Valuing online businesses can be challenging. While you don’t have to abandon standard business principles, you do need to make some additional considerations for enterprises that operate predominantly in the digital space, to reach an accurate estimate of value.
Although all businesses are subject to the same profit and revenue considerations, online businesses are unique for a number of reasons, such as the fact it can be hard for an external viewer to see where an online business generates its sales from. Margin, brand limitations and general business models may also differ when compared to offline businesses.
As such, the way we determine certain valuation factors for internet businesses can vary massively. We’re going to explore exactly how you can reach an accurate estimate for the value of your online business, as well as outline the different valuation approaches commonly used by the experts.
Reading this article should give you a solid grasp of what it takes to come to a reasonable, and provable, value for any online business – whether you’re planning to sell, buy or simply take stock of your progress
Which way is best?
It’s important to acknowledge that valuing a business is more of an art than a precise science; there is no one universally correct approach.
Business owners and brokers often employ a combination of methods to gain a more comprehensive understanding of a business’s value. This is because businesses are inherently complex and diverse, and the perception of value can be highly subjective.
Buyers may have various motivations for purchasing a business, such as gaining access to an existing customer base, merging with a well-known brand, or eliminating competition. However, many buyers are primarily interested in securing a share of the business’s future profits. As a result, most valuation methods involve taking some measure of annual profit and applying a multiple to account for the expectation of continued profitability.
In most cases, these valuation models begin with historical profit as an indicator of future earnings. Depending on the nature of the business, future profits may be anticipated to increase or decrease, and the applied multiple should align with this expectation.
Ultimately, different valuation methods can yield varying figures, and the determination of the final value depends on the specific context. Typically, arriving at a price involves negotiation between buyers and sellers, who consider various factors contributing to the business’s monetary worth.
Buyers tend to focus on potential risks that could lead to a decline in future profits, while sellers often emphasize opportunities for future profit growth. An accurate valuation should strike a balance between these perspectives.
Another crucial aspect of business valuation is the role played by the seller in the business. If you are actively involved in the day-to-day operations but plan to step away after selling, this can increase the perceived risk for the buyer. In such cases, not only are your skills being lost, but the cost of replacing you must also be factored in.
For a rough estimate, a simple calculation of your business assets may suffice. However, for those seeking a comprehensive understanding of their online business’s value from various angles, it is advisable to consider a range of assets, especially when engaging in merger and acquisition (M&A) transactions
|Seller’s discretionary earnings and multiples||Situations where the owner who runs daily operations will sell to an individual who takes over these responsibilities.|
|Precedent sales (EBITDA & Multiple)||A popular option for businesses that have been established for a considerable amount of time and have a predictable profit trajectory.|
|Discounted cash flow (DCF)||Suited to growing businesses that have invested significantly in future growth, meaning historic profits alone will not reflect the business’s value accurately.|
Is there a simple calculation that can be used to gain a rough estimate of value? The short answer is yes, but it’s not as straightforward as you might think. Value is not solely determined by a fixed formula; rather, it’s intricately shaped by the dynamics of the market and the competitive landscape.
When multiple potential acquirers recognize the potential synergies and hidden value in a business (which may not be immediately obvious), their valuation diverges from the traditional approach of merely applying a multiple to net profitability.
While industry experts can offer valuable insights by considering factors like sector, value proposition, profitability, owner involvement, and client base, this is just the starting point of the valuation process
Valuation approaches for online businesse
Seller’s discretionary earnings and multiples
Seller’s Discretionary Earnings X Multiple = Value
What is it?
This approach stands as one of the most favored valuation methods, particularly when assessing smaller online businesses, and it’s a tool frequently wielded by brokers in the realm of online M&A.
At the heart of this method, like many other business valuation models, lies the concept of multiples. It’s important to grasp from the outset that the ‘multiple’ you select for your specific formula can be highly variable.
In essence, this number should be uniquely tailored to each individual business and must gain consensus from all parties involved. It serves as a reflection of a business’s intrinsic qualities and attributes as a valuable asset. The higher this figure climbs, the greater the anticipated future value of the business.
To arrive at a valuation using this method, an online business multiple must be established, factoring in several pertinent variables such as traffic volume, customer base access, and market positioning. This figure is then multiplied by the business’s Seller’s Discretionary Earnings (SDE) to yield the ultimate valuation.
Seller’s Discretionary Earnings (SDE)
To execute this valuation method, it’s essential to have a firm grasp of your Seller’s Discretionary Earnings (SDE). If you weren’t already aware, SDE represents the residual income that remains after subtracting all costs of goods sold and essential operating expenses from the gross income.
The SDE can sometimes fluctuate based on interpretation and what owners choose to include as discretionary operating expenses. To establish a common understanding of this figure, it’s advisable to examine how it’s computed and come to a consensus on the specific amount before integrating it into your valuation formula.
