There are many factors to consider when evaluating an online business. It shares many considerations with traditional businesses: revenue, operations, transferability. But it also has some unique considerations like scrutiny of traffic and technical knowledge necessary to run the business. In this article we will examine the most important factors to consider in evaluating an online business. It’s not exhaustive list, but if you can track down the majority of what we list here, you certainly have enough information to make a buying decision.
Profits
Revenues often get owners excited, but buyers are most interested in profits. EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) is a very useful number. This number should be examined in the context of long-term and recent history, i.e. what has been the trend in the last years, and what in the last months?
There are also some points of savings/additional costs that should be considered in relation to what you bring to the table. For example:
- Owner compensation. Does the current owner take any compensation? Does he/she fill roles in the company due to a skill set that he/she has that you may not. Will you need to bring someone in to do that?
- Operational costs. Does the owner use an office space to run the business which could easily be absorbed into a home office? Are there any other savings you could make?
Additionally, you should consider:
- One-time costs. Were there any costs which will not recur, like legal costs for obtaining a trademark or acquisition of a type of software, which you can consider when looking at future profits?
- Owner integration. Does the owner have relationships with vendors and customers that are transferable to you? If not, that can make the business less valuable, or sometimes, unable to be acquired. How much does the owner work in the business instead of on the business?
Traffic
If you can’t get access to the Google Analytics page, you’re going to want a number of screenshots to get the data you need. For each item you need to be considering long and short term trends.
- What is the breakdown of the traffic in relation to organic, referral, paid, or direct linking? Is that stable or has it changed? Regarding the referral traffic, is it lopsided or well diversified? Is it sustainable?
- How secure are the search rankings?
- What do the short and long tail searches look like?
- What is the amount of traffic?
- What does the industry trend look like? You can use google trends to investigate this further.
For a website, your traffic is really important. A bricks-and-mortar business can still have the occasional walk-in customer, but in an online business, intentionality from the customer accounts for everything.
Operations
The single most important question in this category is: how long does it take the owner to run the business every single week? This can be a make/break answer for you, especially if the owner currently doesn’t do tasks that you plan to take on in order to affect cost savings.
Related to the question of time is what are the specific tasks that need to be accomplished in those hours each week? Is there an “owner’s manual” or “company manual” with policies and procedures?
How much technical knowledge is necessary to run the business? With the simplicity of many platforms like WordPress and the vast number of plugins that power these sites, very often you don’t need to know how to code or design in order to run a site, but you need to ask, regardless.
Are there employees in the business? Are they envisaged in the future? Where are they situated in relation to you?
Industry
The internet has proven time and time again that there are very many ways to make money. No longer do you have to involved with “luggage,” for example, but you can focus solely on backpacks. And not just backpacks, but backpacks that are theft resistant. And built with sustainable materials. Very healthy businesses have been built on such specific niches. The question you as a buyer should have is what is the health of the industry overall?
- How big is the industry as a whole? Is it growing or plateauing?
- Is it a mainstream niche or one that requires specialized knowledge? (perhaps more learning for your customers, as well as yourself)
- What are some predictions you can find in the media and elsewhere for the industry?
- Are there competitors in your space? How long have they been there?
- What are the barriers to entry?
- What are some possibilities for expansion within the industry? (i.e. adding other niches, subniches to your repertoire)
Risks
We have six specific risks we want you to consider:
- Legal. The EU Parliament recently passed a directive that relates to internet content and may affect some content businesses. While most people think of legal risk in terms of a disgruntled customer or a powerful competitor, there are larger legal issues that sometimes you simply cannot do anything about as an individual business or citizen. But what’s important is not to be blindsided and to have done at least some basic research in relation to your industry or the country you are headquartered in.
- Competitive. As we mentioned above in discussing your industry, what is the velocity of entrants into your space? Does excessive fragmentation threaten your business model?
- SEO. Google changes its algorithm fairly regularly. Where are you positioned in relation to that?
- Traffic. Again, as we have mentioned before, is your traffic diversified? Lopsided traffic, i.e. a significant percentage of the overall from one specific source, is a major risk. As Peter Diamandis often asks, “How would you disrupt yourself?” Taking away your major form of traffic would be one. How can this risk be addressed or mitigated?
