Are you hoping to sell your online shop? Or are you interested in what your store could be worth? Whether you’re selling a Shopify business or any other kind of e-commerce store, this article will teach you how to obtain an accurate business valuation and how to complete an e-commerce business sale.
Before we get into the technical side, it is important to understand the context of why e-commerce has become so popular and mainstream which has driven a lot of the buyer and investor demand to buy these businesses, regardless of their size.
It’s no secret that e-commerce has become woven deeply into the fabric of our everyday lives. If you haven’t tripped over a pile of Amazon boxes at some point over the past holiday season, you’re likely in the minority. So, how have we ended up here?
- Age of Business
- Level of Owner Involvement
- Customer Service
- Streamlined Logistics and Fulfillment
- Inventory Management
- Formalized Supplier Relationships
- Reducing Technical Burden
- Coding Best Practices
- Secure Intellectual Property
- Work-for-Hire Agreements
- Assets to Transfer
- Transition Assistance
“After nearly 20 years of delivering roughly the same e-commerce experience, the industry is finally beginning to make some big strides. What’s exciting is that these strides are not just focused on the online shopping experience, but the merging of offline with online to create some truly unique and brand-driven experience for consumers. Even more exciting, the democratization of e-commerce means that this is no longer limited to large companies.
“In the next few years, we’re going to begin seeing some of the biggest advancements in e-commerce with the addition of augmented reality and virtual reality. To say the future of the e-commerce industry is bright would be an understatement.” – Richard Lazazzera, Founder – A Better Lemonade Stand
Amazon tends to get most of the attention when we speak about e-commerce. This is largely understandable. How many other corporations could capture the attention and resources of the 238 cities across the USA that vied for Amazon’s HQ2 complex? Then, Amazon created headlines when protests and political turmoil led it to abandon its plans for a campus in New York City projected to provide 25,000 jobs.
While Amazon and the world’s richest man, founder Jeff Bezos, have been in the news lately for reasons other than Amazon’s e-commerce dominance, the numbers behind that preeminence are remarkable. Amazon generated $141.92 billion in product sales in 2018, up 19.7% from $118.57 billion in 2017. One study recently forecast that by 2023, Amazon will be responsible for 50% of total US e-commerce sales.
Third-Party E-Commerce Sellers
While one might look at these numbers and assume that e-commerce retailers not named Amazon must be struggling, nothing could be further from the truth. A little-known fact is that third-party e-commerce sellers actually sell more product on Amazon, through its Marketplace platform, than Amazon itself. 52% of units sold in the fourth quarter of 2018 were sold by third-party merchants, netting Amazon more than $13 billion in fees. 20% of professional Amazon merchants sell more than $1 million a year, double that of the previous year.
So, while Amazon Marketplace and Fulfilled by Amazon merchants are thriving, what about those e-commerce businesses operating independently of the Amazon ecosystem?
Total US retail e-commerce sales in 2018 reached $504.6 billion in 2018. That number is expected to grow by 46% to $735 billion by 2023. While 64.7% of e-commerce sales are made by just five retailers–Amazon, eBay, Walmart, Apple, and The Home Depot– that still leaves an estimated $128 billion in sales up for grabs by independent e-commerce retailers.
Average revenue or net earnings numbers for independent e-commerce stores using platforms like Shopify, Magento, WooCommerce–or running custom hosted solutions–can be difficult to come by. However, figures from Shopify indicate the strength and scale of the independent e-commerce sector.
In May 2018, there were 600,000 active merchants on the Shopify platform, and during Black Friday and Cyber Monday weekend 2018, Shopify merchants garnered over $1.5 billion in sales.
FE International and E-Commerce Businesses
The FE International team has advised on the valuation and sale of hundreds of profitable online stores for a decade. One of the most common questions we get asked by e-commerce business owners is “How much is my online business worth?”
That’s not an easy question to answer, but we’ve written this resource to help merchants arrive at a ballpark estimate of how much their e-commerce business may be worth. We also hope to show e-commerce business owners the fundamentals of raising their business’ value.
We hope that this post clears up some of the inaccuracies about the e-commerce valuation process. If you’re a business owner interested in an e-commerce business sale, don’t hesitate to reach out to the FE International team for a free valuation.
Determination of Earnings
The first step in arriving at an accurate valuation of an e-commerce business is to determine earnings or “net revenue.” For companies with an estimated value of $10 million or less, the Seller’s Discretionary Earnings method is used almost exclusively.
