What an SBA loan means for buyers and sellers

What an SBA loan means for buyers and sellers

Accessing finance to buy an online business can be a tricky area. It is essential to evaluate all potential sources of funding including seller financing. While some investors do have cash readily at hand and are just looking for an investment with profitable returns, most buyers certainly have the energy, enthusiasm and ideas to invest but fall well short of having the total funds required. Hence the need for borrowing.

Most mainstream lenders, particularly banks, are reluctant to lend for online businesses. If you are intending to build your own business from scratch, you can basically forget about a bank loan. If you are buying an established online business your chances are only slightly higher. Even where there is audited evidence of financial success over a period of at least two to three years, typically online businesses have very little in the way of saleable physical assets or inventory to provide collateral. Even if the borrower has separate assets such as real estate to mortgage, major banks tend to shy away from lending for online business purchases even if the loan is fully secured. Banks aren’t sentimental, but foreclosing on mortgages is never a good look for them!

So, where to go for a loan?

Perhaps surprisingly the most common loan source for startups and online business purchases still remains family and friends funding. In most cases this comes with some advantages but many drawbacks and limitations. Alternatively there are numerous small business lending providers who are willing to back an online business purchase, but usually at a hefty interest rate and with a relatively limited pay-back period required as part of the contract. Obviously unsecured loans are more expensive than secured loans. While this is always a borrowing option, think carefully before committing to one of these loans as paying it off could be financially draining.

What about an SBA loan?

Depending on your circumstances this could be where an SBA loan comes in. The US Government Small Business Administration loans underwriting program is designed to enable funding of small businesses as an incentive for investment and as an economy growing measure. The SBA program has numerous strands and is designed to meet many different contingencies, including even business loans for disaster recovery. However, in the case of borrowing to purchase an existing online business the relevant scheme is the SBA 7(a) loan.

How does an SBA loan work?

The government does not lend any of the money directly to the borrower. Rather it guarantees the loan, or typically a high proportion of it such as 85%, for the security of the lending institution. Many but not all banks will consider loan applications where the borrower is securing an SBA guarantee. The process is complex and quite arduous for the borrower, so it is vitally important to source in advance a bank or other major lending institution which has plenty of experience with loans underwritten by the SBA and the capacity to provide advice and guidance throughout the application stages.

Because the process is time-consuming, working with a potential lender without an established record in fast-tracking SBA loans will definitely delay the process to an extent which may dissuade the seller from entering into an agreement. Even with an experienced SBA lender the loans process is still likely to take somewhere between 45-90 days. This is very important to understand because a formal letter of intent to purchase and signed Agreement subject to SBA-guaranteed finance must be lodged before the application will be considered.

There are many private SBA loan facilitation specialists who will guide you through the process and connect you with a lender most likely to approve your SBA-guaranteed loan application – but for a fee of course. This cost can significantly erode your net financial position before you even start, so it’s worth investing the time and effort to understand the process so you can work your own way through it.

Eligibility Requirements

These are pretty strict, which is why only a small (but growing) proportion of borrowing for online business purchases comes from this source.  

Technically the borrower does not have to be a US citizen but the business development needs to be considered economically beneficial within the US and any borrower who is a foreign national needs to meet strictly defined residency status conditions.

The qualification requirements are too complex to cover in full here, but in a nutshell the business itself must be:

  • based primarily in the US
  • within the technical definition of a ‘small business’
  • for profit – and demonstrably profitable
  • an existing business, established for at least 2 years, with invested equity.

Any person borrowing for investment in the business must have:

  • an established credit score (at least in the high 600 range)
  • a bankruptcy-free record
  • no criminal history
  • no unpaid debts to any Federal agency
  • demonstrated competence to manage and develop the business proposed for purchase
  • an absolute minimum of 10% deposit after all fees incurred in the acquisition have been accounted for.

Detailed business financials and a clear business plan need to be provided with the application and it must be demonstrated that there is a proven need for an SBA loan. That is to say, other sources of finance are not available or financially viable for the borrower.

Advantages for buyers

Don’t let the seeming complexity of all this put you off. After all, your business success relies on diligence and perseverance! The advantages of an SBA-guaranteed loan are enormous, including minimum personal equity required, favourable interest rates and an extended loan repayment period.

It also provides you with substantial reassurance of the business profitability and development viability if the seller is willing to undertake the degree of financial and business plan scrutiny which the SBA loan process requires.

