Valuation of Online Businesses
With few, if any, tangible assets, valuing an online business can sometimes seem to be a little less than scientific. However, there are some critical things to consider. The key for ascertaining a realistic value for an online business relies on consumer and market research and the application of a number of valuation methods used for more traditional businesses.
Online customers are volatile and it’s important to understand market trends to make the best judgment as to the sustainability of the revenue stream. What might be the people’s favorite one day could be history the next; it’s easy to make costly mistakes. Once you have done your research into the markets in which the business operates, forecast trends, growth, competitive threats. Once this has been done and understood, the analyst can apply traditional valuation methodologies.
Traditional Valuation Methodologies
– Asset valuation. For a supplier of products to the marketplace, there will be inventory, equipment, and facilities to take into account. Other assets, however, can be much harder to value. Intellectual property, reputation, customer databases, the quality of a product/service, and goodwill are intangible assets. Their worth will come down to an assessment of financial factors, such as the strength of the sales pipeline, and perceived position of the business in the marketplace.
– Financial performance. Historic performance of the business, including cash flow and net profit are key. A business valuator will recommend a P/E (price/earnings) ratio, whereby the business is valued at an industry-recognized multiple of the annual net profit. If the internet business in question is relatively new and has few assets, it may be valued according to a discounted cash flow method. This involves analyzing the forecasted future cash flow over a number of years and then discounting this to take into account the time value of money and the risk inherent in the cash flows.
– Entry cost. For young businesses where you don’t have historical accounts to rely on, another method of valuation might be to establish how much it would cost an individual to set up the same business from scratch including facilities cost, assets, inventory, marketing costs and staff training costs. However, such valuations will not take into account the time and effort invested by the seller in getting the business off the ground and developing its potential growth.
– Personal circumstances. Does the seller need a quick sale because of illness, relocation or relationship issues? This will reduce the value of the business. If a buyer needs to borrow a significant sum of money to fund the purchase, or is desperate to get a slice of a competitive market, this could have an impact on the value of the business too.
– Operational factors. Is the business dependent on the skills and knowledge of the seller? Or does it have established systems, procedures and trained staff who can operate the business independently of the owner? A business that can operate without the owner’s input will attract a higher value, as will a business that is scalable. The latter being the ability of a system, network, or process to handle a growing amount of work or to be enlarged to accommodate that growth
As with any business, as a seller you must remember that the value of an online business is only what someone is prepared to pay for it. And, as a buyer, don’t believe everything you’re told by the seller – dig deep for the real reasons behind the sale and do your homework. At the end of the day, for the purposes of business appraisal, fair market value is defined as the expected price at which the subject business would change hands between a willing buyer and a willing seller, neither being under a compulsion to conclude the transaction and both having full knowledge of all the relevant facts