Ultimate E-Commerce Valuation Guide
Do you have an ecommerce store that you are looking to sell? Before you decide to sell your business it’s important to understand how valuable it is so that you can decide whether or not it’s worth it in the first place.
Before we dig into valuation, I wanted to provide a short foreword on what’s going on in the ecommerce world as we see it.
The Amazon Effect
Companies like Amazon have brought ecommerce into the mainstream, which has done two things: 1) increased its popularity as a business model, and 2) brought a huge influx of investors and business buyers into the industry.
Additionally, it has created new business models and thousands of new business. 10,000 of Amazon’s top sellers participate in the FBA program, which is almost a business model in its own right. If you have an FBA business, we discuss valuation multiples here.
The good news is, you, as an ecommerce business owner, benefit from the Amazon effect, even if you don’t sell product on their platform. They have brought a swarm of investors into the marketplace, creating a buyer base for your business.
How is an E-Commerce Business Valued?
While you might have been taught the “discounted cash flow” methodology in your college finance class, applying a DCF to any online business simply isn’t realistic or practical. Calculating a discount rate for a small, digital business would be a shot in the dark.
A much more practical approach is applying a “market multiple” (commonly referred to as the “valuation multiple, or just simply “multiple”) to an earnings number, usually SDE or EBITDA. The earnings number should be for the trailing twelve month period, aka the most recent twelve months going backwards.
Calculating Earnings
The two accepted earnings “formats” are using Seller’s Discretionary Earnings (“SDE“) or Earnings Before Interest, Taxes, Depreciation & Amortization (“EBITDA“).
Whether you use SDE or EBITDA, the goal is to get down to a number that represents the profitability or economic value a buyer will receive if they buy your ecommerce business.
Generally speaking, SDE is more appropriate for smaller businesses and EBITDA is more appropriate for multi-million-dollar businesses with >$1 million of net income.
Seller’s Discretionary Earnings (SDE)
SDE is calculated as: Revenue – COGS – Operating Expenses + Owner’s Salary.
This formula assumes the business is owner-operated and that the owner pays himself a salary, rather that just distributions. By using SDE we are assuming that the person who buyers the business will also act as an owner-operator, replacing the seller.
This methodology gets us to an earnings number that is representative of how much discretionary “cash flow” a new owner will receive, which could then be used to put in their pocket or reinvest in the business.
If your business has two owners, it is customary to only addback one owners salary – unless the two owners combined spend less than 40 hours per week on the business. If the two owners each put in 40 hours a week, we only addback one salary because we assume that the new owner will need to hire an employee to handle the extra workload. However, we can “normalize” this salary if the second owner is being paid more than it would cost to hire someone to take over the workload.
Using EBITDA as Earnings
Larger businesses are sold based on EBITDA. EBITDA is the most widely used earnings metric in the traditional, private M&A marketplace. It’s usually used by investment banks and business brokers who are selling $10M+ brick-and-mortar businesses.
EBITDA is calculated by taking Net Income + Interest Expense + Tax Expense + Depreciation & Amortization. The end result is a “quick and dirty” estimate of free cash flow available to both debt and equity holders.
The primary difference between SDE and EBITDA is that an owner’s salary is not added back to EBITDA.
Addbacks to Earnings
It is common to see numbers added back (called “addbacks“) to both SDE and EBITDA, usually increasing the number.
Addbacks are used for expenses that will not reoccur under new ownership. Business owners run personal expenses through the P&L all the time for tax benefits. We see car expenses, phone bills, food and dining, vacations, you name it, flowing through the P&L to reduce taxable income. Because these expenses are all personal and not required for normal business operations, they are added back.
The list of potential addbacks is exhaustive, and there it is possible to have negative addbacks as well. If you aren’t sure what you can and can’t addback, feel free to reach out to me and ask.
What about Inventory?
Inventory is usually valued and sold separately in smaller ecommerce deals. On $10M+ businesses, you’re liking going to see inventory be included in the purchase price as these transactions become more complex and require the businesses to be sold with sufficient working capital.
Inventory is valued at its landed purchase cost and priced out separately. For example, you will see an ecommerce deal listed as:
“Asking Price: $500K + $100K Inventory”
Some sellers will offer to discount their inventory price, or even completely include it in the purchase price to sweeten the deal for a potential buyer. Including the inventory is viewed as a purchase price reduction, as the seller has already paid cash out their pocket to purchase it.
Average E-Commerce Valuation Multiples
E-Commerce businesses usually sell for 1.5x to 3.0x earnings.
By analyzing recent broker sales data, the average valuation multiple for E-Commerce stores is ~2.1x earnings.
Although the average multiple is 2.1x, it wouldn’t be accurate to simply apply that multiple to your earnings and think that you have your valuation.