Implications for sellers

If you are confident of the worth of your business and want to secure the highest possible sale price, and if an ultra-short settlement period isn’t your highest priority, then entering into an agreement with a buyer intending to use an SBA loan may be a win-win outcome. Those buyers with ready cash or access to a rapid funding source will expect a discounted price in return for the certainty of a quick settlement. Cutting out a prospective buyer who is depending on an SBA loan will narrow your field of potential purchasers and may not yield the high sale price you could achieve.

The SBA-guaranteed loans program is a significant source of buyer finance for small businesses. The online business segment is still only a small proportion of these loans. But to provide just a slight indication of the scale here, Wells Fargo’s annual lending in the SBA 7(a) loans field alone is worth around $5 billion. Five billion dollars from just one single SBA lender. That’s a lot of small business investment money to spread around.

So, as online business sales increase, as a seller it’s certainly a good idea to be open to an SBA funded purchase offer.

 

What sellers need to know about valuations

What sellers need to know about valuations

There is no shortage of motivated buyers on the lookout for great online businesses. While the stock market is highly volatile, there is increasing enthusiasm for investment or purchase of online businesses. So, the potential appetite for buying is enormous. However, by far the major brake on buyers committing to a final purchase decision is their uncertainty about pricing. There is little understanding of sound valuation principles and buyers are wary of what they see as pricing based on an arbitrary multiple of net profit. Not to put too fine a point on it, buyers believe that sellers generally over-value their businesses and they find it hard to define a reliable and objective valuation method. The outcome is that too often an enthusiastic and highly motivated buyer fails to follow through with a final purchase because of the understandable anxiety about paying more than the business is worth.

How to value an online business

Typically with an online business, there will be little or no inventory to value and only a very limited if any physical asset base. Accordingly, the business will generally be valued almost entirely on the projected profits, calculated on the basis of current and relatively recent past profits.

While there are various alternative techniques for valuing an online business, including the traffic valuation method for sites with high traffic as a business asset but with no or incomplete monetization, many of these methods are highly technical and yield disputable outcomes. They are often suitable only in highly specific situations, depending on a precise definition of the particular revenue model, current and projected OR you are the next Facebook which is highly unlikely.

For that reason, online businesses are almost always sold on a negotiated value based on an earnings multiple or a price to earnings ratio. While it is very common to define the ratio in terms of a multiple of average net monthly profit, it is simpler for most purposes to quote the ratio as a multiple of annual net profit. Using this basis, average asking price multiples have increased from 2.4 in 2010 to around 3.4 now (sourced from our good friends at Centurica), with final selling prices typically at around a 10% discount to the asking price. This suggests that generally speaking sellers who value their businesses realistically can expect to achieve a sale outcome within reasonable range of the asking price. But putting a realistic value on the business is complex and there is an understandable tendency of business owners to over-value their business.

The average net profit multiple varies markedly from one kind of online business to another and also depends greatly on the specific market niche. However, the absence of highly consistent profit ratios can cause buyers to be both surprised and sceptical about the valuation proposed by a vendor. On objective grounds SaaS and e-commerce businesses sell for a significantly higher profit multiple than content-based or media businesses, because of the higher reliability of recurring income in the former models and the generally much higher operational time demands in the latter cases.

As an example, a currently listed relatively small SaaS business (not on Flippa) with a claimed $55k net annual profit has an asking price of $250k, a hefty earnings multiple of 4.55. You would expect that ratio level to make any buyer hesitate. Let’s assume it doesn’t have rocket ship growth (doubtful because they are selling) a buyer simply will not pay that amount.

Vendors who are seeking to sell at an earnings multiple above the prevailing average need to factor in the understandable buyer nervousness and be sure that the audited income and expenses figures are going to stand up to serious interrogation. While there is never an absolutely guaranteed success in any investment decision very few buyers overall, and virtually none in the six and seven figure range, are interested in taking a wild gamble on getting value for money.

The valuation factors that buyers will weigh up

Because it goes without saying that buyers generally regard sellers’ asking prices as inflated, it’s important that the vendor has realistically priced the business having regard to all the considerations which the prospective buyer will be factoring in.

The income figures must be accurate and cover the duration of the business operation, including only those income streams which will fully transfer to the new owner with the sale. Gross and net income trends will be crucial to the buyer’s assessment. All expenses must be transparently declared in detail, including all payments made to service providers and suppliers of goods and expertise. It is vital to new owners that they will be able to maintain all of the necessary business operations within the same cost structure, or ideally achieve some savings where possible. Any outstanding expenses or other debts transferring with the business obviously must be declared.