Once you’ve successfully determined your SDE, the next step involves reaching an agreement on an appropriate multiple to finalize your business multiple valuations.
SDE formula example
- + Profit Reported for income taxes
- + Nonrecurring expenses
- – Nonrecurring income
- + Non-operating expenses
- – Non-operating income
- + Depreciation
- + Amortization
- + Interest expense
- + One owner’s total compensation
Examples of discretionary operating expenditure:
- Electricity and other bills
- Travel expenses
- Advertising costs
- Employee training
- Meeting and events allowances
Defining the multiple
Selecting the appropriate business multiple is a pivotal decision in ensuring the accuracy of this valuation method. Consensus on this figure is imperative, involving all stakeholders, including the buyer, seller, and any pertinent brokers engaged in the process.
For business sellers, the goal is to identify as many favorable factors as possible that both your broker and the prospective buyer can align on. This strategic approach serves to enhance the multiple, ultimately elevating your company’s anticipated value.
The variables influencing your multiple can be as diverse as the facets of your online business, but at their core, they hinge on fundamental business attributes such as scalability, sustainability, and transferability. If your business boasts integral components that contribute to these aspects, your multiple will be directly impacted.
Quick example of a multiple calculation:
|VALUE FACTOR||MULTIPLE SCORE (RELATIVE TO MARKET VALUE)|
|Organic SEO presence (High)||0.5x|
|Active customer base (Moderate)||0.5x|
|Market competition (High)||–|
|Number of employees required to run operations (Three)||0.5x|
- Seller’s Discretionary Earnings – £200,000.00
- Multiple – 1.5
- Value of Business – £300,000.00
The objective is to establish a consensus on the critical determinants that shape the multiple, and to assign appropriate weights to each facet of the business. When this process is executed effectively, all involved parties should possess a clear understanding of how the overall value of an online business is computed. Below, we’ve enumerated a comprehensive, though not exhaustive, list of factors that can be employed to help you gauge your own multiple.
Market dynamics, encompassing industry type, financial considerations, and prevailing economic conditions, play a pivotal role in influencing the requisite rate of return expected by prospective buyers. These dynamics are subject to change over time and can exert a substantial impact on the prices buyers are willing to propose.
“As a corporate financier and valuer of diverse businesses, both online and offline, and as the founder of the UK200 SME Valuation Index, it’s evident that online business valuations often exist in a realm distinct from their more conventional counterparts.
Numerous instances exist where online businesses have been appraised at billions of pounds or dollars, even before turning a profit or generating revenue. These valuations underscore the recognition that profitability or present revenues are not the sole metrics upon which a valuation should be based. Instead, the potential of a platform serving millions of users, whether for banking, transportation services, or social media engagement, embodies substantial value.
While adherents of traditional wisdom may emphasize ‘turnover is vanity, profit is sanity,’ there appears to be room, at least over time, for valuations to be predominantly rooted in future possibilities rather than historical realities.”
Simon Blake, Strategic Corporate Finance Partner, Price Bailey
“For most businesses, unless they are exceptionally asset-rich or underperforming, the primary driver of value will be their profitability. This profitability must be built upon sustainable earnings, considering their operational and inherent characteristics, rather than a mere average of the past.”
Lake Falconer, Partner, Corporate Finance
Factors affecting the value
- Business Longevity
- Historical Gross and Net Earnings (Last Three Years)
- Replicability Potential by Competing Businesses
- Periods of Financial Loss or Reduced Revenue (Last Three Years)
- Consistency in Revenue Streams
- Feasibility of Transferring Customers and Suppliers to a New Owner
- Sustainability of search traffic
- Organic SEO rankings vs. Paid Search rankings
- Fluctuation of search traffic depending on external factors
- Online networks and link structures internally and externally
- Overall traffic to similar enterprises in the market (traffic share)
Brand strength and exposure
- Visibility and Reputation of the Brand Within the Industry
- Brand Position Relative to Other Well-Known Brands
- Strength of Brand Assets and Website Presence
- Time Commitments Required from the Workforce
- Ease of Work Processes and Procedures for New Owners or Employees (Content Management System Structure)
- Owner Responsibilities
- Workforce Requirements to Sustain Essential Operations
- Level of Competition in the Target Market Segment
- Quantity of Businesses Providing Comparable Services
- Market Dynamics and Trends (Positive or Negative)
- Adaptability to Changing Market Conditions
- Market Share
- Anticipated Future Market Evolution
- Size of the Active Customer Base and Frequency of Repeat Customers
- Customer Demographics
- Expenses Associated with Customer Acquisition
- Lifetime Value of Customers
- Churn Rate (Customer Attrition)
- Customer Subscriptions and Newsletter Signups for Retargeting and Remarketing Purposes
- Scalability of the Website and Content Management System (CMS)
- Prospects for Expanding into New Markets or Customer Segments
- Transferability of Current Cost Structure to Prospective Owners
- Exclusive Access to Specific Markets or Business Networks Unavailable to Competitors
- Continuation of Established Trade Relationships with Suppliers
- Investments in Machinery, Equipment, or Other Physical Assets
- Preexisting Responsibilities or Obligations to Other Businesses or Employees
Do it yourself
Step 1: Calculate your SDE
Step 2: Define your multiple based on agreed criteria
Step 3: SDE X Multiple = Value
How does valuing an online business differ to valuing a traditional business?
