Having made an offer for a business, had it accepted by the seller and signed a letter of intent (LOI), the transaction will proceed to due diligence. For larger website acquisitions, depending on relative size and complexity, due diligence is likely to be the most lengthy aspect of the business sale process.
Due diligence of an internet business can be a tricky thing but if you take a structured approach and take care to do it in detail then you will sail through without an issue. When evaluating websites for sale, you should always have due diligence issues in the back of your mind.
Why Conduct Due Diligence?
In effect, due diligence in both an offline and online sense is based on the premise that any major investment should be examined from a number of different perspectives to unearth any underlying risk that has not been duly considered, which may influence final negotiations and decision-making.
Therefore due diligence is a critical step to be taken by any business or individual prior to making the commitment to any legally binding contract. Conducted well and with an appropriate standard of care, due diligence should bring peace of mind to both buyers and sellers alike.
Due Diligence of an Internet Business – Art or Science?
Due diligence should be thought of as an objective fact-finding exercise (science) used to inform subjective decision-making (art). There is no right or wrong way to do it and one person’s perspective or interpretation of the information put forward may differ substantially from another’s.
Sharp investors will be thorough when conducting due diligence and will approach the task with inquisitiveness, using the breadth of collected data to inform their final go/no go decision. At the end of the day, if something goes wrong during the course of due diligence, at least it was picked up before signing on the dotted line. Also, don’t be afraid to ask a broker for help on what to look for.
As discussed, due diligence can be conducted in a host of different ways, the level of detail may depend on the size of investment and associated risk as well as the nature of the internet business or website for sale. To bring due diligence to life in the context of online, we will explore six key tenets of a robust process for due diligence of an internet business:
It is worth mentioning that some parts of the process may be considered more important by some investors compared to other. Equally, some will matter more for some business models versus others. Regardless of this, all aspects should at least be probed to some extent.
1) Traffic Verification – Assess the Traffic Before Crossing
Traffic verification is a case of analyzing the traffic reported to be coming into the website, checking for anomalies and ensuring the link profile looks natural.
When assessing traffic (using Google Analytics, for example), ensure that any bought traffic appears on the income statement and reconciles in terms of money spent and traffic generated. As always, transparency with the seller is key, if the seller is buying traffic without fully disclosing, there could be a material misrepresentation.
Even if traffic volumes look legitimate, the traffic sources may still require validation. It is important to look for any signs of paid or sponsored links that may not have necessarily been declared. For example, a well ranked website that has a number of links may seem good on paper, but in reality the seller may be paying (and not disclosing) thousands of dollars a year in sponsorship for the privilege. It is a good idea to evaluate the link profile in general (tools for this are outlined below) and examine how many back links have been added in the last six to twelve months and what the nature of these additions are.
Other things look for include:
Average time on site – how long (on average) does each visitor spend on the site? If this figure is low (<30 seconds), then website links may be of poor quality or the UX/content is of poor quality depending on the nature of the website content of course.
Number of pages visited – how many webpages is the visitor viewing? If high, then the content across these pages is likely to be appealing and the audience is captivated.
Traffic numbers vs. financials – how much is each unique visitor generating in terms of revenue figures, if they don’t correlate, it is likely that there is alternative sources of traffic (e.g. inorganic).
Traffic sources – where is the traffic coming from? Traffic sources include search, social media and referral. Is the website over reliant on one specific traffic source that could be considered unstable? How have these sources evolved over time and are their explanations for the changes?
It is best practice for the seller to allow the buyer access to Google Analytics or whichever 3rd party traffic analytics platform they use in order to facilitate analysis of the traffic during due diligence.
2) Financial Verification – Assess the Financial Situation
Financial verification is a key stage in both the due diligence and overall buying process. When acquiring a business, it is critical that you are fully aware of the historical and current financial position of the business. In order to do so, check that the business has maintained an accurate and detailed financial record since its inception.
Buyers should start the audit trail by checking monthly affiliate statements and/or merchant processor statements against the bank statements provided by the seller. Tax returns are often requested but less often useful. Most internet business or websites for sale are owner managed and usually part of a larger LLC, so reviewing the tax returns shows a muddled picture. A combination of merchant/affiliate statements and bank records is typically enough to allay any concerns on the financial audit trail.
A document check is the first round of verification, buyers should also always request a live screen share with the seller to go through the back end of the website, any affiliate partners and possibly online banking portals in order to conduct a 2nd stage of verification of the financials as well as authentication of ownership.
It is also worth tracing any historic, current or likely future debts/liabilities associated with the business (credit rating checks are a good place to start). Doing so, will put you in good stead for assessing whether the business is, from a financial perspective, in a healthy or unhealthy state.
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3) Owner Verification – Know Who You Are Dealing With
It may seem obvious to some but owner verification is important. That is, ensuring that the owner is who he or she says they are. Unlike in the offline world, it is uncommon that buyers will meet the sellers during the sale process. Ensuring that the seller has a company, history, a decent reputation and a legitimate audit trail should be a key step in your verification exercise.
The growth of social media has made this easier, albeit still relatively subjective. You could try looking the seller up on LinkedIn, Facebook or Twitter. If they don’t exist, there may be a plausible reason why, either way it is worth exploring. Websites like Scam are useful ways to quickly check the trustworthiness of the seller.
4) Technical Verification – Avoid Investing in a Burning Platform
Depending on the business and underpinning technology, it is important that you are comfortable with the level of technical risk. After transfer, you do not want to be left in a position where a technical issue could jeopardise the continuity of business operations. For example, if you are looking to acquire an e-commerce business that sits on the Magento platform consider whether custom plug-ins or extensions been used. If they have, will you have access to clean code that can be modified quickly and cheaply, if required? If no, will you be put in touch with in-house programmers if technical issues arise?
For content sites operated on WordPress, conduct an audit of the plugins used and ensure they have been paid and licensed for by the seller. For SaaS and software business, ensure you are given a sample of the source code for auditing to ensure authenticity as well as gaining comfort with the quality and annotation of the code for any future amendments.
5) Operational Verification – Understanding the Size of the Task Ahead
Before making a formal offer, buyers should verify the time commitment required to successfully run the business. Whilst it is difficult to know the precise time/effort, the seller should be able to break down the tasks, responsibilities and an estimation of the number of hours required to run the business.
By analysing this information, you should be able to gain a good understanding of the size of the task ahead.
6) Legal Verification – Stick Within the Law
Put simply, is the internet business or website for sale illegal? It may not be illegal in your country of origin, but it may be illegal in another. Therefore, opportunities for growth may be constrained, thus limiting the value you place on it as a business. They might be running a site that’s perfectly legal where they live, but where you’re buying it is not necessarily legal.
As the deal size increases, the more the legal due diligence will be required, contracts being a pertinent example. Common litigious issues include trademark infringement and image licensing, for example.
Final Thoughts – Due Diligence of an Internet Business
In summary, due diligence is critical to any major business transaction; it helps to put both buyer and seller at ease. It is the time to pinpoint and discuss any underlying risks that may influence the purchase decision.
Following the six-step process outlined above is a good basis for conducting due diligence of an internet business, but be flexible and don’t be afraid of approaching it in a different way based on the specifics of a particular transaction. Remember: NEVER buy a website or internet business without doing due diligence.