While even the average range is 1.5x-3.0x, we’ve seen ecommerce websites sell for anywhere from 0.5x to 5.0x. There are dozens of factors that affect where your value falls, so it’s important to get a professional valuation rather than assuming 2.1x applies to your business.
If you have a multi-million-dollar ecommerce business (>$2 million in earnings, give or take), the valuation range tends to increase and can range from 4x-6x as the investor base broadens. When a business’s value surpasses the $5 million mark, the potential buyer base expands beyond individual investors into traditional private equity firms, family offices, and strategic buyers. These investors have deeper pockets and more access to traditional acquisition financing which results in increased multiples.
How Are E-Commerce Valuation Multiples Determined?
Valuation multiples are determined by risk. If an ecommerce business is deemed risky, investors compensate for that risk by reducing the valuation multiple they will pay.
Risk is always related to future business performance. How likely is it that the business continues to growth both revenues and profitability?
There are dozens of different types of risk that an ecommerce business can face: financial, traffic, operational, niche, customer base, products, etc. With that being said, there is no formula or “if this, then that” approach you can take to valuation.
The best way to determine valuation multiples is by using a market-driven approach
Because the value of a business is ultimately what a buyer is willing to pay for it, the best way to value an ecommerce business is by using what I call a “market-drive” approach.
A market-driven approach analyzes the valuation multiples that real buyers paid for other ecommerce businesses that have recently sold. The goal is to find comparable businesses and use the multiples that they sold for to estimate what a real buyer would pay for your business in the current market environment.
1. Style of E-Commerce Business
I’m going to generalize ecommerce down into three distinct categories:
- Dropshipping
- 3PL or Outsourced Fulfillment
- “In-House” Fulfillment
These categories focus on how the product fulfillment is handled. Product fulfillment matters because it affects the workload required by a new owner. Investors are generally looking for passive business models, so using outsourced fulfillment or dropshipping is more attractive than in-house fulfillment.
Dropshipping
Although dropshipping business are beneficial for buyers because they outsource fulfillment, they, on average, sell for lower multiples than other types of ecommerce business.
Dropshipping businesses on average sell for approx. 1.9x earnings multiples, compared to 2.1x for other ecommerce models.
The reason dropshipping is less valuable is because they are usually just re-selling other brands products, instead of selling their own branded, proprietary products. Also, they have lower barriers to entry since there is no inventory required, custom product design, manufacturer sourcing, etc.
3PL or Outsourced Fulfillment
Ecommerce stores that use 3PL fulfillment AND are selling their own branded products are the most valuable.
By taking fulfillment off the table, a new buyer can focus their time exclusively on growing the business through marketing, new product development, and so on. A crucial piece here is that the product that is being sold is branded, unique, or proprietary.
If you are bulk ordering other brands products, then using a 3PL for fulfillment, you will get a lower valuation unless there is something that prevents another online entrepreneur from starting a similar store and selling the same products.
In-House Fulfillment
In-house fulfillment is usually the least attractive ecommerce model since it requires the most time to run. Rather than spending time focusing on marketing and growing the brand, the owner has to spend time picking, packing, and shipping orders.
If you have an ecommerce business and you yourself are physically fulfilling orders, you should consider using a 3PL to reduce your workload and make your business more attractive for potential buyers.
2. Products and supplier relationships
The bread and butter of a high-valued ecommerce store is its products. A custom, one-of-a-kind, no one else sells something similar type of product is the best and most desirable. There is usually limited competition, and this creates a market advantage.
The second-best type of product is one that is branded, but not proprietary. Usually, you have competitors that are selling similar products, but you at least have your own brand and reputation in the market.
The least attractive model is the “reseller” model where your store is simply selling someone else’s products. These have high competition because there are almost always other stores selling the exact same products.
Having unique supplier agreements or relationships can increase valuation as well. If you have an exclusive agreement with a manufacturer or supplier where they won’t sell a similar product or the same product to anyone else, you’ve built a barrier to entry around you.
3. Brand and brand value
If customers love your brand, they’ll come back to you over and over again and keep buying. Repeat customers is a strong indicator of brand value and how much customers love your product. These customers are very profitable, because you don’t have to keep spending marketing dollars on them to get them to spend dollars in your store.
Organic social mentions are also a great way to track or analyze brand value. Word of mouth marketing can drive massive free revenue. If your product is so good that you get a lot of free word-of-mouth marketing, publicity, articles written about your product, and so on, you have a great product and a great brand.
Having a strong brand reputation is a competitive advantage. Buyers love this and are willing to pay more for a business that has a great brand.