Absolutely all operating expenses need to be disclosed, not disguised, by the seller and discoverable by the buyer. Often overlooked, the full value of any unpaid work which has been invested in the operation of the business will be accounted for in the buyer’s own valuation of the business. The predicted cost of the new owner’s time, and any specific technical expertise required, will significantly affect the buyer’s business valuation. It is absolutely essential to the prospective buyer to be able to rely on an honest declaration of the time and expertise required to manage the business, as the new owner will need to put a dollar value on this expense.

The prospective buyer will need to analyse all the financial indicator trends over the longest time frame for which the figures can be produced. Sources of customers and the cost of gaining them will be important factors for the buyer, as will the effects of any changes to attracting traffic such as Google algorithm changes or even penalties which may affect search traffic.

The buyer will need to assess how competitive the niche is and whether there are barriers to the entry of competitors, which raise the business valuation, or the likelihood of increased competition in the absence of any significant barriers to entry, which will lower the valuation. It is crucial to the buyer to ensure that any licences required are fully transferable, or readily obtainable by the new owner, and that any branding, trademarks or other unique advantages will transfer with the sale.

The seller needs to appraise the business through a buyer’s eyes

The seller will be keenly aware of the time, energy, money and vision which has brought the business to its current status and positioned it for a successful sale. Naturally the vendor wants to achieve the highest possible price. However, seller over-valuation is the prospective buyer’s biggest turn-off. It really enables the sale process if the current owner evaluates the business using the same valuation indicators that the buyer will be applying.

It is worth mentioning that some buyers will apply a discounted cash flow (DCF) measure in their valuation. This is a somewhat less relevant consideration in an era of low inflation as at present, but put simply the principle is that a dollar of profit now is worth more than a dollar will be in the future, so a formula is applied to compensate by lowering the notional future profit value, given that the buyer will be paying in advance the equivalent of some years of projected net profit.

The bottom line for the buyer is that the online business acquisition must be fully transferable, it must be sustainable, it must have scalability, and above all it must be purchased at a reasonable earnings multiple. While it is still relatively unusual for an online business to be bought using funds from an institutional lending source, lenders may place a ceiling on the multiple, determined by the actual business model and specific market niche.

Overall, to achieve a reasonable pool of potential buyers interested in undertaking onerous due diligence and finally negotiating a fair sale price, sellers need to keep their initial asking price close to buyer expectations. Avoid ambit claims with the view that eventually you will negotiate down. The process of carefully considering a purchase is time-consuming for the prospective buyer. The factors outlined above will determine where the buyer expectation sits in terms of an earnings multiple. There are so many variations in play that the ratios will vary between around 2 and 4. There would have to be exceptional circumstances taking a selling price outside this already wide range.

Know exactly why you have decided on your own seller valuation, and understand what the buyer will be factoring in. Your initial asking price should not be more than 10% higher than you believe on reasonable grounds the buyer will consider fair after all due diligence and consideration of all the factors covered here.

It is very clear that a reasonable seller valuation is always the key to a successful sale.

 

Why buy an online business if you can build it from scratch?

Why buy an online business if you can build it from scratch?

Many potential buyers ask themselves this question when they are considering the seemingly high cost of an online business purchase. The average monthly net profit multiple is affected by many different factors, but as a general guide the purchase price is usually around a 30x multiple. As a simple illustration, an established online business generating a dependable monthly net profit of $10,000 will typically sell for around $300,000.

This multiple equating to, in some cases, as much as three years of the foreshadowed profit naturally causes buyers to pause for thought. Why not invest a much smaller amount building a business in the same general niche from the ground up?

It’s a lot to do with time

Yes, the short answer is time, in two different senses. Firstly, there is the significant period involved in building the business from scratch given the basic requirements for clarification of the niche and precise product or service focus, establishment of the site, the creation of content, the development of relationships and formal agreements with suppliers and content creators, the building up of a critical mass of customers or subscribers and the attainment of a recognised brand presence with a reputation of trust. During this lengthy establishment period there will still be significant outgoing investment, although obviously lower than the alternative of a straight-out purchase price, and with initially little or no cash flow in return. Secondly, the establishment phase will also require an enormous input of the developer’s time on which it is essential to place a dollar value. This valuation will depend, of course, on the individual circumstances of the business owner. For investors whose time is scarce or of high value if deployed elsewhere, then starting a business from scratch makes no sense at all – unless the vision for the business is highly original with virtually no existing equivalents.

