If you’ve been trying to understand how to value a website or internet business you’ve come to the right place. Accurately valuing a website for sale can for many be the most challenging part of the purchase process. An internet business’s lack of physical assets can often complicate valuations, but if you’re clear on the pros and cons of the methods available, gather the right data on the relevant valuation drivers and apply this correctly, you will almost always arrive at a website valuation that makes sense.
At FE International we value and broker the sale of internet businesses with a wide range of monetization strategies (e.g. SaaS, AdSense, Subscription) across almost every niche. We’ve sold businesses with earnings multiples ranging from 1.5x up to >6x (more on that later) and seen more than a few interesting valuations devised by buyers! From experience of over 700 transactions, we’ve pulled together some of the best practices from our most experienced investors and snippets of knowledge from our own acquisitions to provide some guidance for new and seasoned buyers alike to answer: how do you value a website or internet business?
The Main Challenges
Stepping back and reflecting on the issue, the main challenges to deriving a fair business valuation seem to be 1) misunderstanding or bad use of valuation techniques, 2) gathering or using the wrong information for inclusion in the analysis and 3) oversight of extraneous factors or ‘the bigger picture’ as it were. In this post, we will dispel some common valuation myths, discuss some useful valuation techniques and provide examples of real-life situations we have seen recently to help crystallize the facts.
How To Value A Website Or Internet Business, Which Method Should I Use?
Discounted Cashflow Analysis
One of the most thorough ways to value a business is through a DCF analysis, which 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. The model’s theoretical underpinning is based on the time value of money which stipulates that a dollar today is worth more than a dollar tomorrow. You can read more about DCFs here and if you’re interested in employing one for use there are some good off-the-shelf models here.
A DCF should be a serious consideration for investors appraising mature, stable businesses with predictable cashflows. Unfortunately, those prerequisites are rarely satisfied even with the most established and consistent internet businesses. The variance in monthly cashflow, immaturity of the business model and quality of financial data available typically make a DCF at best a useful data point for comparison and, at worst, redundant. As such it’s something of a nice-to-have in the internet business context.
Looking for precedent acquisitions of similar companies is another traditional approach to benchmarking a valuation for a business. It is typically used as a frame of reference or sanity check against a DCF (or another method) rather than being the foundation of a valuation. With the comparable transactions method, you are looking for comparable metrics, usually multiples of earnings or revenue. It is important to identify the key valuation parameter for each deal. That is, were the companies in those transactions valued as a multiple of EBIT, EBITDA, revenue, or some other parameter? If you figure out what the key valuation parameter is, you can examine at what multiples of those parameters the comparable companies were valued. You can then use a similar approach to value the company being considered.
The main prerequisite for a useful and accurate precedent transactions analysis is access to transaction data. In a public company situation this type of information is abundant but in the world of private M&A and specifically, the nascent area of internet business M&A, transaction data is mostly privately kept. There have been a few examples of analysis from Centurica and SitePoint, which can provide a helpful starting point for new investors. For the most part though, precedent analysis is a tricky technique to work with unless you know the parties involved in previous deals. There is scope to analyze deals on marketplaces, but these are often misrepresented or low quality versus brokered deals.
The third major valuation method is the use of earnings multiples. In a public company setting this tends to manifest as P/E multiples as well as EV/EBITDA and EV/Sales or other iterations of these core metrics. In the internet business world, investors have increasingly gravitated around the multiple-based methodology because of its simplicity and robustness in the face of scant financial or comparable data.
The multiple-led method stipulates the buyer should arrive at a valuation by multiplying the seller’s discretionary cashflow (SDC) by a multiple that is appropriate for the business. Naturally the “appropriate” multiple is where all parties seek to formulate their own opinion and hopefully (read: eventually) arrive at a consensus before consummating the deal. The factors that underpin what should affect a business multiple are the KEY component of internet business valuation and the next major aspect of this article.
Before moving on though, it’s worth taking a look at some other relevant valuation approaches.
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Some Other Methods And Metrics
Another approach to determining the value of a website, specifically sites that have yet to be monetized but have traffic, is the traffic value method. To do this, the buyer must research the top key phrases that drive the majority of search traffic to the site. Then identify the cost-per-click value of the keywords. For example, if a site has three key phrases driving over 90% of its traffic, find the CPC in Google Adwords and multiply that for each phrase by the number of visitors being driven to the site by that search term. That will give you some sense on the value of the traffic for the site.
The traffic valuation method can be useful for devising a value for a non-monetized site (e.g. sites primed for AdSense) but falls down against other methodologies with its prescriptive approach to traffic-only evaluation. Websites that don’t rely on significant traffic (e.g. software or SaaS businesses) to drive revenue, will be valued significantly below fair market price using the traffic valuation method.
Traffic metrics can be an interesting way to triangulate or sense-check valuations. Justin at FlipFilter has written a nice article on them that is worth a read for more information if you’re interested in how to value a website.