SDE Method of Valuation
SDE is a relatively simple formula. Cost of goods sold, and operating expenses are subtracted from gross revenue. Then, assuming that the business is owner-operated, any salary taken by the owner is added back into earnings. This is considered a discretionary expense that a new owner could elect to reduce or not to pay.
Adding owner compensation back into revenue helps uncover the true earnings power of the business. Examples of additional expenses that may also be added back might include personal travel or any other discretionary personal expenditures that have been passed through the business for tax purposes.
For businesses with an estimated value above $10 million, the Earnings Before Interest, Taxation, Depreciation, and Amortization formula is almost always used to calculate earnings.
EBITDA Method of Valuation
E-commerce businesses with an estimated value of $10 million or more tend to have more complex ownership structures with multiple stakeholders. With EBITDA, any compensation paid to an owner is considered a legitimate operating expense and is not added back. EBITDA is used to gauge the performance of a business in terms of profitability before certain uncontrollable or non-operational expenses. EBITDA is the industry standard for valuing and comparing the valuations of different companies for businesses valued at over $10 million.
Revenue and Growth-Based Valuations
For the vast majority of e-commerce businesses, either SDE or EBITDA will prove sufficient for determining earnings. However, for some fast-growing, typically well-capitalized companies that are investing heavily in technology and future growth, neither benchmark will be effective. In this instance, it is possible to forecast future earnings based on revenue and growth, even if expenses currently exceed income.
Earnings forecasts based on revenue are inherently more volatile than those using SDE or EBITDA as they are based solely on growth. For this reason, they are only used when neither SDE or EBITDA is effective. In some instances, a blended approach may be taken, and SDE or EBITDA may be combined with forecasts based on revenue.
Finding the Earnings Multiple
Once a determination of earnings has been made using one of the above methods, it is time to find the earnings multiple. This is the most complex part of the valuation process. At FE International, we use a proprietary method that considers thousands of different data points and has been honed over hundreds of transactions. The goal is to determine an earnings multiple that most accurately predicts the maximum price at which a business will be successfully sold.
Depending on the fundamentals of the e-commerce business, most companies will garner an earnings multiple of between 2.5x to 4x. So, an e-commerce business with $4 million in annual earnings and a 3x earnings multiple achieves a valuation of $12 million.
Depending on a measure of the above valuation drivers, an e-commerce business should fall between 2.5x – 4.0x multiple of SDE, EBITDA or Revenue:
Most valuation drivers fall into three broad categories: transferability, scalability, and sustainability. Here we take an in-depth look at the most critical drivers for valuing an e-commerce business.
Age of the Business
One of the first things a potential buyer will look at is the age of the business. As a general rule, buyers will not consider an e-commerce business that has been operating for less than a year. Many buyers will want to see a minimum of three years of operation, while an e-commerce business that has shown steady growth for five years or more will tend to fetch a premium multiple.
It should go without saying that the financial health of any e-commerce business will be one of the critical factors in determining its value. No two e-commerce businesses are exactly alike, but the following will be prerequisites to preparing a company for valuation and potential sale.
Thorough and Verifiable Financial Records
Maintaining solid and verifiable financial records is one of the most crucial steps owners can take not only to increase the value of their business but to operate it effectively. Fortunately, thanks to accounting software such as QuickBooks and Xero, much of the traditional grind of bookkeeping has been eliminated.
Both QuickBooks and Xero sync effortlessly with company bank accounts, credit cards, and payment processors: virtually eliminating data entry. We strongly recommend to all our clients that they begin using QuickBooks or similar from the earliest stage of their e-commerce business. This will reduce the need to backtrack when preparing the business for sale, while simplifying tax preparation for a tax professional. They will put business financial reporting capabilities at a business owner’s fingertips.
Concentration of Revenue
Once revenue has been verified (typically through the use of bank and payment processor statements paired with an up-to-date account file from QuickBooks as mentioned above), it is essential with an e-commerce valuation to break down revenue in several ways, the crucial ones being:
- Breakdown of revenue by customer
- Breakdown of revenue by product
- Breakdown of revenue by supplier
By analyzing each of these, it is possible to spot potential strengths and weakness in each revenue stream. For example, if 15% or more of revenue derives from a single customer, the business could be put at considerable risk if that customer were to leave. Certainly, any customer that is responsible for such a significant share of revenue must be paid close attention to.