4. Financials and financial trends
When analyzing risk, every risk ties back to one thing: revenue. How much impact could this one risk have on revenue? The bigger the revenue impact a risk could have, the more it hurts your valuation.
Buyers try to predict future performance of a business before they buy it. If they feel very comfortable that the business will continue to grow revenue and profits, they pay more for it. Historical financial results and trends are a key indicator of future performance.
Buyers will analyze things like:
- Year over year revenue growth
- Returning customer rates
- Average order value
- Sales by traffic channel
- Paid advertising ROI’s
- Conversion rates and trends
- Revenue by product
- Revenue by customer
These are just a handful of dozens of financial-related things a buyer will analyze. By reviewing these things over prior year periods, a buyer can paint a picture of the trends, and use these trends to help them make a prediction around how the business will perform into the future.
We like seeing year-over-year revenue growth, diversification of sales by product and customer, increasing traffic, returning customer rates, and marketing ROI’s.
Selling an ecommerce business that has downward revenue trends is very difficult.
5. Chargebacks, returns, and refunds
Amazon throws away billions of dollars of returned goods every year. Returns are the bane of an ecommerce store.
High return rates mean more work for the owner, more customer service support, etc. Additionally, high return rates can indicate that the product isn’t very good or that customers do not think the product has enough value for the price they paid.
The average ecommerce return rate is around 20%. Having a sub-5% return rate is ideal to achieve the highest valuation multiple.
Chargebacks are killers too. These are less preventable but can suggest that your store gets a lot of high-risk orders, which aren’t the type of customers you want to have.
6. Traffic channels and reliance on paid ads
Organic traffic is free and recurring. Referral traffic is free, and sometimes recurring. Social traffic can be free (or paid, too) but is not recurring. Paid ad traffic is not free and not recurring.
Having a business that relies on paid traffic is risky because a lot can happen that either makes this traffic disappear or become unprofitable. If you break an advertising policy, your ad account gets disabled. If a competitor enters the space, your CPC goes up. Paid ads is not an effective, sustainable, long-term business model.
Buyers want ecommerce stores that have diversified traffic channels.
While organic traffic from Google is the most appealing, having 100% organic traffic is also risky. What happens if you get a penalty, de-indexed, or fall backwards in SERPs? However, most businesses do tend to have traffic channel concentration. Have a concentration in organic traffic is better than a concentration in any of the others.
I’m not your buyer so my opinion might not matter, but a 40% organic / 20% paid / 20% referral / 20% social traffic split seems like the perfect mix for an ecommerce website.
7. Operations, logistics, and owner workload
We discussed how buyers want passive businesses. How your ecommerce business handles day-to-day operations like order fulfillment, customer service, marketing, manufacturing relationships, and so on matters.
The more work that is outsourced, the better. If I’m spending six-figures buying a business, I don’t want to spend 2 hours dealing with a customer who can’t find their package or wants to return a $40 product. My time should be reserved for high-level strategy, focusing on marketing, improving, and growing the business.
The most important question you’ll get here is: how much time do you spend per week running the business? and, what are your responsibilities?
10 hours per week or less is the ideal level. Selling an ecommerce store that requires 40 hours per week from the owner is super difficult! If you are spending 20+ hours per week on the business, think about what you can outsource to reduce that number down to something in the single digits.
8. Age of the business
While I’ve got this listed at #8, that isn’t a representation of how important this is.
3 years or more of history is ideal. You can occasionally get away with 2+ years, but anything less than that will result in a decreased valuation multiple. The older the business is, the more historical data it has for trend analysis which helps a buyer predict future performance.
If an ecommerce store is 8 years old and has been growing at 5% per year, consistently, I feel really confident that it isn’t going to fall 20% next year. If a store is 2 years old and grew 50% this last year, I’m pretty scared that this might not have been sustainable growth. Things that rise fast fall faster.
But this doesn’t tell me how exactly much my site is worth…
There isn’t a magic formula, unfortunately. Valuation is subjective to a buyer – if there is only one buyer in the world for your business, it’s worth what that one buyer is willing to pay.
A valuation is a point-in-time number. It changes as your business changes, as the market changes, and as the overall economy change.
Because of this, valuation is also driven by the state of the overall ecommerce and online business investing market. Right now, as I write this article, the current health pandemic is certainly affecting valuations (negatively).
So what can you do?
Build the best possible business, and then reach out to a professional, such as myself, for an accurate valuation and consultation on what you can do to improve your business value before you sell your ecommerce business. Professionals in the market talk with buyers and sellers on a daily basis, and they see every deal that hits the market (even when it’s not their own). They have the best understanding of what the current buyer sentiment is, what multiples deals are getting done at, so on and so forth.
