Selling your e-commerce business is a serious decision for any owner and the process of seeing a sale through to completion can be intimidating for first-time and experienced sellers alike. Hiring an M&A advisor is a good step in helping to ease the effort but as with any major endeavor, it pays to be well prepared from the outset. Having successfully sold over 1,000 online businesses, we’ve put together some guidance on how sellers of e-commerce businesses should best prepare for the exit process. We’re experts on e-commerce business exit planning.
Know Your Numbers
Understanding the financials of your e-commerce business from the outset is vital to the successful sale of your business. Before you initiate an exit process you should be clear on every aspect of your business including all sources of revenue, cost(s) of sales and operating expenses. It is important that you have a solid understanding of the flow of goods, including the supply chain and how the goods get to the end consumer. Increasing your knowledge on this will provide you with a clearer image of how much you spend on each sale. This can ensure your Cost of Goods Sold (COGS) calculations are more accurate and can reduce the time spent on due diligence. You need to be in a position to compile an accurate profit and loss statement for your e-commerce business as this will form the basis of prospective buyers’ valuation methodology and due diligence. Your business’ valuation will be calculated after reviewing various factors that are specific to e-commerce businesses. Here are some things to think about.
- Sources of revenue – Direct sales.
- Cost of sales – COGS (landed cost basis), Advertising & promotion, Payment processing fees, Outside services (Including fulfilment services like 3PL), Shipping & delivery (accrual basis), etc.
- Operating expenses –Employees including warehouse staff, Inventory costs, Outsourcing, Refunds/Chargebacks.
Keep in mind that during the due diligence process, prospective buyers will likely look to convert COGS, at the very least, and potentially revenues to accrual basis if they are presented in a different format. The reason for this is because it enables the investor to have a better understanding of financial trends and margins of the business.
Record Keeping
As part of the above you should be looking to collate all the financial and supporting documentation to prove the financial performance of your e-commerce business. Not only will this verify the numbers you provide at the outset but FE International will audit the financials and this will be the starting point for the buyer’s due diligence process. As part of the preparation for sale, pull these files together in one place. You will want to gather monthly bank statements, credit card statements, merchant processor statements and inventory and shipping invoices.
While on the subject of documentation, standard operating procedures (SOPs) are valuable when managing a business but are even more critical when taking on a new business and getting oriented to new processes. Help the new owner(s) of your business get acquainted by providing them with detailed SOPs. To do so, you will want to review and modify your already existing SOPs and create new ones as needed. Chances are, as your business has grown, new processes were added and you may not have gotten around to writing detailed guides for all of these yet. Now is a good time to write them.
Security and Compliance
Security is more important than ever. An Accenture/Ponemon Institute study reported that a majority (68%) of business leaders believe their cybersecurity risks are on the rise. Because of this, security and compliance will likely be top of mind for potential buyers. Knowing you are focused on security will leave potential buyers with one less thing to worry about. They will be interested to learn what steps you are taking to protect your customers’ information. Not doing so could lead to complications during the due diligence process and potentially result in a deal falling through. By putting security and compliance measures in place, this could easily be avoided.
Other Considerations for Your E-Commerce Exit
When preparing to sell an e-commerce business, there are several steps you can take to position your business for greater success. You will want to make sure you have contracts in place with suppliers outlining their commitment to supply specific products for a set period of time. Additionally, for goods that your company sells, make sure you protect the intellectual property by having trademarks and patents in place. Organize all related documentation as buyers will be interested in this information. Patents, trademarks and exclusivity agreements with suppliers are all selling points that make your business more attractive to potential buyers. Additionally, potential buyers look for businesses that emphasize developing and maintaining customer reviews. If your products are sold on Amazon, earning Amazon Choice badges are also viewed favorably.
Most buyers are looking to acquire a business, not their next full-time job. Because of this, the owner’s involvement in running the business should be limited. If you are currently more involved, we advise that you take steps to delegate mundane tasks to a team that is willing to transition with the business when it is acquired. This will make your business more attractive to potential buyers and will help streamline the transfer process. However, if you do not have a team in place, it is not necessary to hire one as it is possible to find a buyer who is looking to operate a business like yours. Furthermore, if you operate your own warehouse, we advise that you look into third-party logistics (3PL) since going this route makes scaling easier and these businesses are in higher demand for this reason.