“Online businesses frequently experience accelerated growth, a stark contrast to traditional businesses that typically encounter an initial growth phase before either stabilizing or plateauing. This underscores the importance of online business sellers exercising caution to avoid undervaluing their enterprises. It’s worth noting that online businesses are frequently transacted within the first five years of their establishment, a trend not commonly observed in the realm of traditional businesses.”
Ran Carmon, Managing Director, Chelsea Corporate
Do automated business valuation tools work?
Accurate valuation demands access to dependable data. In certain instances, this data remains privately held and only disclosed upon request. Consequently, while online tools exist to automate the valuation process, they possess inherent limitations in ascertaining the genuine value of a business. Furthermore, these methods inherently involve a degree of subjectivity.
Typically, they necessitate human discretion to ascertain the pertinent valuation factors and to determine the most fitting metrics for assessing worth. Naturally, automated tools are bound to fall short in this endeavor since each business boasts its own distinctiveness and necessitates a tailored approach for gauging its financial performance and overall monetary value.
Precedent Business sales
What is it?
Another digital business valuation approach is to look at past deals made for similar companies. Admittedly, this can only really give you a benchmark value, as all businesses are unique, but it can be a good initial measure to get a rough estimated value.
If a value derived via the precedent sales method is wildly different from the value generated by the seller’s discretionary earnings and multiples approach, you may want to take another look at your formula. It can also be used by one party to argue a price higher or lower than the one generated using another method.
In essence, this approach involves the identification of relevant precedent sales that can be used to gauge another business’ general value. The hard part is deciding which businesses to use in this comparison. While some enterprises may be similar in turnover and size, they may also differ massively in other value factors such as those mentioned above in the table.
What are some of the common mistakes that people make when valuing their business?
Unrealistic expectations often cloud the perspective of business owners. The asset they’ve nurtured, often through years of relentless dedication, carries a value that extends well beyond conventional valuation methods. My advice to someone would be to seek diverse professional perspectives and appoint an advisor you have confidence in to represent your interests in the market. So long as they genuinely comprehend the unique story that defines your business, they can identify buyers who resonate with this narrative.
Mike Whittle, Managing Director, EvolutionCBS Ltd
Defining valuation parameters
An uncomplicated approach to assessing relevant precedent sales is by utilizing a company’s Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). This method offers a tangible and comparable metric, establishing robust valuation parameters for any precedent sales comparison.
EBITDA, in essence, represents one facet of measuring profitability, akin to the way SDE or net income are employed in various contexts. EBITDA, however, serves as the primary metric in the valuation of most significant corporate transactions. When employed as a standalone valuation method, it’s important to bear in mind that EBITDA doesn’t encompass the value of capital investments like equipment, technical infrastructure, or real estate.
Who needs to know?
The method of evaluating the worth of online businesses can exhibit substantial variations, contingent upon the underlying purpose for assessing its value. As an illustrative case, when selling a business, the distinct criteria of each potential buyer can fluctuate significantly, inevitably impacting the perceived value of the asset.
Mergers and Acquisitions (M&A) entities, often characterized as predators, might predominantly target the core assets with intentions to divest and reap profits. In contrast, investors may adopt a more comprehensive perspective, encompassing additional value-influencing factors and gauging the business’s growth potential in the future.
Discounted cash flow (DCF
Do it yourself
Step 1: Define valuation parameters (EBITDA)
Step 2: Find precedent sales for similar businesses
Step 3: Use sales prices as a benchmark for your business’ value
What is it?
The Discounted Cash Flow (DCF) analysis is a method employed to appraise investments, whether it be a business or another asset, grounded in the assessment of cash flow. Essentially, it is structured to compute the value of an online business predicated on the anticipated future cash flows, factoring in the application of a discount rate. The outcome furnishes an approximation of the return on investment when acquiring an online business, taking into account the appropriate time adjustments and inflation considerations.
