no online tool can provide an accurate valuation simply by crawling your site. The most important factors in the e-commerce business valuation process include:
- How long you have been in business
- Your 12-month average revenue
- Your operating expenses
- Your fulfilment solutions
- Customer satisfaction
- The diversity and resilience of your income streams
- The level of owner involvement in the business
How Are Businesses Valued?
There are two formulas that are used to determine the value of e-commerce businesses: SDE and EBITDA. SDE is used for smaller businesses with annual revenue under €5 million and EBITDA is used for businesses with annual revenue of €5-10 million or more. You can find the different figures for these formulas in the sales reports and analytics generated by your merchant services provider.
SDE stands for “seller discretionary earnings” and is calculated using your net profit. The formula for SDE is:
(net revenue – the wholesale cost of goods sold – operating costs) + owner compensation + discretionary expenses
In this formula:
- Net revenue is your annual revenue after taxes
- Operating costs are your annual operating costs
- Owner compensation is the salary you pay yourself
- Discretionary expenses cover one-time setup costs, your home office, a once-off website redesign and other expenses the new owner won’t have to pay
In this model, owner compensation is added back in because the new owner may choose to take a lower salary or not to take a salary at all. The owner may also choose not to invest in a home office or website redesign, making these expenses non-factors in a sale.
EBITDA stands for “earnings before interest, taxation, depreciation and amortisation”. The formula for EBITDA is:
(gross revenue – expenses) + depreciation + amortisation
In this model, the salaries and compensation paid to the owner, managers and other staff members are considered expenses because large companies typically have a much more complex business structure and these salaries are considered a necessary expense. Taxation is also taken out because businesses of this size are typically international and the new owner may be subject to a different tax rate.
Once you’ve worked out your earnings using either SDE or EBITDA (small business owners will use SDE), you can calculate the listing price of your e-commerce business by finding the earnings multiple. This is the number of months’ or years’ revenue that the buyer will pay in the purchase price. In essence, this is a figure of risk for the new owner and a figure of achievement for you.
Higher-risk businesses can expect to receive an earnings multiple that values their business at 2-3 times their annual earnings. Stable, highly profitable businesses can be purchased for up to 6 times their annual earnings. In 2020, according to Digital Exits, the average multiple was 3.41. Seeing that a higher earnings multiple leads to a much higher purchase price, this is the figure you want to work to increase.
A Note about Multiples…
It’s important to be aware that some brokers calculate earnings multiples in months and others in years for the purpose of e-commerce valuation. If the multiple is calculated in months, it will be multiplied by the monthly average earnings. If the multiple is calculated in years, it will be applied to your earnings over the last 12 months.
If your earnings are calculated in months, you will generally be asked to provide a window of 12 months’ earnings from which to calculate the average. This is the most reliable window of time for valuing an e-commerce business and few investors will consider buying a business that provides a smaller window of their earnings.
In very few cases, a 6-month average will be accepted—especially for young businesses and businesses that made significant changes and the past 6 months more accurately reflect their current earnings. A window that is less than 6 months will not be considered reliable as it is not long enough to flatten out seasonal variation.
Factors that Affect Your Valuation Multiple
How Long You’ve Been in Business
Businesses take time to grow, and few investors will take a chance on an online business that has been operating for less than a year. To secure a premium multiple, you will want at least a year of sustained profitability. To fetch a premium price, your e-commerce business will ideally have been profitable for three years or more and will have shown steady growth during the period in question.
Your Fulfilment Method
Online businesses with third-party fulfilment are much easier to sell than e-commerce businesses that handle inventory themselves. That is because inventory management takes time and space and could limit the potential for the business to scale. For a higher valuation, your e-commerce business should have multiple fulfilment providers that can ship to your customers quickly and cheaply.
A resilient business should also have more than one supplier—and ideally in more than one country—to buffer against events like border closures, natural disasters and conflicts. If you have negotiated lower rates with your suppliers, you should also provide any supplier agreements and make sure these can continue once the new owner takes over the reins.
The Diversity of Your Income Streams
A resilient e-commerce business is one that hasn’t put all of its eggs in one basket. Just as relying on a single supplier or fulfilment centre is a risk, so is relying on a single product that sells particularly well for revenue. If your highest selling product is a fad, the revenue generated in sales is not sustainable. However, if you have several income streams that have proven to be consistent over time, your e-commerce store is more likely to receive a higher valuation multiple.
Risks Associated with Payment
E-commerce businesses come with all the risks of online payments, including the possibility of fraud and chargebacks. To reduce these risks, it’s important to have a secure global payment gateway and merchant services that protect your business with sophisticated e-commerce fraud prevention and chargeback mitigation tools. Potential buyers will not be impressed with a business with a high rate of chargebacks, so it’s important to address (and ideally prevent) issues like this before you sell.