Similarly, focusing attention on what percentage of revenue is derived by sales of each product may identify areas of opportunity and risk. If a large proportion of income comes from one product, how susceptible is the business to a competitor coming along and selling it for a lower price? Is it a trendy item that may have a limited shelf-life?
Lastly, if the business is largely dependent on one supplier, what kind of arrangement does the company have with that vendor? Is it reliant on a relationship with existing ownership or a handshake deal? Is there a written agreement or contract to supply, perhaps even exclusively, that is transferable to new ownership?
Generally speaking, having sales spread across a large number of customers, products, and suppliers can help insulate an e-commerce company from a sudden drop in demand for individual products, the loss of a significant customer, or the dissolution of a supplier relationship.
More so than most other online business models, e-commerce companies may find themselves highly prone to seasonality. Depending on the niche and the type of products the e-commerce store sells—say for example a golf specialty store that does the majority of its business in the summer months—sales may fluctuate significantly based on the season. The longer the company has been in business, the easier it is to spot trends in seasonality and plan for them.
In addition to seasonality, many e-commerce businesses are heavily dependent on sales “holidays” like Black Friday and Cyber Monday, as well as the holiday shopping season in general.
It can be advisable for e-commerce merchants to consider adding merchandise that is less seasonal in nature in an attempt to smooth out the peaks and valleys associated with a highly seasonal product.
Chargebacks, Returns, and Refunds
Customer returns, refunds and chargebacks are a fact of life for virtually all e-commerce businesses. They can also be a highly expensive one. The estimated cost of returning merchandise in the United States is predicted to reach $550 billion by 2020. Shopify found that, on average, brick-and-mortar stores see an average return rate of 8-10%, while e-commerce merchants experience an average of 20%.
Shopify also found that 80% of consumers now expect free returns. That coupled with the finding that 71% of customers who find that restocking fees prevent them from making a purchase means that e-commerce merchants are under considerable pressure to make the return and refund process as cheap and painless as possible for consumers.
While this is excellent news for consumers, the cost of offering free returns can quickly eat into an e-commerce merchant’s margins. Potential e-commerce business buyers will likely examine the rate of refunds, returns, and chargebacks closely. If they are substantially higher than the average for the vertical, there may be a number of operational reasons for this. Better product descriptions, faster shipping with tracking info provided, and improved customer service can all lead to lower return rates.
If chargeback numbers are overly high, this may mean that insufficient fraud prevention measures–such as billing address verification for credit card purchases—are in place.
Overall, returns, refunds, and chargebacks are an area where many e-commerce businesses have room for improvement. Taking steps to reduce them can benefit the bottom line as well as customer satisfaction.
Most, if not all, e-commerce businesses are highly reliant on organic and paid traffic for obtaining new customers. Much like we advise our clients to utilize QuickBooks from the outset of their business, we also recommend using Google Analytics.
Use of Google Analytics to maintain historical data on where the site’s web traffic derives from should be considered a bare minimum requirement for virtually any online business.
There are four critical elements to consider when evaluating the traffic of an e-commerce business:
- Trends – Using Google Analytics to track daily, monthly and yearly traffic trends should be considered a prerequisite for any successful e-commerce business. Somewhat predictably, slow and steady growth across all sources of traffic is preferable, but sharp increases and decreases in traffic are also worth making close note of. Did these spikes correspond with any action on the part of the owner? Did any surge in traffic result in increased revenue? If so, can it be replicated?It is also essential to check whether the site has suffered any Google penalties, which anyone can do with FE’s free Website Penalty Indicator.
- Concentration – Once a picture of high-level traffic trends emerges, it’s time to dig deeper. Many e-commerce businesses derive their traffic from a wide array of sources, while others may get most of their traffic from a relatively small number of keywords. We recommend using SEMrush to potential buyers seeking a better understanding of where their all-important traffic is coming from.Three characteristics to look out for that should increase a site’s value are:
- A substantial number of high-ranking keywords. Ideally, these will appear on page one of Google search results.
- An even distribution of traffic split across the keyword spectrum.
- Consistently ranking high historically for keywords that drive the most traffic.
- Backlinks – These are another crucial driver of Google rankings and organic traffic. The quality of an e-commerce site’s backlink profile can speak volumes about how effective the owner has been with their content marketing efforts.
- Ahrefs is an outstanding tool for delving into the backlink profile of any site. It is a good practice to analyze at least the top 20 backlinks to an e-commerce site. If these have a low “domain rating,” it indicates a weak backlink profile. This potentially makes the Google ranking less defensible in the future. As well as using the domain rating, it can prove helpful to visit the linking domains and gauge whether they look like legitimate sources of quality content.
