The new favoured investment of many busy professionals is the acquisition of online businesses, because of the generally higher yield than real estate or share portfolios. Additionally, in view of their own demanding time commitments, one of their key selection criteria when deciding on an e-commerce business for purchase is that once the deal is done the website on which the business is founded, along with the revenue stream it produces, can be largely self-managing.
On the other hand, many retired or semi-retired ‘baby boomer’ investors like me achieve a great sense of engagement from acquiring online businesses where they can see a potential for growth and improvement, drawing on their own active involvement in the development of the business.
So, fully understanding the level of ongoing time investment which will be needed over the long-term, whether minimal or fully actively engaged, is a critically important consideration in buying any online business.
We all understand the process of buying real estate for investment, or a conventional goods or services business. We have a good sense of the selection criteria to apply in choosing an investment, and the due diligence needed before making a final decision. However for many investors, e-commerce businesses are unknown territory so there is an understandable tendency to play safe and avoid risk by beginning with only a low-cost entry investment to test the waters.
Yet, an overly cautious entry is not necessarily the wisest strategy. The lowest prices are obviously attached to lower-performing and lower-yield businesses, which may or may not have strong growth potential. If the potential is genuinely there, then a corollary of the very modest financial investment will be the need for a high buyer engagement level and ongoing time commitment.
So let’s look at how it all works
Essentially the success of the online business you are considering purchasing depends on the traction gained by the website itself. Generally it is high quality, engaging content that drives regular and growing traffic to the site. Many highly successful e-commerce businesses largely outsource the content to paid freelance content writers. Good content writers are readily available in virtually any field and constitute a very affordable operating expense if the website is established and running effectively. Of course, many business owners either write or edit the content themselves, and often find this direct involvement essential to their sense of engagement with the business. This discretionary control over the level of the buyer’s personal time investment is one of the most appealing aspects of online business acquisition.
There are different types of revenue streams which a successful web-based business can produce, assuming that it is not seeking to sell its own unique product inventory. (Inventory-based businesses which develop and sell their own products in an online environment, or hold the rights as a franchise or official reseller, are in a different category and are not considered in this article.)
The balance of content compared to product marketing varies, and it is important to understand how your potential e-commerce acquisition currently profiles itself. Most commonly the niche content area, just for example boating and fishing or health and wellbeing, is the ‘shopfront’ and the interest generated by high value and continually updated content is what draws the potential purchasers to the site. Encouraging visitors to subscribe to a regular email bulletin is a good strategy to build regular follower numbers. In this profile, the marketing of products is presented as a sideline service and it is essential that promoted products are tightly linked to the niche content, which is the drawcard.
At the other end of the spectrum are the e-commerce sites which directly foreground a vast range of products within an identified interest area, for example skin care products. Again, none of the inventory is owned or handled by the seller. Profits come from the margin between the price paid by the customer and the wholesale price charged to the seller. Alternatively, the profit may be in the form of a commission paid by the manufacturer or, more often, the wholesaler. It is important to understand that profit margins are characteristically small and this e-commerce model generally depends on large volumes of sales.
Using Dropshipping, the visitor/customer purchases directly from the website. The business then purchases the product from a third party (wholesaler or manufacturer) and has it shipped to the customer without ever handling the product itself. Customised product labelling, packaging and delivery branding enables the selling of items which are presented as part of an in-house brand with their own SKUs or Stock Keeping Unit numbers unique to the business.
Even in this model it is generally crucial to success that the customer experience is enhanced with substantial blog content, outsourced to freelance content writers, and often with other incentives such as online product advice when a customer submits a query. Commonly in this model the business will be competing with other sites selling the same products and because there is no viability in competing on price, success depends largely on competing on the basis of providing a highly positive customer experience. Search engine optimisation (SEO) is also crucial here for building customer traffic, but this again is a skill set which is outsourced and not particularly expensive to obtain. Cross-promotion is often established, whereby advertising material such as ‘gift cards’ for another business in an unrelated niche is included in your product packaging, on a reciprocal or even paid basis.
If your online business is geared up to sell items with your own branding, even though the same item is marketed by other e-commerce businesses, then each item will carry its own SKU or barcoded stock keeping unit unique to your own site. Often but not always, e-commerce businesses which use this model for branding and delivery still have an interest-based website which is heavily dependent on quality niche content. There are some highly profitable sites with only a small number of SKUs while others, for example in the apparel and accessories niche, may have hundreds of SKUs.
So how do I choose my investment business?
Clearly the current profitability, or the potential profitability you can see, is the Number 1 criterion. Revenue is not the issue. Net profit is. Ensure the seller is fully transparent about all costs, including all outsourced services. Accurately knowing absolutely all of the business costs which are entailed is crucially important. You can buy e-commerce websites even on eBay, but that would leave you completely exposed to unscrupulous sellers, of which there are many.
As a guide, expect to pay around 24-30 times the audited monthly profit (or 2+ times the annual profit) for most e-commerce businesses, although there are many variables affecting this figure. Check what expertise, for example experienced outsourced content writers, are coming with the business. Factor in a ‘passivity premium’. That is, if it’s unnecessary for you to invest an enormous amount of your own time managing the business in an ongoing way, then it’s worth more financially than if your own time and expertise is a major investment cost.
Generally, it is wise to consider only businesses with an established record of consistency and growth. Ideally, be assiduous in trying to understand why the seller is selling. There are many possible reasons for the sale, beyond profit-taking. Knowing the background to this may be important in your final decision. Has the business already ‘peaked’ perhaps? Having a precise task-matrix of the current owner’s involvement is a key to assessing the cost of replacing the owner’s time and expertise. If you don’t want to take this on yourself, is it outsourceable and if so at what cost?
It is vital to know what exactly is being transferred with the purchase. Will existing product supplier agreements and merchant processes transfer with the business or do they remain with the current owner personally? If so, that is a potential deal killer.
Approaching this whole investment evaluation process in a positive way, it’s actually pretty engaging and energising. It’s been kind of fun for me. In my case I’m looking for active involvement in a niche content-based e-commerce website where I can personally do much of the writing and editing, while outsourcing the website optimisation to others. Looking at the some of the offerings on Flippa and imagining their potential and their ‘fit’ with my personal interests is exciting.
Survey the surroundings, but finally it’s best to dive straight in
Invest just a small amount too over-cautiously and the outcome isn’t likely to be all that spectacular. I’m going to be responsible with the investment amount I’ve set aside – but no toes in the water for me. I’m ready to jump in now. Good luck with your own investment journey!