Editor’s note: Thanks to Thomas Smale of FE International for this guest post on e-commerce business valuation.
The e-commerce sector is a trillion-dollar industry in the United States alone. Investors are actively looking to acquire e-commerce businesses that are successful and continuing to grow.
No two e-commerce stores are alike. What creates value for one store might be different for another. That is why it is important to understand what contributes to your e-commerce business’s value, which will be especially useful when the time comes for you to make a successful exit.
After advising on hundreds of technology business exits every year for the past decade, we’ve honed in on what makes an e-commerce business valuable.
Based on our data working with countless founders of e-commerce businesses, here are key questions to ask yourself that will help determine the value of your e-commerce business.
Does your business have healthy financials?
The financial health of your e-commerce business is a critical component of your valuation. Keep these three questions in mind related to your financials for valuation and a potential sale:
- How old is your business?
- How has your gross and net income been trending for the last 1-3 years? The last few months?
- Are there any irregularities in the financial history of your business?
Your financial performance needs to be thorough and verifiable. As an owner, it is imperative that you maintain solid financial records. Recordkeeping itself does not increase the value of your business, but it helps justify the valuation because everything is in place. It also helps you operate your business more effectively.
Accounting software will help eliminate the grind of bookkeeping. However, it is still a good idea to be aware of what’s happening on your financial statements, even if a bookkeeper or software is covering most of the tasks. You want to avoid the risk of backtracking when you are preparing your business for sale. Using software like QuickBooks or something similar will help you streamline your company’s performance accordingly.
Messy financials will not bode well for an e-commerce seller looking to exit. Why? Because you’ll be forced to organize everything to prove your performance at the last minute before a buyer is willing to pay a multiple on your business.
Founders that keep track of their financials from the get-go and have them organized to a T are often the happiest throughout the exit process because they did all the work upfront.
Are your operations streamlined?
E-commerce business owners should always look to streamline their operations from the very start. This will not only improve the business, but it will also take unnecessary work off you as a founder so you can focus on activities that will provide greater impact.
Ask yourself these questions about your operations:
- How much time is required for you to run the business?
- What are your responsibilities?
- Are there high technical requirements?
- Do you have any employees/contractors in the business and if so, how are they managed?
You should also know which aspects of your operations will be of interest to buyers. This will point you in the direction of areas to evaluate and improve (if possible) in your e-commerce business, such as supply chain and fulfillment.
Streamlining your operations will increase the value of your business and make your business more profitable.
Is your business in an evergreen niche?
The financial history of your business matters. Businesses that outlast the rise and fall of fads often are valued much higher than seasonal businesses. The market of your e-commerce business will be greater if it is an evergreen business and has a business model that can be easily adopted by a new owner.
Consider these questions:
- How competitive is your niche?
- What, if any, barriers to entry exist for your niche?
- Is your niche growing?
An e-commerce business that sustains value is one that continues to grow despite its competitive niche and sustains growth amid the rise and fall of trends in the marketplace.
Do you have a solid customer base?
Apart from your product, customers are easily the most important part of your e-commerce business. Without them, your business would be non-existent. If you can’t prove a genuine customer base, no buyer will want to purchase your e-commerce business down the line.
Building a sustainable customer base takes time. Here are a few basic points you should begin to nail down and create systems around to determine the value of your e-commerce business:
- What are your customer acquisition channels?
- What is your customer acquisition cost?
- How much of your revenue comes from repeat customers?
Want to know a secret? We find that e-commerce business owners with an extensive email list with whom they keep in regular contact are more likely to have a successful exit because they can prove firsthand the reliability of their customers.
Is your product valuable?
Your e-commerce business is only as good as your last satisfied customer and the product itself. Take the time to consider these factors:
- Do you sell a single product or multiple products?
- Where are your suppliers based?
- Are the products you sell unique to your business or being resold?
As a business owner, it is important that you are always ensuring not only the quality of your products but the quality of your order fulfillment and the packaging in which your products are sold. Your order fulfillment should be passive, and the products should be sourced reliably.
There is value in private-label products that are manufactured by a single company rather than outsourced because you can be hands-on in the effort to build goodwill around your brand and products.
So, what’s the value of my e-commerce business?
E-commerce businesses are attractive assets for buyers. While the concept of business valuation is relatively simple, valuing each business is quite a complex process and comes with its own set of challenges.
The first step in calculating how much your e-commerce business is worth is to look at the financial picture of your business and then consider the other valuation factors based on that.
Ultimately, it boils down to these three factors:
Ask yourself at every stage of your business: is this decision going to make my business more transferable, sustainable, and scalable? If the answer is no, it would be wise to reconsider and look at other options.
Whether you plan to exit in 6 months or 6 years, these are good questions for any e-commerce business owner to ask.
Once you have determined the transferability, sustainability, and scalability of your business, you are ready to determine the valuation multiple for your business.
Most, not all, e-commerce businesses will use the Seller’s Discretionary Earnings (SDE) approach to determine their earnings or net income. Simply put, SDE is equal to the profit left once you’ve deducted all costs of goods sold and critical (non-discretionary) operating expenses from the gross revenue.
Any business in the $50 million-plus range will use the Earnings Before Interest, Taxation, Depreciation, and Amortization (EBITDA) formula to arrive at an appropriate valuation multiple.
Conclusion: e-commerce business valuation
I’ve only scratched the surface on what will make for a more valuable e-commerce business. If you begin to implement any of what you’ve read today, you will be well on your way to a higher valued exit.
Regardless of how soon (or not) you want to sell, you can always sign up for a free valuation to determine the current value of your e-commerce business. This information will help guide your next steps.
About the author
Thomas Smale is the CEO of FE International, an award-winning global M&A advisor of SaaS, e-commerce, and content businesses. The firm has completed acquisitions for thousands of founders, owners, and acquirers. Thomas founded FE International in 2010 with the aim of helping entrepreneurs running self-funded and profitable businesses exit. Since then, Thomas has built FE into the industry-leading M&A advisor for $1-100 million technology businesses. With experience dating back to the early 2000s, Smale offers invaluable technical, diligence, and negotiation advice to early-stage and seasoned business owners alike.