- Another critical factor to consider when evaluating the traffic of an e-commerce site is how much traffic is driven by referrals—for example, as part of an affiliate program. If this drives a significant amount of traffic, it is worth examining how secure these sources of referrals are likely to be in the future.
- Quality – Once the broader trends in traffic have been analyzed, it is advisable to examine the “quality” of the traffic. Traffic quality can be measured in a variety of ways and is in many ways dependent on the profile of the target customer. Some of the key metrics include:
- Number of pages per session
- Average session duration
- Bounce rate
- Conversion rate (Conversion can mean making a sale or enticing a visitor to perform a desired action, such as signing up for a newsletter).
A more detailed walkthrough of how to evaluate traffic can be found in one of our previous blog posts on advanced due diligence.
Prospective buyers will pay keen attention to the operations of any e-commerce business they are considering for acquisition. Operations is often an area where a new owner can take quick action to cut costs, increase efficiency and productivity, and boost margins.
E-commerce business owners should also be continually looking for ways to improve their operations, even if they’re not currently considering an exit. Not only can this present an opportunity to increase the value of their business, but it will often make it more profitable. Knowing what aspects of operations are of particular interest to buyers can point e-commerce business owners in the right direction of areas they should objectively evaluate and improve if possible.
Level of Owner Involvement
Most purchasers of e-commerce companies are not seeking a full-time job. Businesses that require 20 hours or less of an owner’s time each week will tend to fetch a higher multiple. Businesses that require less than 10 hours of owner involvement will typically receive a premium multiple.
Making Changes to Owner Involvement
Many e-commerce business owners, especially bootstrapped single founders, are used to wearing many hats and working long hours. While this is understandable and even admirable in the early stages of building the business, a high level of owner involvement can actually have a negative impact on the business’s value.
While some founders may find it difficult to give up control of any aspects of their business, taking a thorough inventory of tasks and processes is highly advisable. Often there will be processes that can be automated or outsourced. Freelance marketplaces such as Upwork and Toptal make it easy to find experienced and talented freelancers. If bring someone in-house seems like a better fit, AngelList is a terrific resource for finding employees that want to work at a startup.
Automating and outsourcing business processes wherever possible will not only increase the value of an e-commerce business, it can also dramatically improve the owner’s work/life balance. It also makes the company easier to scale—after all, there’s only so much even the most driven entrepreneur can accomplish on their own.
For many e-commerce businesses, customer service can be one of the most labor-intensive cost centers. Efforts should be made to streamline the customer service process as much as possible. Here are eight steps e-commerce owners can take to improve their customer service process:
- Have Thorough Product Descriptions – Ensuring that there is adequate documentation available on the website for all products being sold can cut down on the number of customer service inquiries, and reduce costly returns.
- Offer Live Chat – Studies have found that 73% of consumers find live chat to be the most satisfying way of communicating with a business. Additionally, 44% of online consumers say that having questions answered by a live person while in the middle of an online purchase is one of the most important features a website can offer. Robust customer communication suites like Intercom and ZenDesk offer extensive live chat functionality. Adding live chat can have a positive effect on the bottom line. Addition of live chat software typically causes an 8% to 20% increase in conversion rate.
- Use Chatbots – Intercom and Drift offer powerful chatbot functionality that can answer simple customer queries and ensure that customers are directed to the correct person or department.
- Post Extensive FAQs – Most e-commerce businesses will find that they receive the same queries from customers again and again. Be proactive about regularly updating FAQs. Most customers would much rather find the answers they’re looking for themselves without having to contact customer service.
- Create a Knowledge Base – Similar to FAQ’s, a knowledge base can be deployed internally, so that customer service reps have the knowledge to deal with customer queries or they can be a customer-facing self-service resource. Zendesk offers extensive knowledge base functionality.
- Use Help Desk Ticketing Software – In the early stages of an e-commerce business, many owner-operators rely primarily on email to keep track of customer service correspondence. As the business grows, and there are repeat customer transactions, this can quickly become unwieldy. Help desk ticketing software, such as that offered by Zendesk and HelpScout, tracks customer service queries, from initial contact through to resolution. They also help improve customer service by keeping track of all of a customer’s interactions with the company over time.