Advantages of buying an existing business

By contrast, there are numerous advantages to buying an established business. Provided the business can demonstrate reliably audited income, expenses and net profit figures, along with levels and sources of traffic, then there is proof of concept from the outset of the acquisition. This certainly doesn’t apply to any totally new business, regardless of the level of confidence the developer may be feeling. An existing business when acquired should come with the primary domain, all files and codes including product or service codes, transfer of agreements with product or service suppliers including content producers, verified email accounts of customers or subscribers, and marketing methods including social media accounts.

The expertise of the seller as support during the transition period should also be part of the purchase agreement. If an earn-out provision is negotiated this will provide additional confidence in the viability of the underlying business performance and in the continuation of the seller’s active support for the agreed period, as well as somewhat reducing the payment required outright at the transfer date.

Barriers to success if building from scratch

Unless your online business concept is genuinely very highly differentiated from existing businesses in the space and you believe on reasonable grounds that it will meet a significant unmet need or want, then it makes little sense to invest some of your money and more importantly enormous amounts of your time to build the business from scratch. There may also be significant barriers to successful entry into existing niches. ‘Copycat’ barriers are largely informal but nevertheless effective through searches favouring established businesses and those with existing agreements or affiliations with the larger service suppliers. Industry registration standards and other regulations or terms of service agreements can effectively put a moat around well-established online businesses against which you would be attempting to compete, so that it becomes more difficult to simply enter the field and replicate their offerings.

The only good basis for building an online business from scratch is that both of these two following conditions apply. Firstly, the concept is unique and not simply an emulation of an existing successful business. Secondly, you are confident that you have the expertise and most importantly the time to build it. The actual cost of this time, which could be spent on alternative pursuits, needs to be realistically valued. If your primary reason for building a business from scratch is that you simply cannot afford a purchase, then it’s important to ask yourself whether you can afford the long hours, the delayed cash flow at the same time as the necessary establishment costs are invested, and the perhaps exciting but nevertheless highly stressful processes of establishing your website and systems, sourcing product or service inventory, developing a customer or subscriber base, creating business relationships, developing fulfilment systems and building a brand and its social media presence. Sure, it’s initially a lower financial outlay but a massively greater time and effort investment, with little or no cashflow for a prolonged period and no guarantee of success.

The case for buying

On most counts it’s clearly better to buy than to build from scratch. And of course this doesn’t exclude building further on the existing business performance so that the asset continues to grow in its eventual resale value. If feeling a little daunted by the seemingly high purchase price of an established business, never overlook what is taken for granted by traditional investors: it’s the potential capital gain value on eventual resale which is as important as the regular profit returns. Additionally, while a greater outlay is required for buying than for building from scratch, a financial loan if required is generally much easier to source for an established and proven business than for a new and unproven online business proposal.

As always when buying any business, whether traditional or online, doing the due diligence is essential. It’s not just a matter of checking on the revenue, expenses and profit figures. It’s equally important to thoroughly evaluate the agreements and systems already in place. It may be difficult or even impossible to change unfair agreements or inefficient systems which are in place once you have taken control of the business. So, ensuring that the level of control over change which you will have is sufficient for your plans for the future is a vitally important detail, although one which is often overlooked in the intense excitement of an online business purchase. Just a little extra time invested here will allow you to sit back and enjoy your income stream and future capital profit with confidence and, if you wish, little ongoing time demand after settlement and transfer is completed.

Why seller financing makes sense

Why seller financing makes sense

Why Seller Financing might make sense for you when selling your business

Many buyers of businesses are looking to invest in businesses which they can afford to purchase outright, even if this involves short-term Earn-out agreements, which typically are not arranged primarily for finance shortfall reasons. (The many advantages of Earn-outs are covered in a recent Flippa Blog article). However many of those looking to build a portfolio of businesses or to acquire a seriously high-value business may need to source finance.

Traditional business loans from banks and other major lenders are difficult to obtain for business investment. Currently banks are highly risk-averse and even when lending for more conventional business purchases they will be restricting lending to home equity based loans. Amazingly, after all these years of online business progress, the major banks still tend to be out of their lending comfort zones in the business website world, not really understanding or being confident about the way it operates. One of their main reasons for securing the loan with home equity is that banks cannot secure the loan against the physical assets of an online business and they are reluctant to place a value on ‘goodwill’ or business profitability potential.