Considering the substantial variations in monthly cash flow and the requisite historical financial data, crucial for a precise DCF calculation, it’s advisable not to solely rely on this method for online business valuation. In actuality, it ranks among the more intricate valuation techniques, necessitating a deep comprehension of predicting cash flow.
This method finds its best application with traditional businesses characterized by a lengthy track record of consistent transactions, rather than newer online enterprises marked by fluctuating revenue streams. Nonetheless, DCF can serve as a valuable component to assemble a comprehensive evaluation of the value of your online business
How important is it to understand the growth potential of different sectors?
Understanding the growth potential of various sectors is of paramount importance, as it directly influences investment decisions, business strategies, and economic forecasting. The significance of comprehending sector-specific growth potential can be summarized as follows:
- Investment Decisions: Investors, whether individuals or institutions, often allocate their resources to sectors with promising growth prospects. A solid understanding of these prospects is vital for making informed investment choices, managing risk, and maximizing returns.
- Business Strategy: For businesses, recognizing the growth potential in different sectors is fundamental for strategic planning. It helps in identifying opportunities for expansion, diversification, or targeting emerging markets. It also aids in risk management by avoiding sectors with limited growth potential.
- Job Opportunities: The job market is heavily influenced by sector growth. As certain sectors expand, they create employment opportunities, while others may stagnate or contract, potentially leading to job losses. Understanding sector growth can guide career choices and inform job seekers about where to find employment.
- Economic Forecasting: Governments and economic analysts rely on sector-specific growth data to forecast the overall economic performance of a region or country. Positive growth in key sectors contributes to economic stability and prosperity.
- Resource Allocation: Both public and private entities allocate resources based on sector growth expectations. This includes infrastructure development, educational programs, and investment in research and development.
- Innovation and Technology: Growth sectors often drive technological innovation. Understanding which sectors are likely to experience growth can provide insights into where breakthrough technologies and advancements may occur.
In essence, comprehending sector growth potential is not only important but also essential for making informed decisions at various levels of the economy, whether as an investor, business leader, policymaker, or individual looking to plan a career or make financial choices.
Why is the forecasted value discounted?
The concept is straightforward: money received sooner holds greater value. To account for the natural erosion of money’s value due to inflation, a discount rate is applied to revenue forecasts. In essence, if you have access to the funds now rather than later, their worth gradually appreciates due to interest rates. This contrasts with money received in the future, which doesn’t benefit from such appreciation. Consequently, cash flow needs to be discounted to arrive at a suitable present value.
A common method to determine this discount rate is by using the Weighted Average Cost of Capital (WACC). WACC serves as the average cost a business incurs for capital through borrowing or equity issuance. It’s essential to recognize that the actual WACC can vary considerably based on the business type, its capital structure, and the geographical location in which it operates
Calculating discounted cash flow
Where do brokers fit in?
The process of valuing a business can swiftly become intricate. While it’s not mandatory to engage a business valuation broker, seeking the assistance of a reputable one equips you with the necessary tools to navigate the process effectively. Furthermore, having an independently verified valuation figure can substantially enhance your chances of securing a favorable deal if you’re in the market to sell your business.
A skilled broker can also grant you access to a well-established network of potential buyers, simplifying the selling process and broadening your reach in the market. It’s not uncommon for businesses involved in sales negotiations to enlist a third-party broker to assess the company’s value, aiming to achieve an objective result that satisfies all parties involved.
What’s your advice for businesses who want to value their businesses
A word of caution: online tools for business valuation should be used judiciously. Their accuracy is contingent upon the quality of data they rely on. To ensure that the valuation captures the distinctive attributes of your business accurately, it’s essential to invest adequately in obtaining a comprehensive valuation from reputable professionals.
Remember that your business possesses unique qualities and nuances that may not be adequately assessed by automated tools. Therefore, it’s prudent to allocate the necessary resources for a proper and thorough valuation.
Lake Falconer, Partner, Corporate Finance, PEM Accountants
In addition to the methods covered in this article, several alternative approaches can be employed to assess the value of an online business. This diversity of approaches underscores the complexity of the valuation process, with the potential for divergent results contingent upon the chosen method.
It’s crucial to bear in mind that, when negotiating, being well-informed can facilitate a fair deal. By identifying and reaching a consensus in advance on the key factors that influence a business’s value, you can work towards an agreement, even if it necessitates several rounds of negotiations.
The key takeaways are to seek advice, maintain a realistic perspective, empathize with potential buyers, and, above all, ensure thorough preparedness before entering the market.
Jarred Musson is a versatile writer with a diverse educational background and a passion for all things business. Holding a Master of Science (MSc) degree in Marketing and a Bachelor of Arts (BA Hons) in Multimedia Journalism from Manchester Metropolitan University, Jarred possesses a unique blend of expertise that allows him to dissect and communicate complex business topics with clarity and precision.