- Offer Customer Service Over Social Media – Most e-commerce businesses today will have a presence on social media. This additional visibility comes with a responsibility to actively monitor social media channels for customer service issues. Disgruntled customers may show no hesitation in airing their grievances openly on a company Facebook page or Twitter feed. Also, consumers are increasingly likely to expect customer service through Facebook Messenger or other direct messaging channels. Try to view such communications as an opportunity to offer exceptional service and connect more deeply with the customer.
- Make the Billing and Payment History Available – As a general rule, the more “self-serve” options e-commerce merchants offer their customers, the happier they will be. As with extensive FAQ’s and the Knowledge Base, customers should have easy access to all their past invoices, payment methods, and billing and shipping addresses. Giving customers the ability to update these items online, or to see tracking information for recently shipped orders, for example, can significantly cut down on the number of customer service queries the business has to field.
Streamlined Logistics and Fulfillment
One of the areas where there is often substantial room for improvement for e-commerce businesses is in the realm of logistics and fulfillment. Order fulfillment is the lifeblood of any e-commerce business. Studies have shown that 38% of consumers that have a negative delivery experience with an e-commerce merchant said they are likely to never shop with that retailer ever again. Thanks to the success of programs like Amazon Prime, consumers now expect to receive their orders faster than ever before.
While many e-commerce merchants, particularly in the early stages of the business, will elect to handle their own shipping and fulfillment, as they begin to scale, many will outsource logistics and fulfillment to a third party.
Logistics and Fulfillment Solutions
Many merchants turn to Amazon and their Multi-Channel Fulfillment (MCF) program. MCF is available either as a standalone service or as part of the popular Fulfillment By Amazon (FBA) program.. With MCF, merchants ship their product to Amazon’s warehouses, and Amazon takes care of picking, packing, and shipping as well as handling any returns. Amazon charges a per-unit price for this storage and fulfillment service.
Amazon is by no means the only choice for e-commerce merchants seeking to improve their logistics and fulfillment practices. FedEx Fulfillment, Shipwire, Fulfillify, and VelocityShip are other innovative solutions that promise to save shippers substantial time and money. And there are many more.
Streamlining and making the shipping and order-fulfillment processes more cost-effective will add value to an e-commerce business and help keep customers happy.
With drop-shipping e-commerce businesses or those that outsource warehousing and fulfillment, the burden of inventory management is significantly reduced. For merchants that handle their own warehousing and fulfillment, having a robust inventory management solution in place is essential to the smooth operation of the business.
E-commerce businesses that are using QuickBooks as we recommended earlier to manage their finances can also use it to manage inventory. QuickBooks integrates with Shopify, Big Commerce, and a variety of other popular e-commerce platforms.
For those e-commerce merchants whose inventory management needs exceed QuickBooks’ basic functionality, there are a number of QuickBooks apps, such as Stitch Labs and Unleashed, that extend that functionality making for much more robust inventory management.
There are, of course, many dedicated inventory management tools, such as Zoho Inventory or Oracle Netsuite, but if QuickBooks is already in place, there’s much to be said for having financial reporting and inventory management “all under one roof.”
Formalize Supplier Relationships
As much as possible, relationships with key suppliers should be formalized and easily transferable to a new owner. Steps should be taken to ensure price certainty wherever possible. Too often, supplier relationships consist of little more than goodwill and a handshake.
For e-commerce merchants that are dependent on unique or branded product that cannot easily be replaced in the market, the loss of a key supplier can be devastating. For those merchants with a high degree of concentration of suppliers, as discussed above, it is even more vital that there be a supplier contract in place.
Technology is at the core of any online business. Even e-commerce stores built on popular platforms like Shopify, Magento, WooCommerce, Big Commerce, etc. are likely to have custom templates and plugins. For those e-commerce stores built on custom software, the complexity of the technology involved is likely to be much greater.
In order to secure the highest earnings multiple for their e-commerce business, there are crucial steps owners can take to make the business more attractive to potential buyers.
Reduce the Technical Burden
E-commerce businesses are often highly attractive to non-technical buyers, who make up a significant proportion of the market. A recent survey of our buyer network revealed that a substantial majority of buyers classified themselves as non-technical.
E-commerce stores built on custom software–in contrast to those utilizing established platforms like Shopify, Magento, WooCommerce, and BigCommerce–are likely to bear a higher technical barrier to entry. One reason for this is that there is a competitive and easily accessible market for developers for popular e-commerce platforms like Shopify. Finding developers to work on proprietary software can be considerably more difficult and costlier.
If an e-commerce store is built using proprietary software, having a trusted developer either in-house or a reliable freelancer under contract will go a long way towards assuaging any concerns a non-technical founder may have about the technical requirements of running the business.
