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Evaluating An Internet Business To Buy I sold an Internet business for $3.5 million three years ago today. A friend who still owns an Internet business asked me to evaluate his business for him. He was mostly interested in knowing how to place a value on an Internet business. So we went through the process. The first step is the books of course. A website sells for about 10 months of net income currently. A real Internet business comes in at about 2.5 years of net income. So we can start with the books to easily set the lowest possible value on our Internet business by simply looking at it as a web-site or a collection of web-sites. Take the last ten months of bottom-line net profit and add them up. You can always get that amount for your Internet business by simply selling off the sites and ignoring other business assets and infrastructure. While we are there though, we want to graph out those ten months and calculate the monthly growth or loss rate. If the business is in trouble, we'll see a negative growth rate. If it is a launch style business, then we might see an incredibly large growth rate that doesn't seem sustainable. In that case, we'll want to look at some more history. The next step is also in the books. Get the current balance sheet. It will show assets, liabilities and owner's equity or shareholder's equity. An Internet business often runs with a very low balance sheet and that's OK. But if we are going to buy the business, then we are going to assume the liabilities which means that we need to make sure there aren't significant liabilities. Subtract those from the bottom-line number we calculated from the last ten months of net income. Or add the assets if there are significant assets. Make sure assets are fairly liquid though and not just paper assets. The next step is to look at the business system. Ask for the procedures. If the seller looks at you like they don't know what you are talking about, then there is no business. You already have your number. Everything else is locked up in that owner's head and their head doesn't come with the business. If they give you their business system documentation to review then look for dates. Was it created three years ago and there is no continuous improvement process? If so and you saw a negative growth rate, you now know why. That can be a good thing though. You know that the problem is that the business system exists, but it needs to be updated. That's doable. Creating a business system from scratch by guessing what the owner used to do isn't viable though. If the business system is up-to-date, go through it and make sure you understand how everything works from suppliers all the way to customers. Is everything documented? Can you understand it? If not, then you will have significant problems getting a new crew to understand it. Your new crew won't be as smart as you are! If everything checks out with the business system, it is time to check out good will. At this point, you can already double the 10 month's of income figure. You are buying a real business, not just some profitable web-sites. But goodwill means the difference between assuming the current human resources and customer base or having to re-implement that business system with new human resources and potentially a new customer base. The only way to do your due dilligence when it comes to good will is to pick up the phone and talk. I recommend calling the three most critical vendors, the three most critical employees and the three highest spending customers. Ask open ended questions like "How do you like working for ________?" and "What's the biggest problem you see at _______?" If goodwill looks like it is in the tank, this is also your chance to start rebuilding. Tell the vendors and employees that you are planning to buy the business and ask them if they would be happy again if ________ problem was fixed. The same goes for customers. At this point, you know what you are buying. You know the expected income level from following the current system. You know how the current system works. You know your liklihood of keeping current vendors, employees and customers. If everything looked good, then you can triple that 10 month income figure that was just for the web-sites. You have a turn-key profitable Internet business and it is completely reasonable to pay 2.5 years of income for such a business. There are other steps you can take to get an even higher value for an Internet businesss, but they will require an IP attorney and generally only apply to larger Internet businesses who are publicly traded or on their way to being publicly traded and have a very hot proprietary technology. If you are like 95% of Internet businesses though, you now know how to place the value of your Internet business. It is somewhere between 10 months and 2.5 years of net income. Where is dependent on how well you have documented your business system, how effective your business system is, and how well you treat your vendors, employees and customers. I hope you find that useful. |
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