A Word On Automated Tools
The internet is a breeding ground for quick-fix solutions and nowhere is this more prevalent than after a cursory Google search for “website valuation tool.” As this article aims to show, a proper valuation of a website or internet business requires hard data, some financial analysis and most importantly, human judgement. This is unfortunately where automated website valuation tools cannot compete.
Online valuation tools instead usually work off publicly available traffic statistics (typically Alexa rank) and apply an estimated CPM to guess advertising revenue. Some arbitrary discount rates are applied based on domain age, number of backlinks and other metrics. Naturally there are a host of issues with this: no accounting for financial performance and no accounting for different types of monetization to name a couple. If we take the top four tools on Google for example (CheckWebsitePrice, SitePrice, NetValuator and Webuka) the resulting valuation for Facebook (helpfully now publicly listed) we see a valuation range of $1.1 billion up to $6.8 billion. At the time of writing, Facebook’s enterprise value is $138 billion.
Major corporations aside, just inputting a handful of five recent transactions completed by FE International into SitePrice’s tool showed errors in the magnitude of 5x to 90x the actual sale price, in every case a significant undervaluation.
Don’t be mistaken in thinking online valuation tools always undervalue websites for sale. Often they are just as inaccurate in the other direction. These calculators are not able to properly value websites because they simply don’t have enough information to give an accurate valuation. Because of this, you are never going to get a fair and accurate representation of what your website is actually worth.
Conclusion? Don’t use them.
A Multiple-Based Approach to Valuing a Website or Internet Business
Earnings multiples are by and large the most popular valuation approach in small internet business M&A. There are two elements to the method that buyers should become experts in: defining profitability and identifying the factors that should influence the multiple.
The profit number that is of use in a multiple-based valuation for an owner-operator managed business is the seller discretionary earnings or SDE (sometimes called SDC). SDE is the money left once all costs of goods sold and critical (read: non-discretionary) operating expenses have been deducted from gross income. More formally it is defined as:
“The pre-tax earnings of the business before non-cash expenses, one owner’s compensation, interest expense or income, as well as one-time and non-business related income and expense items. If there are additional owners working in the business, their compensation needs to be adjusted to market rates”
SDE is subjective in nature and can vary based each investor’s own interpretation of what is discretionary operating expenditure (e.g. “we should include/exclude [x]”). Fortunately, internet businesses on the whole enjoy simpler cost structures so there is less margin for deviation in SDE estimates. That said, when evaluating the financial statements of an internet business you should sense check the SDE calculation of the broker and ensure it features only the right add backs, such as:
- Owner compensation
- Depreciation (uncommon but a legitimate add back)
- Travel expenses (if unrelated to the business)
- Office rent (if the business can be run from home)
There are a number of other valid add backs so it is worth digging into the financials to make sure you come out at the right number.
With SDE clearly defined and calculated, the next step is to devise a suitable multiple.
Factors That Influence The Multiple
Evaluating a business acquisition is a complex task, and as a result, there are many factors that influence the multiple of a business. While there is no definitive list of variables, there are certainly three key focus areas, which are the transferability, sustainability and scalability of revenue. Any operational or market factor that directly or indirectly impacts these core drivers will influence the multiple.
At FE International, we take into account dozens of factors on our internal valuation scorecard to derive the value of a website or internet business. Below are some of the major ones you should think about when appraising acquisition opportunities.
- How old is the business?
- How has gross and net income been trending for the last 1-3 years? The last few months?
- Can a new owner replicate the cost structure? Can they make any savings?
- Are there any anomalies in the financial history of the business? If so, are they explained?
- Can all of the revenue streams be transferred to a new owner?
- How stable is the earning power e.g. are CPMs in this niche on the decline/hard to replace?
- Is the owner an influence on the earnings power (i.e. owner-specific earning relationships)?
- What percentage of traffic comes from search? (i.e. what percentage is potentially at risk from search engine algorithm changes)
- How secure are the search rankings? What is the mix of short and long tail?
- How has traffic between trending for the last year? The last few months?
- Has the site been affected by any Google algorithm changes or manual penalties?
- What is the industry trend (see Google Trends)?
- Where does the referral traffic come from? Is it sustainable?
- How much of the owner’s time is required to run the business?
- What are the owner’s responsibilities? Are there high technical requirements?
- What technical knowledge is required to run or manage the business?
- Are there employees/contractors in the business and how are they managed?
- How competitive is the niche?
- What are the barriers to entry?
- Is the niche growing?
- What are the recent trends and developments in the niche?
- What expansion options are available?
- Where does the business get customers from?
- How much do customers cost to acquire?
- If subscription, what is the customer lifetime value and churn rate?
- If one-time, how active is the customer base? Are they re-ordering?
- Is it possible to remarket to the existing customers? Is there a mailing list?
- Are there physical assets or specific regional responsibilities with the business?
- Are there any licensing requirements in order to run the business?
- Does it infringe in any trademarks?
