An old saying by Warren Buffet “Price is what you pay, Value is what you get”. Still, buyers don’t want to pay more and sellers don’t want to get less. Certain parameters and factors determine the fair value of an online business that buyers and sellers can agree on or at least negotiate on.
Emphasis should be given to the word “fair.” To derive fair value of an online business proper valuation methodologies should be employed and relevant information should be gathered for overall valuation analysis.
Factors affecting the valuation of Online Business/Website
Traffic- Traffic plays an important role in the valuation process and is considered as the heart of any online business. Without traffic, there wouldn’t be any sales but more traffic isn’t always good and mostly it’s the case of quality over quantity. Best way to evaluate the quality of the traffic is to use a metric which is popularly known as Revenue per User (RPU). This metric shows how much revenue is generated from each visitor.
For example, if Amazon’s traffic has a RPU of $0.70 and Alibaba’s has a RPU of $0.03, it’s very clear that which traffic source is better and of higher quality. This implies, Higher the quality higher will be the value of online business.
Financials and Operations- At heart, an online business is operated like any other business. Hence, it is necessary to consider the customary financials of a company, for example gross revenues, net income, profitability, costs of inventory and operating expenses. Other factors shall include cost structure, Scalability, Product concentration, Assets, Payroll, Trademarks and Licenses, Liabilities and Future Commitment.
Customer Base – A customer base is a pool of data of shoppers and is considered as a subset of traffic. An active customer is one of the biggest assets of an e-commerce business. In layman’s language an active customer base signifies people who are loyalists to the business and the bigger the customer base, higher is the value of any online business.
Brand Differentiation- A Website with an established and well-known brand identity is of great value to a business. It is important for any online business to have its distinguish brand identity in the market, since most of the online business follow similar business model and have overlapping inventory. The only distinguisher that remains is the price. A loyal customer base encourages continued revenues and well-known brands also attracts new customers. A good brand makes the customer choose one competitor over other competitors.
Methods of Valuation
Traffic Value Valuation Method– In this method, the business identifies top key words that will pull majority search traffic to the respective website. Then bid for Cost-Per-Click (CPC), which is the monetary value of each keyword.
For instance, if a website has two key words which are driving most of its traffic. First step is to identify the CPC in Google Ad words and multiply that for every keyword by the number of audience that are driven to the site. This will give the value of the traffic for the site.
Formula for Traffic Value Valuation Method– “Cost per click x Monthly Unique Visitors from That Keyword”.
Customer Value Valuation Method- There are a few parameters that are used by the owners for this valuation method which are as follows:
“LTV = Life Time Value of a Customer, DPE = Dollar per Email”.
In order to create x number of consumers, it is important for the buyer to consider LTV, which will determine the amount which has to be spent on website.
Discounted Cash Flow Method Valuation Method- One of the most accurate ways to value a business is through a DCF analysis as it involves forecasting the free cash flows of the acquisition target and discounting them with a predetermined discount rate (usually the weighted average cost of capital (WACC)) for the business in question.
Precedent Transactions Valuation Method – Precedent acquisitions of similar companies is another approach to value business. The purpose of former is to access the transaction data. If it is a matter of public company, the database is readily available in public domain. However, if the comments is privately held, the data is provided a great deal of privacy. Precedent analysis can be a tricky technique to work with.
Earnings-Multiple Valuation Method- Earnings multiples is another vital valuation example.. P/E multiples as well as EV/EBITDA and EV/Sales are the core metrics.
Investors have become extremely inclined multiple valuation method. Its nature of simplicity entails to a robust solution.
Earnings multiples is widely considered to be the most synonymous valuation approach for small internet businesses The profit of business is calculated as = “Total Sale – Cost of Goods Sold – Expenses + Owners Wage”.
Revenue Multiple Valuation Method- Divide the monthly/yearly profit by the sales price, will yield into revenue multiple valuation method.
Formula for Multiple Valuation Method: “Monthly/Yearly Revenue divided by Sale Price = z”
Z is the number of months it will take to attain ROI on the price paid for buying the website.
Most internet companies are start-ups or early staged businesses, hence looking at price/revenue or price/ earnings multiples is not very informative. Predicting the market for these businesses is difficult since the market size and share is very wide. Amazon, which has been the most popular amongst internet stocks, showed how sensitive its valuation is to meet their expectations about growth. To prosper in this competitive world companies will need to be more lively and innovative. Some internet businesses will turn out to justify their current valuations and Amazon may be one of them. But most will not. The “auction economy” advertised by the internet is likely to make the environment more competitive which would be less comfortable for companies, both in online and offline markets, with effects on their forecasted margins.