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.
|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.|
Before we start, it’s important to note that business valuation is more of an art than a science (and no one way is absolutely correct).
Often, business owners or brokers will use a number of methods at the same time to get a more ‘complete’ picture of value. This is because businesses can be incredibly complex and varied by nature, and value can so often be in the eye of the beholder.
While a number of reasons exist for a purchaser to buy a business, including access to an existing customer base, merging with a popular brand or eliminating competition, many buyers are typically interested in gaining access to the future profits of the business. This means that most valuation methods take some form of annual profit and apply a multiple, to reflect an expectation that it will continue into the future.
Most models also start with a view of historic profit as an indication of future profits. Depending on the nature of the business, future profits may be expected to increase or decrease, and the multiple used should reflect that.
Ultimately, each potential method can churn out a different figure, and deciding on your final value will depend on your situation. For example, settling on a price will typically take negotiation between buyers and sellers, over some of the different factors that contribute to monetary worth for any given business.
A purchaser will typically focus on the risks that may cause future profits to decrease, whereas a seller will tend to focus on the opportunities to grow future profits. A realistic valuation will balance both these things.
Also, one of the most important considerations in business valuation is the role that the seller themselves takes in the business. If you run your business day-to-day, but do not plan to do so after selling, then this potentially increases the risk to a purchaser as not only are your skills being lost, but they will have to factor in the cost of replacing you.
If you’re looking for a rough estimate, then a quick and simple calculation of your business assets might suffice. But for those who want a complete picture of their online business from multiple angles, we recommend having a range of assets to play with when valuing your business – especially when making deals in the merger and acquisition (M&A) space.
Seller’s Discretionary Earnings X Multiple = Value
What is it?
This is one of the most popular valuation methods for smaller online businesses and one commonly used by brokers in online M&A.
Underlying this approach, and other business valuation models, is the use of multiples. Before you get anywhere, you’ll need to understand that the ‘multiple’ which you choose to use in any given formula can vary considerably.
In short, it will be a number that is appropriate for a specific individual business and should be agreed upon by all parties involved. This number will represent the strength of any business, based on its characteristics and traits as a profitable asset. The higher this figure is, the higher the estimated future worth of the business will be.
To reach a value with this approach, an online business multiple will have to be determined based on a number of relevant factors, such as traffic volume, access to customer base and position in the market. This is then multiplied by the businesses Seller’s Discretionary Earnings (SDE) to give you the final value.
As mentioned, you’ll need to know your SDE to perform this method of valuation. And if you didn’t know already, this is essentially the money left once all costs of goods sold and critical operating expenses have been deducted from gross income.
While an SDE might vary depending on how it is interpreted and what owners will include as discretionary operating expenditure, you can check how this figure is reached and agree upon the sum before using it in your formula.
Once you have calculated your SDE, you can move on to agreeing on a suitable multiple to complete your business multiple valuations.
Examples of discretionary operating expenditure:
SDE formula example
Deciding on the right business multiple is crucial for getting this valuation approach right. This figure will have to be agreed on by all parties, including the buyer, seller and any relevant brokers involved.
If you are selling a business, you will be looking to find as many favourable factors as possible that your broker and buyer will agree upon. This will increase the multiple figure and your company's expected worth.
The different factors influencing your multiple can be as wide and varied as your online business, but underpinning them will be core business qualities such as scalability, sustainability and transferability. If your business has key components that contribute to these aspects, then your multiple will be directly affected.
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 employers required to run operations (Three)||0.5x|
The goal is agreeing on the relevant driving factors that influence the multiple and attributing a suitable weighting to each business component. When this is done right, all parties should be clear on how the total value of an online business is reached. We’ve outlined a long (but non-exhaustive) list of factors below that could be used to help you determine your own multiple.
Market forces, such as the type of industry, financial costs and general economic conditions will influence the proper rate of return needed by potential buyers. These forces may fluctuate over time and can affect the prices buyers are willing to offer.
“As a corporate financier and valuer of a wide range of businesses offline and online, and as the founder of the UK200 SME Valuation Index, it is true to say that online business valuations are often in a different stratosphere to their more-traditional counterparts.
There are many examples of online businesses that have been valued at billions of pounds or dollars, while loss-making or even before generating revenue. These reflect the underlying acceptance that profits or current revenues are not the only data points for which a valuation should be based. Instead, a platform with which millions of users will transact – whether for banking, taxi services or social media use, represents significant value.
While traditionalists will always come back to a ‘turnover is vanity, profit is sanity’ response, there does seem to be space, in time at least, for valuations to be largely based on the future possibilities rather than the historical realities.”
Simon Blake, Strategic Corporate Finance Partner at Price Bailey
Brand strength and exposure
Do it yourself
How does valuing an online business differ to valuing a traditional business?
Online businesses often enjoy rapid growth. Traditional businesses usually go through a period of growth at the start and then they either maintain the growth trajectory or their growth goes flat. And that is why a seller needs to be extra careful not to undersell their online business. Online businesses are often sold within the first five years of inception which is not often the case with traditional businesses.