- Does the business offer any unique advantages? (e.g. trademark)
With a sense of the relevant valuation drivers, prospective buyers can be much clearer about what to look for when appraising a business and what to seek information on from the seller. This is where a good broker is vital for asking the right questions of the seller. They will weed out companies before they even come to market and help you along the way.
With answers to the above and more questions relevant to the business in hand, one can begin to devise a multiple for the business.
Naturally, some frame of reference is needed. Typically website valuations range from 1x to 5x annual net income with the vast majority of transactions occurring between 2x to 4x. To guide further, there have been a handful of empirical studies conducted by various industry commentators, including Centurica and SitePoint, which helpfully detail precedent transaction data for different monetization models to show how valuations deviate. WARNING: As mentioned earlier, both studies fall prey to the limitations of publicly available data. The major stipulation being their derivation of multiples from asking price not sale price which can be significantly different.
We took a sample of 60 transactions by FE International in recent years, established a mean sale price multiple across the group as a base (set to 100) and calculated each business model’s variance from the mean:
Intuitively, it makes sense that SaaS and subscription businesses are valued at a premium to the average as buyers’ pay for the certainty of recurring income. E-commerce businesses generally attract a broader audience (the offline crowd in particular) which creates a halo of demand around them. Content and lead generation sites can often be high workload and search-dependent, respectively, so tend to be discounted for these factors.
A final word – it’s important to note though that no two internet businesses are the same and you should carefully examine each one in isolation when establishing how to value a website as we demonstrate below.
Valuation Multiples In Practice
Below is an example and comparison of two internet businesses for sale, a travel blog and an online photography software business, that sold through FE International for 1.5x and 3.7x, respectively. The major influencing factors here were site age, financial trends, competition in the niche and time required to manage as well as the nature of the work required.
A Word On Buyer Profile
As the father of value investing taught in his seminal investment book, value means different things to different people and, as a result, the price offered by different buyers for the same asset can be quite substantial.
The investing context and criteria of each buyer can dramatically influence the perceived value of an asset. Some examples include:
- Strategic investors. Buyers with an existing interest in the same or a complementary niche may look at an acquisition target as a bolt-on or merger with the current asset and be able to realize significant cost and revenue synergies
- Financial sponsors. With greater formalization in the industry, there are more and more investment funds participating in internet business M&A. Often these funds guarantee investors a fixed ROI or have a self-governed IRR which will dictate their investment multiple more than anything else
- Debt-financed investors. A rarer breed but similar to ROI-focused investors, those parties using debt to acquire an internet business will usually have a ceiling valuation multiple in order to repay the principal and interest on their loan
All of these investment-specific elements, where relevant, should be considered in arriving at a valuation for a website or internet business.
The Market Effect
While a rational investor shouldn’t be overly influenced by the market prices for assets, it pays to keep abreast of changing trends in internet business M&A. Some interesting research by Centurica suggests that industry-wide, multiples have increased from an average of 2.4x in 2010 to 3.3x in 2017. Those numbers are caveated with the fact they are based off asking prices rather than sales prices but the general trend is consistent with FE’s own experience in recent years.
As the industry continues to develop, formalize and mature over time, it is only natural that more buyers will be attracted to the space and, consequently, demand for internet businesses will rise. At FE International we are experiencing more newcomers to the industry on a daily basis. Supply of high-quality internet businesses, particularly sub $1 million, are relatively low and, as a result, we expect increased competition for listings for the foreseeable future. It’s important though, as an investor, to stick to an objective, rational, deductive valuation process and try not to get caught in market dynamics, instead just be aware of where there are high levels of competition, for instance.
The Last Word – Due Diligence
“Diligence is a priceless treasure; prudence a protective charm.”
Reflecting on everything that has been discussed so far, the real underpinning to a successful website valuation and indeed online acquisition is due diligence. From observing hundreds of transactions over recent years, the one common theme in the most successful and subsequently valuable deals has been robust due diligence. Successful buyers do their homework and as the saying goes “Great riches come from heaven; small riches come from diligence.” It’s a very simple principle: Gather the right information for your valuation and verify it thoroughly during due diligence.
The key areas you could focus your due diligence on are financials, traffic and operations (see more about that here). A recent survey of due diligence failures showed the most frequently cited problem areas are:
Some Final Thoughts
Hopefully you’ve learned a few things about how to value a website and internet business through this article and also picked up some due diligence points for use in the future. A final takeaway should be the importance of the ‘bigger picture’ when looking at an internet business for sale. Without doubt, some of the most successful investors we have worked with at FE International over the years are the ones that have a bigger picture for the site they are acquiring. Buyers with a solid growth strategy in place are the ones that tend to look past the numbers and offer with a view toward much greater success. Sometimes they pay a premium to begin with, but almost always they end up with a very valuable end product.
If you own a SaaS business, it might be worth checking out our post specific to valuating a SaaS business. You will find resources that will help you determine the salability of your business and how to value it.