We’ll cover SBA loans in a future blog post where the situation is entirely different again.

Unsecured loans from small business loan specialists, including online lenders, are more readily available but generally come with unattractively high interest rates and often quite burdening fee structures. Private equity firms which finance online business acquisitions tend to be interested only at high-value levels, and with lots of strings attached including an intrusive degree of business control or oversight.

Why you should consider seller financing

Whether you are a buyer or a seller, give serious thought to the mutual benefits of vendor financing. As a seller, if you are definitely in need of the full purchase amount immediately then of course this arrangement is out of the question. However, you will greatly increase the pool of potential buyers and the purchase price achieved if you are able to offer vendor finance for an agreed proportion of the purchase price. Unlike an Earn-out agreement which is usually limited to a minor proportion of the cost of purchase, does not entail interest payments, and is generally paid out in full within an agreed number of months, seller finance funds a proportion of the purchase with a longer-term payout period and with interest charged on the remaining balance until final settlement.

To illustrate, the owner of the business (owned outright and with no existing mortgages or liens attaching to the business) agrees to a sale price of $100,000. The buyer who has only $40,000 available as deposit, after judiciously retaining sufficient funds for immediate operating expenses and contingencies, has been enticed to pay a premium price because of the availability of seller finance. A reasonable interest rate to be applied to the outstanding monthly balance is agreed and a repayment period of typically around 5 years is determined.

The interest rate can be fixed, or floating and indexed to the official rate. In reasonable fairness to both parties, because the loan remains essentially unsecured the rate is initially set commensurately higher than major bank lending rates for business loans. In the simple illustration above, given the current interest rates and the buyer paying the seller a monthly instalment of $1000 plus the applicable monthly interest, the vendor would receive an income stream averaging around $15,000 annually for the five years. The bottom line for a seller who is in a position to defer full settlement is effectively a significantly higher final sale price, while the buyer is able to afford an acquisition which otherwise would have been out of reach.

It goes without saying that a legally binding contract is necessary for this kind of vendor financing arrangement, whereas Earn-out agreements typically rely on a less formal memorandum unless they are particularly complex or involve six or seven figure sums.

The mutual advantages of seller finance

While for the buyer the obvious advantage as already stated is the capacity to access an business business purchase which could not be afforded if the entire amount was required up-front, there is an additional benefit in the continued interest of the seller in the success of the business. Further, the willingness to provide vendor finance confirms the seller’s confidence in the business model and its ongoing viability and profitability.

For the seller, provided access to 100% of the funds from the sale is not required immediately for other purposes, then the regular income stream with an interest rate which is fair and reasonable but actually quite favourable to the seller is a great advantage and effectively raises the actual sale price achieved. Because the pool of prospective buyers has been increased by the availability of vendor financing, the agreed purchase price is more likely to be at a premium level also. Additionally in some circumstances, there may also be taxation advantages in the delayed payment of the full sale proceeds; this is a complex matter and as a seller you will need professional tax advice on this aspect, but it’s something further to consider.

A win-win solution to a business purchase arrangement

While this will not suit all sellers or buyers, seller finance is certainly an option which should be considered. In fact, it’s such a mutually beneficial situation that a rapidly increasing proportion of online business acquisitions are now financed on this way. For most vendors, offering seller finance is a sure-fire way to seal a deal.

Overall 2019 is emerging as a highly promising year for business investment, and we can expect to see exponential growth in seller financing arrangements.

An earn-out arrangement and what it means

An earn-out arrangement and what it means

Most people get a thrill out of buying a business whether it be to expand their existing empires or as a stand-alone operation. Thrills aside it’s an investment so like any other, whether real estate, shares or traditional business, it is never totally risk-free. That said, our experience says it’s unwise to be tentative and overly risk-averse. Instead, go for the business you want and offer to buy the business on ‘creative terms’.

Deal Structuring

So, you have finally settled on an online business you’re really interested in acquiring. You’ve done your due diligence, meticulously analysed the net profit figures, and thought through the rightness of the ‘fit’. It all seems good and you’re ready to go ahead. Now it’s a matter of negotiating and deal structuring. This is the most critical part. How many times have you seen institutional investments and acquisitions go wrong? Even the most seasoned make mistakes so while it’s a time for excitement it’s not a time to become overly emotionally-invested in the acquisition. Be crystal clear on the value you are placing on the business…this should be on the basis of its analysed profitability and potential.