Ran Carmon, Managing Director of Chelsea Corporate
An accurate calculation requires reliable data. Sometimes this data will be privately-held and only available on request. As such, online tools that automate the business valuation process can only go so far in determining real value. Also, there is a significant amount of subjectivity in each of these methods outlined.
Generally, they require human judgement to determine what the appropriate value factors are and how to appropriately measure worth. Naturally, automated tools will fail in their endeavour, as each business is unique and requires a specialised approach when it comes to measuring financial performance and overall monetary value.
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. For most business owners, the asset they have grown (often over many years and through significant blood, sweat and tears) has an intrinsic value far beyond any standard valuation mechanism. My advice would be to seek a range of professional insight and select an adviser that you trust to represent you at market. As long as they really understand the narrative that underpins your business, they will find buyers with whom this resonates.
Mike Whittle, Managing Director, EvolutionCBS Ltd.
One simple way of evaluating relevant precedent sales is to use a company’s earnings before interest, taxes, depreciation and amortization (EBITDA). This will give you a tangible comparable metric that will provide strong valuation parameters for any precedent sales comparison.
Essentially, EBITDA is just one form of measuring profitability, just as SDE or net income are sometimes used in other circumstances. EBITDA, however, is the metric used for almost all large company transactions. If used alone as a valuation method, remember that EBITDA does not include the value of capital investments such as equipment, technical infrastructure or property.
Who needs to know?
The approach to online business valuations may differ considerably, depending on the reason for ascertaining the value in the first place. For example, if you are selling your business, the criteria of each buyer can vary dramatically and will certainly influence the perceived value of an asset. M&A predators may be primarily focused on your core assets, with a view to stripping and selling them for a profit. On the other hand, investors may take a more holistic approach, considering additional value factors and the ability for the business to grow in the future.
Do it yourself
What is it?
Discounted Cash Flow (DCF) analysis values an investment such as a business or other asset based on cash flow. As such, it is designed to calculate the value of a business based on expected future cash flows, with the addition of a discount rate. The result will be an estimated return of investment for purchasing an online business, with appropriate adjustments made for time and inflation.
As online businesses can fluctuate massively in terms of monthly cash flow and the history of financial data, which is needed to make an accurate DCF calculation, it is not recommended that this is used as your only valuation approach. In fact, it is one of the most complicated methods to use and requires a keen understanding of how cash flow can be predicted.
Traditional businesses with a long record of stable transactions will be best suited to this method, rather than relatively new online enterprises with fluctuating revenue streams. Nevertheless, this method can be used as yet another component to gather a full picture of your online businesses worth.
How important is it to understand the growth potential of different sectors?
Critical – how can you help acquirers understand the potential value of a business without the right research? This does NOT mean an adviser needs to be a sector specialist – after all, the client is undoubtedly one of those! The adviser needs to do thorough research and create a campaign in collaboration with their client.
Mike Whittle, Managing Director, EvolutionCBS Ltd.
The sooner you receive money, the more it’s worth. A discounted rate is added to the revenue forecast because inflation naturally erodes the value of money over time. Or to put it another way, if you receive the money now, rather than later, it will gradually increase in value based on interest rates. This will not happen for money that you receive in the future; therefore, cash flow will have to be discounted to reach a suitable value for the present.
The weighted average cost of capital (WACC) can be used as a discount rate for estimated future cash flows. This is the average cost which a business pays for capital from borrowing or selling equity. The actual WACC can vary substantially depending on the type of business, how it is funded and which country it is in.
Calculating discounted cash flow
You can see that things can get complicated rather quickly when valuing a business. While brokers aren’t always necessary, using a reliable business valuation broker will help you to approach the process with the right tools at hand. Having a provable third-party figure will also go a long way in securing a good deal if you are looking to sell. A broker can also provide access to an established network of buyers, making the selling process easier. Often, businesses negotiating a sale will use a third-party broker to value a company, in order to reach an objective result that everyone is happy with.
What’s your advice for businesses who want to value their businesses?
Don’t use online tools – they’re only as good as the data provided, and make sure you spend enough on getting a proper valuation done, or the results won’t properly reflect the unique features of your business.
Lake Falconer, Partner, Corporate Finance, PEM Accountants
As well as the methods outlined in this article, there are a number of other approaches that can be used to determine the value of an online business. This perhaps illustrates how complicated the process can be and the chance for very different results to be reached, depending on your approach.
The important thing to remember is that there is usually a fair deal to be made if you are negotiating from an informed position. If you are able to identify and agree in advance on the important factors that determine the value of a business, you should be able to reach an agreement – give or take a few rounds of negotiations, if necessary.
Seek advice, be realistic, put yourself in the buyer’s shoes, but more than anything, BE READY BEFORE GOING TO MARKET
Mike Whittle, Managing Director, EvolutionCBS Ltd.