Get a free valuation
I'll happily provide a free detailed valuation for your E-Commerce business, and even offer 30-minutes of my time for a consultation call on steps you can take to improve your business value.
4 Strategies for Increasing E-Commerce Website Value
Before you consider selling your ecommerce business, make sure you are getting maximum value and positioning your business for a quick and easy sale by following these strategies.
If you set on selling your business tomorrow, there isn’t going to be much that you can do. But, if you can wait 3-6 months, it’s always beneficial to plan for your exit and set the business up for an easy transition.
1. Reduce owner workload by outsourcing
As we discussed earlier, investors are looking for passive opportunities; businesses that can run themselves if they need to.
The goal is to get the owner’s workload and responsibility down to 10 hours per week, or less. Here are some things you can think about:
- Fulfillment: outsource to a 3PL, or see if your suppliers will dropship
- Customer service: hire an overseas virtual assistance to handle customers
- Advertising/marketing: hire a freelancer or marketing firm to handle your paid ad campaigns
Where you can cut time out of your workload depends on where you currently spend your time. These are just the 3 most commonly outsourced aspects of running an ecommerce business, from what we have seen.
2. Diversify away from paid advertising
I didn’t say stop paid advertising. Keep running paid ads, especially if it’s working really well. But diversify away from it by building other traffic channels.
Don’t get any organic traffic? Try doing some SEO or writing some blog posts to start ranking for more keywords and increase your Google footprint. Not a good writer? Outsource it!
Lacking social media traffic? Run a campaign to increase your followers, and then continually provide them with new content and products.
No referral traffic? Find bloggers in your niche and send them your product. Ask for a product review in return.
3. Stop reselling products and build a brand
This is one probably more than a 3-6 month strategy, but it can be a great nugget to give to a potential buyer. If you are currently reselling products, explore the possibility of how you can either create your own unique product or private label an existing product. Even if you only do it with 1 out of 25 of your products, you can pitch this as a big growth strategy for the new owner. Now, you already started the fire, the new buyer just needs to add the gasoline.
4. Reduce unnecessary expenses
The sooner you do this the better, since it will have a compounding effect over the coming months. Cancel any unused subscriptions you pay for, stop running unprofitable ads, don’t spend money on any “experimental” ideas, etc.
I pay $99/month for Ahref’s for one of my automotive blogs. I don’t need Ahref’s to come up with new content ideas, but I like having it. It certainly isn’t a requirement, like hosting is, for the business to keep operating. So, I should either cancel that subscription, or move it over to my personal credit card.
I could try to claim it as an addback since I probably wouldn’t sell the account with the business – but the new buyer might say “no, I think I’m going to need it to continue running the business”, and I won’t win that argument since I’ve been paying for it and running the expense through the P&L.
If I cancel this subscription 6 months before I sell my ecommerce business, I saved $600 in expenses, so my trailing twelve-months earnings are going to be $600 higher. If my business sells for the average 2.1x multiples, that’s an extra $1,260 in extra value I just got. If I cancelled it a year in advance, that’s $2,520 of increased value. It adds up when you have multiples expenses you can remove.
5. Consult a broker to take advantage of addbacks
Adding expenses back to your earnings number has the same effect I mentioned above. One simple example is a cell phone bill. I run my cell phone bill through the P&L, which is justifiable because I need my cell phone to make calls and do business. But a new owner is already going to have his own cell phone that he pays for. Unless he will need to get a 2nd cell phone specifically for your business that he is buying, then this can be added back.
The same goes for any other personal expenses that you run through your P&L. Addbacks are any expenses that you are showing on your P&L that are at your discretion and will not continue to re-occur under new ownership.
E-Commerce Businesses That Will Not Sell
I didn’t want to go here, but we’ve seen a ton of it lately, so I’m going to cover it.
Aliexpress or China dropshipping websites will not sell. That might be harsh, we do see some of them sell, but not for the multiples other ecommerce stores sell for. These types of businesses will generally sell for 0.5x to 1.0x and almost always require seller financing.
We’ve seen the popularity of this business model explode, especially with all of the “Guru” Facebook video advertisements going around. These businesses have very little value because someone can design a store exactly like yours for $30, steal your Facebook ads audience and copy your business in 2-3 hours’ time.
They rely almost exclusively on paid advertising and most do not make it more than a year before they start to fall off a cliff or require you to find a new “winning product”. It’s not a sustainable business model so please don’t expect to sell one of these for a decent price.
Jake Mayock
Jake is an experienced M&A professional with over 4 years experience in the private equity and investment banking industries. Outside of his day job, he owns and operates a portfolio of 8+ revenue generating websites and online businesses that generate over $150K of annual revenue. Additionally, Jake helps online business owners successfully sell their digital assets.