When it comes to compliance, different regulations apply depending on the niche you operate in. Complying with these requirements is important. For example, if you sell a product with small pieces, you will want to check that these parts do not present a choking hazard. It is also wise to keep up with and align your product offerings with industry best practices. Potential buyers will be on the lookout for businesses following best practices and will be wary of businesses selling products that do not meet compliance requirements.
While preparing your e-commerce business for sale, you will want to resolve any open legal matters. Potential buyers will be more inclined to purchase a business without these types of issues. We recommend gathering all legal documents prior to the exit as not doing so could slow down the audit and listing processes.
We spoke about SOPs earlier but there are procedures specific to e-commerce businesses that you should document. These include processes related to inventory and packaging. Outlining these procedures for the new owner of your business will ease the transition process.
Lastly, while preparing to divest of your business, take stock of your inventory and your business’ plans and if possible, leave some powder in the keg (in the form of a new product, supplier, etc.) for the new owner. This will be appreciated by the buyer and will help facilitate a smooth transition period. Additionally, you will be paid for inventory, so this will not be money wasted.
The E-Commerce Buyer Landscape
When preparing to divest of your e-commerce business, it is worthwhile to have a sense of the types of investors most likely to be interested in acquiring your business. Depending on the specifics of your business, these potential buyers may include individuals, private equity firms, strategic businesses in your market, aggregators (roll-up companies) and larger, sometimes public companies that sell similar or adjacent products on a different scale. Soon you will be in talks with these potential buyers so it can be helpful to have some background on who they are and what they are looking for. Your M&A advisor will help you prepare for these conversations.
Know Your Reason for Selling
One of the most important pieces of information for any transaction process is the seller’s reason for sale. Know your reason for selling – it is one of the first questions a buyer will ask, so you need to be able to articulate your motivation. Your answer needs to be honest and, ideally, shouldn’t express any urgency. Buyers expect to hear reasons such as selling to move into another niche, financing an offline endeavor or paying down debt etc. Red flags are raised if the sale rationale seems ambiguous, unsure or connected to the underlying performance of the online business.
How to Value Your E-Commerce Store
Earlier in this article we touched on valuations briefly, however when preparing for a sale, it is important to understand how your business’ valuation will be calculated. At FE International we have extensive experience valuing and advising on the sale of e-commerce businesses.
The first step in arriving at an accurate valuation of an e-commerce business is to determine earnings or “net income.” For companies with an estimated value of $10 million or less, the Seller’s Discretionary Earnings (SDE) method is used almost exclusively. For businesses with an estimated value above $10 million, the Earnings Before Interest, Taxation, Depreciation, and Amortization (EBITDA) formula is almost always used to calculate earnings.
For more information on e-commerce valuations and valuation drivers and advice to keep in mind when divesting of an e-commerce business, read our article “How to Value and Sell an E-Commerce Business”.
Valuations of SaaS Businesses
When it comes to SaaS business valuations, most businesses under the $5 million valuation mark are valued using a multiple of seller discretionary earnings (SDE), also called seller discretionary cash flow. This is particularly the case if the business is relatively slow-growing and does not have a management team in place.
SDE is the profit left to the business owner once all costs of goods sold and critical (i.e. non-discretionary) operating expenses have been deducted from the gross income. Crucially, any owner salary/dividends can be added back to the profit number, too.
Most SaaS businesses are valued within a multiple range of 4x to 10x. For businesses with revenues below $2 million, the typical range is 4x to 6x and for businesses with revenues over $2 million, the typical range is 6x to 10x.
There are numerous factors that contribute to valuation multiples. These include the age of the business, the owner’s involvement in the business, growth trends, churn and other SaaS metrics.
For more information on SaaS valuations including a more comprehensive discussion of factors that influence what these types of businesses are worth, read our article “SaaS Valuations: How to Value a SaaS Business in 2021.”
Run the Business
Don’t forget to run the business – the sale process usually takes several weeks by which time you will likely have another reportable period of numbers. Time and again buyers ask for these during marketing or due diligence and it’s a far superior message to report stable or improved numbers than ones which have slumped from seller neglect. It’s an unfortunate fact that a good month of numbers won’t improve the sale price but a bad month will open the door for renegotiation.
Integrity is Important
The common thread running through all of these steps is credibility. If you want buyers to move forward, you must show respect by being open, honest and accurate about all things, both good and bad. Misrepresentations and conflicting statements will always be identified (we’ve never seen it otherwise) so it’s best to be completely open and honest from the outset.
If you want to know more about the sale process, please read our overview here. Additionally, you may be interested in getting a free valuation of your business.