Employ Coding Best Practices
If the e-commerce business is built on custom software, it’s essential that contemporary coding best practices are followed. The code should also be thoroughly annotated. The goal is to make it as easy as possible for a new developer to be brought in to make the inevitable changes and upgrades that any online business requires.
Even if the e-commerce business is built on one of the major platforms like Shopify, Magento, WooCommerce, etc. there may be a high level of customization, whether of the front-end template or custom plug-ins. Here, the goal is the same. Coding best practices should be followed, and the code should be thoroughly annotated.
Legal and Escrow
It is crucial that e-commerce business owners who are considering selling their business retain legal counsel early in the process. If a reputable ecommerce business broker is being used to advise on the sale, they will be able to advise on any legal steps that need to be taken. Certainly, non-disclosure agreements will need to be put in place before any proprietary information is divulged. And if a sale of the business is agreed, an attorney will be helpful for finalizing the terms and the deal.
In these matters, it is wise to use an attorney that has extensive experience in dealing with the unique intricacies of online businesses. A seasoned M&A advisor will be able to facilitate this.
There are additional legal steps that should be taken well in advance of a sale.
Secure Intellectual Property
For most e-commerce businesses, branding is a vital component of their marketing strategy. It helps distinguish them from competitors in the eyes of the public. It is essential that any trademarks, copyrights, and–in the unlikely event it’s applicable– patents, be registered and defended. Other branded assets such as domain names should be registered long-term.
Proper registration of intellectual property, carried out by an appropriate legal professional, will not only help defend it but should facilitate a transfer of ownership to a new owner.
Additionally, if there have been any trademark or copyright actions against the e-commerce business in the past, it is important to disclose them and provide proof of resolution.
If an e-commerce business relies heavily on graphic or written materials—for example, content for a blog or graphics for a t-shirt—it is a best practice to have “work-for-hire” agreements in place making it explicit that the company owns the copyright for the content. Contrary to popular belief, copyrightable material created by an employee in the course of their work or by a commissioned freelancer does not automatically transfer to the business.
Not only is it best to resolve any ownership of content well in advance of any issue, but astute buyers may also ask to see proof of ownership of copyrightable material before agreeing to purchase a site.
Putting a non-compete agreement into place between the buyer and the seller of an e-commerce business is a common practice. A non-compete is designed to protect the buyer from the seller starting a new business that competes too closely with the one being sold. A good advisor will seek to strike a balance between shielding the buyer from undue competition and not being overly restrictive of the seller’s ability to pursue starting a non-competing business in the future.
Sellers need to pay close attention to the exact wording of the “Restricted Business” definition which specifies the activities restricted post-sale. A non-compete should be highly specific to the company being sold so as not to unduly restrict the seller’s ability to start and operate a business going forward.
Assets to Transfer
It is crucial to be specific about all assets to be transferred as part of the sale. Larger e-commerce sites typically have substantial amounts of content and other assets to be transferred. Such assets should be thoroughly detailed in the Asset Purchase Agreement (APA).
Here is a list of assets typically transferred at the time of sale:
- Website source code, content, and related files
- Graphics, images, logos, etc.
- Social media accounts
- Customer database (email lists, etc.)
- Payment processor(s)
In most instances, a seller is expected to offer support to the buyer for a fixed period of time following the sale of the business. The sale contract should indicate the term of post-sale support, expected response times, and the number of hours per week/month that the seller must be available to offer assistance.
Additionally, it usually makes sense to build in an agreement to introduce the seller to relevant partners of the business such as suppliers, freelancers, logistics and fulfillment providers, etc. As a general rule of thumb, sellers should expect to spend at least one month working the same number of hours in post-sale support as they did operating the business. In the case of larger acquisitions, the support period may be longer.
Once the APA is complete, it is time to arrange escrow for the transaction. A reputable M&A advisor will usually direct both buyer and seller to a third-party service like Escrow.com to ensure both parties are protected throughout the transfer of funds and ownership.
Escrow.com is an independent service that has processed over $3.5 billion in transactions for more than one million customers. Escrow.com collects, holds, and releases the funds online once the transaction terms agreed upon by the seller and buyer are met. The process typically follows these steps:
- The buyer and seller agree on escrow transaction terms.
- The buyer transfers the funds securely into escrow. The funds are secured by Escrow.com, but not released to the seller.
- The seller transfers assets to the buyer.