- Monetization. Monetization can be diversified as well, but doesn’t need to be, especially in the case of SaaS or Subscription businesses, as there’s additional assurances of recurring revenue that other models cannot necessarily promise. An ecommerce business can also look at its 12-month history to offer some sense of regularity. But if your business has a combination of advertising and affiliate revenue, those fields are volatile and the risks mitigated.
- Industry. This is probably best considered in the light of the ongoing controversy regarding marijuana businesses in the United States. Many states have approved medicinal use of the product and hence the business ecosystem necessary to support the product has sprung up. However the federal government of the United States still considers the plant/drug illegal and has made it nearly impossible for business owners to bank legitimately due to threat of prosecution that most banks fear. Another example less focused on the United States is cryptocurrency. Many people understand the true importance of the blockchain technology and that using it as a medium of exchange/store of value is only one use case. As we have seen in recent times, it seems the market — both the proponents and the neophytes — is not entirely convinced and this has led to major swings in valuation not just of the big currencies but to some outright fraud in the case of some ICO (Initial Coin Offerings). There are many businesses you can examine that don’t have these significant industry specific risks, and you may also consider that where there is a big risk, there is a big upside as well.
You can’t ever eliminate risk in any business, but it’s perhaps one of the single most important factors to consider when examining an online business.
Moat
Where are you in relation to your competitors? It’s a global marketplace and as we’ve watched the marketplace for online businesses grow and develop over the last 15 years it has become clear that competitive advantage is hard to maintain, and that business models can often be duplicated. An example from some years ago was Blockbuster using the Netflix SEC disclosures from its IPO to immediately erect a superior competitor, Blockbuster Online. It allowed customers to take discs they received in the mail and return them directly to the store, a key advantage that Netflix, devoid of physical locations, simply could not compete with. Unfortunately for Blockbuster, a CEO change led to a change of direction away from this business line and among other factors, a demise for that business.
In his book Zag Marty Neumeier refers to the “Only ____ that ____.” The blanks are spaces for your business to fill in. For example, the “only website that does reviews of vaping devices in Chinese.” If you can maintain an “only” you are in a good position. If you can’t maintain, only, be “the best” and if you can’t be “the best” be “one of the best,” e.g. “One of the best travel hacking sites for those who wish to travel to the South Pacific When you can’t maintain a superlative that matters for your bottom-line profitability, your moat has been breached.
Quality
We have all seen the trashy sites. They have poor content, are over-monetized by ads, or have low link quality. There’s also the ecommerce sites with bad customer reviews or SaaS products with poor reputations. Unless you feel you can affect a major turnaround, this should be a red flag for you.
Age
How long has the business been around? In traditional brick-and-mortar businesses 3-5 years is a healthy minimum rule of thumb, but you can look at half that (or even less sometimes) for an online business: 18 to 36 months. Age is no guarantee of future success, but it does argue for some level of resilience to the current day.
Brand
What kind of brand have you established in the marketplace? This can be a powerful part of value in the marketplace and can overcome some negatives that may concern you. Brand comes with loyal customers and goodwill that cannot be bought. Do you buy into the culture and can you foster it as an owner/operator?
Transferability
Can all accounts and assets be easily transferred to the buyer? A classic example would be paypal subscriptions. They cannot be transferred, so if the paypal account is not included in your transaction, some of your recurring revenue will be lost. There may also be some legal constraints that relate to the specific locality/country you are doing business in with relation to transfer of assets to a non resident/non citizen. This is a key part of your due diligence.
Protections
Is there IP (intellectual property) that has been appropriately safeguarded? Why or why not? Are there any patents or trademarks held? In which countries? Are there any long-term agreements/partnerships/licenses in place and what are the severability clauses related to each? Is the business model at risk if any of these are lost?
Ultimately, these items are all part of your due diligence and as the buyer you’re responsible for it all. The purchase of a business, however exciting it might be, does have the numbers aspect behind it, which can be (deceptively) boring. Remember to embrace the journey. A business isn’t just about status and flashiness, it’s also about the dirt and grind involved in creating value. That can (and should) excite you as you do the research necessary to evaluate online businesses.