Get to know the seller

Good negotiation produces a win-win settlement in which both you and the seller come away with what you need. Understanding what the seller wants, including the reasons for selling at the present time, the seller’s valuation and reasons underpinning it, and the payment timeline wanted by the seller, are all critical to your effective negotiation.

Building trust with the seller is vital. Assuming you are acquiring an established business with a record of profitability and on a growth trajectory (and, if not, why are you buying it?), then the seller will have authentic reasons for the sale which are important to understand. Assuming, also, that you are looking at a high six or seven-figure purchase price, then the way the deal is structured is vitally important to its success and you should go to the negotiating table fully understanding what you want to achieve.

For obvious reasons it will almost certainly be in your interests to negotiate only a partial up-front payment. It would be unusual for a seller to agree to a 40% delayed payment, but withholding up to 30% until an agreed final settlement date is common. This is technically a form of balloon payment ‘loan’ as the seller continues their equity investment during an agreed period, characteristically only a few months, during which the seller continues to provide expertise, advice and training. It also enables testing of external relationships and links on which the business depends and which are supposedly being transferred with the business.

The Earn-out Agreement

A more complex form of temporary ‘seller retained equity’ is an Earn-out agreement. For substantial businesses with a high six-figure or higher purchase price, this form of arrangement may be essential to negotiate. (Ongoing seller retained equity arrangements are different altogether and are used to enable a mutually desired continued involvement of the seller in the business over the long term.)

So, what is an Earn-out and how does it work? Essentially it involves a partial upfront payment at the time of transfer to the buyer. The proportion of upfront compared to delayed payment is subject to negotiation, but around 70% is a general guide. The remaining 30% is then paid in instalments according to negotiated performance criteria such as achieving the seller’s predicted milestones, or minimum monthly profit projections.
To illustrate with a simplified example. You have agreed to purchase an online business for $300,000, based on an audited net profit averaging $10,000 per month. In real terms the monthly profit figure could be seasonal rather than regular, and this would be factored in to the agreement. But for simplicity here let’s assume a regular monthly net profit. It has been agreed that the upfront settlement payment will be $210,000. The remaining $90,000 will be settled on the basis that each month $15,000 will be paid, but entirely contingent on achieving the projected $10,000 net profit in that month. There are any number of possible intricacies, such as no payment being made in a ‘shortfall month’ or more commonly payment on a sliding scale reflecting the percentage of the projected profit actually attained. This entails a higher repayment in a higher performance month.

This may sound complex, particularly if we factor in that the total purchase amount in this scenario could be finalised earlier or later than the approximately 6-months timeframe envisaged for the Earn-out period in the situation described above. In a nifty variation on this approach, some Earn-out agreements fix the time frame itself rather than the instalment amounts, with the effect that if the business fails to perform fully to expectations the final price paid is somewhat lower than initially envisaged and conversely if it performs better then the buyer finally pays a little more in total than initially anticipated. Few buyers would be concerned about this as it is a win-win situation all-round.

Given the complexity of the Earn-out detail to be negotiated, why do it? The advantages for the buyer are immense. Firstly, the obvious one of delaying full payment and the interest costs of investing 100% from settlement day. But more important is securing the self-interest of the seller in actively ensuring that all goes to plan, the projections are achieved or exceeded, and there is a smoothing of any potential bumps created in the transition process while migrating service provider accounts and supplier and client relationships.

While a six-figure or higher business acquisition will always involve a legally binding agreement, at the end of the day if there has been a 100% purchase payment made at the time of transfer then it will be close to impossible in practice to achieve compensation for any shortfall in predicted performance or for any unanticipated hurdles in migrating accounts. Retaining a proportion of the final payout figure provides real leverage to engage the interest of the seller in ensuring the smoothest transition. Leverage beats lawyers hands down.

Finally, honest relationships are the key to success. If the seller won’t agree to an Earn-out provision find out why. There may be a compelling reason for the seller’s position. If so, then that loss of leverage at the very least justifies you offering a somewhat lower purchase amount to offset the downside of settling in full at the time of transfer.

Negotiation needn’t be stressful. It’s a matter of understanding the seller, while remaining crystal clear about your own needs as a potential buyer.

Just a toe in the water or dive straight in? Buying an eCommerce business

Just a toe in the water or dive straight in? Buying an eCommerce business

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!