- The buyer acknowledges the receipt of assets and commences the inspection period. The duration of the inspection period is mutually agreed in advance by the buyer and seller.
- The buyer uses the inspection period to confirm the correct representation of assets
- Upon the buyer’s confirmation of satisfaction with the assets, Escrow.com releases the funds to the seller.
Escrow.com (and other similar services) provides substantial protections for both the buyer and seller. The seller ensures that the assets have thoroughly and reviewed by the buyer during the inspection period before the funds are released. All assets must be approved within the agreed inspection period. If something goes wrong, either party can file a grievance through Escrow’s arbitration service.
Escrow.com typically charges a fee of approximately 0.9% on transactions over $25,000 or more. This cost is usually split between buyer and seller. For deals of $1 million or more, it is commonplace for an attorney to handle the escrow process. At that deal level, an attorney will generally be more cost-effective than Escrow.com and will better comprehend the nuances of a larger transaction.
For information on how to value and sell an Amazon FBA business, please refer to our guide here.
How to Sell an E-Commerce Business
If, after examining all the personal and professional reasons for selling an e-commerce business, an owner decides the time is right to seek a successful exit, there are a number of options, which we will explore below.
Using a Mergers and Acquisitions Advisor
- Pre-vetted and Qualified Buyer Network – One distinct advantage of using an experienced M&A advisor is gaining access to their extensive network of thoroughly vetted and qualified buyers, many of whom may be repeat customers.FE International, for example, has a proprietary database of over 36,000 qualified buyers actively looking for online businesses such as a successful e-commerce company to acquire.
- High Success Rate – FE International has a 94.1% sales success rate for businesses it lists. Most deals close with four to eight weeks.
- Maximum Value – As discussed in the valuation section above, the goal of an M&A advisor is to extract the maximum possible value for the seller while ensuring that the asking price remains attractive to buyers. At FE International, we use our proprietary valuation model to achieve this goal.
- Full Service – Selling an e-commerce business is a complex process, especially for first-time sellers. A seasoned M&A advisor will direct the sales process from start to completion. Once the seller has provided all the requisite information requested by the advisor, the advisor takes the reins.Services typically provided by an M&A advisory include valuation, preparation of marketing materials such as a prospectus, finding a buyer, negotiation, due diligence, drafting of contracts as well as helping resolve any other legal or regulatory matters, facilitating the transfer of assets, and finally closing the deal.
The goal of a quality M&A advisor is to extract maximum value for the seller while requiring the least amount of effort from them to complete a successful exit.
- Security – As alluded to above, all buyers are vetted to ensure they have serious interest in acquiring an online business, and the means to do so. Advisors will ensure that intellectual property, trade secrets, and all other assets are safeguarded throughout the sale process. Even if the sale ends up not being finalized.
- Fees – Full service comes at a price. Any reputable M&A advisor will charge a fee of up to 15% of the final selling price, depending on the size of the transaction. This is only paid on completion of the transaction.
- Barrier to Entry – As a natural corollary to M&A advisors stringently vetting and pre-qualifying buyers, the benchmarks an e-commerce company must hit to become listed are substantially higher than when selling through other means. Being selective with sellers as well as buyers is just one way an M&A advisory such as FE International can maintain its enviable 94.1% sales success rate.
Selling Through A Marketplace
Online business marketplaces such as Flippa or WebsiteBroker can initially seem appealing to e-commerce business owners. Businesses can be listed for a small listing fee. The documentation and due diligence requirements are minimal. Marketplace sites tend to get plenty of traffic, but how many of these visitors are high-quality buyers is highly debatable. While a listing fee may seem reasonable, note that many of the most popular marketplaces also charge a “success fee” or commission of 10-15%. In other words, if your business sells, you may end up paying a similar fee to what you would have paid an M&A advisor or broker with virtually none of the support.
While marketplace sites have their place, primarily for pre-revenue businesses or sites selling for less than $10,000, established, successful e-commerce site owners will likely receive a higher valuation and an overall better result by working with an M&A advisor.
Auction sites share many of the same advantages and drawbacks as marketplace sites. Flippa hosts both an auction and a marketplace model. Sellers can set a timeframe for the auction, a reserve price and let the market speak for itself. It’s essentially an eBay for online businesses and should be approached with extreme caution by owners of established and successful e-commerce sites.