The Structure of Your Team
Aside from risks associated with the sustainability of sales and the risk of fraud, potential buyers will want to be sure that your team can continue to function without you. Whether you have employees or operate mostly with the help of freelancers, it can help to establish standard operating procedures (SOPs) and outsource jobs that require special technical expertise. E-commerce businesses that rely heavily on the owner for technical support are unattractive to potential buyers.
E-commerce business investors who are paying tens or even hundreds of thousands of dollars are generally looking for a hands-off business that they can run in 5-10 hours a week and spend the rest of their time driving growth, investing in other projects or perhaps enjoying an early retirement. If you are still actively involved in the day-to-day running of your online business, upskill your team and outsource your day-to-day jobs to ensure that running your business is an attractive proposition.
Your Marketing Strategy
Another factor in the revenue multiple your business will receive is your marketing strategy and how much ongoing investment it takes to maintain. When working out how to value an e-commerce business, brokers consider organic traffic from search engine optimisation (SEO) to be more valuable than pay-per-click (PPC) advertising because it takes less monthly investment to maintain. The broker will also consider traffic quality—what is the conversion rate for the traffic that your e-commerce website receives?
Customer Satisfaction and Retention
When doing a background check of your e-commerce store, brokers and potential buyers will read independent customer reviews on websites like Trustpilot to find out your brand’s reputation and anything that needs to be improved. They will also analyse how many new customers vs. repeat customers your business has and calculate the cost of customer acquisition. If you have mostly new customers and few repeat customers, that indicates that significant improvements need to be made.
Tip: Be Upfront about Issues with Your e-commerce Business
If you are aware of specific problems with your business that are turning customers away, it’s best to be upfront about them and explain the measures that you are implementing to rectify the situation. There are investors that are prepared to purchase a business with issues (no online business is perfect) and make the necessary improvements themselves for a higher return on investment. However, if you are prepared to make the changes to improve your customer retention rate now, you are more likely to get a premium price.
Email Lists and Social Following
While it’s not one of the most basic essentials, having an email list and social media following show that you have a well-recognised brand identity and most likely, an active customer base. These factors, in turn, mean less work for the new owner and make your e-commerce business more attractive.
Tip: An Email List Isn’t “Make or Break”
If you don’t already have a solid email list or social media presence, you don’t necessarily have to rush to create them—other factors like customer satisfaction and consistent earnings are more important. However, if you do, be sure to include this in your company profile as it may improve your valuation.
Why Do Business Owners Decide to Sell?
There are many reasons why owners decide to sell their e-commerce business, some of which are related to life goals and others to circumstances.
In some cases, the business owner is an entrepreneur at heart and loves the challenge of starting and establishing new projects. Selling their e-commerce store allows them to start other new projects and avoid becoming stale or bored once the initial passion wanes.
Too Many Pies
Another reason to sell is that the business owner has a lot of activities on their plate and is no longer able to give the e-commerce store the time that it needs. In this case, it’s better for them to sell the business to someone who can dedicate themselves to taking it into the future and free up that time for other things.
Ready to Relax
The ultimate reward for building a successful online store is to retire early and enjoy a life of leisure. Medium-sized businesses frequently sell for €1,000,000 or more, so if you invest your assets wisely and live off the dividends or interest, you may never have to work again and can instead spend your time relaxing, adventuring, volunteering or dedicating yourself to whatever other activity you choose.
When Is the Best Time to Sell Your e-commerce Store?
There is no best time to sell your e-commerce business. e-commerce businesses are bought and sold all year round just like brick-and-mortar businesses. However, if any of the following situations apply, it might be a good time to sell:
- You have worked hard to improve your business and you’ve finally achieved your target valuation.
- Someone wants to buy your business now and is offering you an excellent price.
- You no longer have the time or passion to lead your business well and—should you continue—the store will only go downhill.
- Another commitment has arisen that requires your full attention.
Work Hard Now to Achieve the Best Price
When and if you decide to sell, listing your store with an experienced website broker will help you achieve the best price, taking every aspect of your business into account. Ideally, however, you would have your business valued regularly from the time it starts turning a profit. The process will help you identify areas to improve for a better multiple and you’ll be ready to sell at any time.
All in all, the best valuation will come when you can demonstrate:
- Month-on-month and year-on-year earnings that show steady growth
- Diversified income streams that are resilient in the face of disaster
- A large base of happy, repeat customers
- A website that consistently ranks well thanks to excellent search engine optimisation
- An e-commerce store that doesn’t rely on much involvement from you
Wherever you are at with your online business now, understanding how to value your e-commerce business and taking steps to improve your multiple will put you in the best stead when—and if—the time comes to sell, allowing you to finally sit back and enjoy the rewards!