While the desire to cut out the middleman is understandable, selling an e-commerce business directly to a buyer—which sounds at first blush a simple prospect—can end up being a time-consuming, expensive, and overwhelming process. For a seasoned entrepreneur with a long track record of selling businesses and a robust network of reputable buyer contacts, selling direct may be a viable option. For sellers without this experience, it can be anything but, and the chances are high that the business will be sold for well below its full value.
The chart below summarizes the basics of each selling option:
Understanding Financing Options
For the vast majority of sellers of an e-commerce business, the most desirable outcome of an exit would be a one-time all-cash payment. For many buyers, this is not an option they are willing or able to consider. Buyers typically seek to secure the best possible deal according to their available funds and risk profile. Often, in order to align the expectations of the buyer and seller, creative financing methods are employed. Here are the four most common financing methods used in the acquisition of an e-commerce business.
Cash typically forms the most substantial portion of total consideration in acquisitions of e-commerce businesses. Buyers may limit their search to online businesses they can purchase with liquid assets, such as the money in their bank accounts. This can lead to buyers limiting themselves in their ability to make an offer on an otherwise desirable business. In this instance, many buyers turn to more creative and sometimes unconventional methods of raising cash. Some of these methods include:
- Cashing out retirement funds
- Borrowing against a 401k account or taking regular IRA payouts
- Revoking a Roth Contribution
- Small Business Administration (SBA) Loans
- Asset or collateral-based lending
- Bringing aboard a partner with cash and/or experience
- Peer-to-peer lending platforms like Prosper and Lending Tree.
- Seller Financing
One of the most commonly deployed methods of financing in online business acquisitions is seller financing. Seller financing allows the buyer to bridge the gap between their available cash and the purchase price of the business by using the cash flow of the business to pay the outstanding balance over a fixed period post-closing. A seller’s willingness to agree to this type of financing has the additional benefit of showing the buyer that the seller has confidence that the business will not decline going forward.
Seller financing is popular in online business acquisitions because it eliminates the red tape involved with the buyer borrowing from a bank or other lender. However, it is critical to keep in mind that seller financing bears risks for both parties. Buyers must be realistic about future cash flow, as a missed payment may prove costly and, depending on the agreement, can even result in the seller repossessing the business without having to pay back any cash consideration thus far received. Sellers should retain some collateral in the business until the buyer pays off the financing in full.
In an earn-out agreement, the buyer agrees to pay the seller a percentage of either profit or revenue over a fixed amount of time. Earn-out agreements are typically seen in acquisitions involving younger businesses, sites with inconsistent cash flows, or with companies facing an uncertain future. With an earn-out, the buyer attempts to leverage the seller’s knowledge and resources in an effort to grow the business immediately after the sale is complete.
In order to structure an earn-out, the buyer will need to forecast future cash flows based on historical data, as well as micro and macro industry trends. For an earn-out arrangement to work for both parties, it is vital that the buyer and seller agree on what the site is expected to earn over the term of the agreement.
Given that earn-outs agreements are based solely on projected revenue or profits, they carry a high degree of risk, particularly for the seller. The seller must be confident that the buyer is capable of operating the business successfully and that they will not default on payments. Due to the additional risk, it is not uncommon for the seller to demand an extended earn-out period beyond the somewhat standard 12 months.
Because earn-outs carry a high degree of risk, sellers are advised only to consider such an agreement when the buyer has a track record of growing and operating businesses successfully. With inexperienced buyers, the risk that the business will not perform as forecast is likely too great to make an earn-out satisfactory to the seller.
In a holdback agreement, the buyer retains a portion of the total consideration payable under the APA until certain mutually agreed milestones or obligations are met. Examples of such milestones include:
- The seller meeting mutually agreed upon commitments subsequent to the sale.
- Employees continuing to work for the firm for an agreed period of time.
- Long-term service agreements being honored and fulfilled
- Agreed upon targets being met, for example, maintaining monthly gross revenue averages.
- Verification of agreed-upon revenues and costs that are difficult to evaluate thoroughly prior to sale. Examples of this could include refund rates and chargebacks.
Holdbacks carry risk for both the buyer and seller as either party may under or overestimate the value of post-sale obligations.
E-commerce is well on its way to becoming a trillion dollar business in the United States alone and is expected to exceed $3.4 trillion in sales worldwide in 2019. There is a robust market of qualified buyers actively seeking to acquire successful, growing e-commerce businesses.
If you’re an e-commerce business owner who’s contemplating an exit, or simply considering your options, please do not hesitate to get in touch with the leading M&A advisory for online businesses, FE International, for a free valuation.