Valuations for Buying and Selling Websites

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Forget everything you know about conventional valuations.

Valuing internet businesses with a value below $250K can seem a little random when you look at what's currently being sold, but there is some logic to the process.

This presentation, given at the 2012 Internet Investment Summit, delves into site valuations and also gives some practical advice on how to improve the value of an asset you intend to keep for a while.

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  • This format is not conducive to resolving our differences. Let's just agree to disagree. Thank you.
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  • @TomMacPherson You're inventing things now. I thought we were talking about a business that produced $100,000 in profit per year, now you're saying 'Well now... he wants to pull a salary.' A profit is the money left over after you've paid salaries and wages and all other expenses (again, you should know that). On the other point, if you're a broker, then your position as a broker may make you concerned about the pool of buyers because you want to close the transaction, but a seller is stupid if they consider anything other than their own needs. If the seller needs to sell, if they need capital, then sure, they have to worry about how to attract buyers, obviously. But if a seller does not need to sell, they have no need to make accommodations for potential buyers who may come sniffing around. A seller should sell an income producing asset at a price they are comfortable with, period. As for buyers, if you can't do better, income wise, with a website than the current owner, you shouldn't be in the business of buying websites. An ideal transaction as such would be an owner who earns X from their asset selling to a seller who, because of better execution abilities, could earn x*y from the same asset. That is the only situation where both parties are winners, otherwise someone has to be the loser. And if someone is selling a long term income producing asset for the equivalent of a 50% cap rate, it is probably the seller. If you had something that tossed off $100k a year for the past 10 years and you sold it for $200k, you should get your head checked. So, anyways, a website that earns $100,000 in revenue but pays $80,000 in wages has a $20,000 profit, not a $100,000 profit. That makes a big difference, selling a website that makes $20,000 in profit for $1mm is a bad deal for the buyer for sure.
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  • Chris Beasley: I respectfully differ with you in many ways, as I’ll show below:
    Your comment: “@TomMacPherson it is irrelevant to the seller how the buyer pays for a purchase, no matter what that purchase is. Someone could easily pay cash, they could get private financing, they could get an SBA loan as you say (good luck).” My response: With all due respect, it is extremely important how a buyer pays for a purchase. If there is no money to complete the transaction, than there is no transaction. In my 12 years in M&A, I’ve never come across a buyer willing to pay cash for a business; and 90% of my deals (ranging in value from %500K to $4MM) have been financed using SBA guaranteed loans. The rest have used seller financing – which most sellers are loath to even think about. So, unless the seller is willing to finance the transaction, then the price must be in line with lending criteria, or there’s no deal.
    Your comment: “A seller must sell an asset at a multiple that makes them comfortable considering the income they're losing.” My response: The seller who considers what makes them “comfortable”, and ignores the market, is doomed to own the company for many years – or until is goes under. Sellers who successfully negotiate a business transition transaction understand that the net cash they receive for their business (for which they have worked many days and nights) cannot be reinvested in a passive investment that produces the same returns. Not happening! The seller’s comfort is over-rated if he actually wants to sell his business.
    Your comment: “Also, I don't think you understand how leverage works, which is alarming considering your purported position as 'principal at summit acquisitions group' which I can only assume uses leverage to buy things (or hopes to one day?).” My response: No need to be patronizing. I do know how leverage works.
    Your comment: Buying things with other people's money is a great way to juice your returns. You didn't include the down payment in your hypothetical SBA loan. My response: I know about the “juice”, and I DID include the d/p.
    Your comment: “Let’s call it 20%. So you pay $200,000 for an asset that makes $100,000 a year in net profit. You then incorrectly list debt service costs as the sum of P&I, when it is only I (interest) and any associates fees.” My response: Debt service IS principal AND interest. http://www.investopedia.com/terms/d/debtservice.asp Your comment: Paying back principal is not an expense under any accounting regime. My response: I’m talking about “cash flow”, not net income.
    Your comment: “Go ahead, try to expense it with the IRS. If paying back principal was an expense, loans would be income, and they're not. These are basic accounting concepts. My response: I’m a CPA - I know the difference.
    Your comment: “But ignoring that. You're only investing $200,000, not $1,000,000. Your income off that $200,000, even with your incorrect expensing of principal, is $23k, a yield in excess of 10%, which is pretty good. Using actual GAAP accounting under your loan scenario with my assumption of 20% down since you didn't indicate a down payment... You'd pay ~240k interest over the life of the loan, that obvious is front loaded but we'll just average it to $2,000 a month for 120 months. Or $24,000 a year. So in reality, your debt serving expense is $24,000 a year, not $77,000 a year. Putting your net profit at $76,000 a year, off an initial investment of $200,000. That gives you a yield of 38%. You understand, you get a higher yield by using leverage? You'd have a yield of only 10% if you had paid cash, but by using other people's money you have a yield of 38%. You increase your risk of course, but you definitely increase your yield. I am genuinely alarmed you don't understand this considering your resume.” My response: You don’t earn points for attacks at my professionalism. After all, I’m the guy in the trenches, successfully helping business owners sell their companies every day. Back to this case: I’m assuming the hypothetical buyer is going to actually work on the business, and wants to earn market compensation. Someone able to come up with $200K down payment would probably want to be paid at least $80K a year – his likely market value as an employee. So, when you factor that additional expense, under our equal scenarios (please recall, I did include the down payment), this buyer would have to pay $77K in debt service (P&I) for ten years for the privilege of working for himself – rather than working for someone else and keeping his after-tax salary. The buyers I encounter in my deals would never enter into such a transaction. I wish they would. I'd sell my deals much faster.
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  • @TomMacPherson it is irrelevant to the seller how the buyer pays for a purchase, no matter what that purchase is. Someone could easily pay cash, they could get private financing, they could get an SBA loan as you say (good luck). A seller must sell an asset at a multiple that makes them comfortable considering the income they're losing. Also, I don't think you understand how leverage works, which is alarming considering your purported position as 'principal at summit acquisitions group' which I can only assume uses leverage to buy things (or hopes to one day?). Buying things with other people's money is a great way to juice your returns. You didn't include the down payment in your hypothetical SBA loan. Lets call it 20%. So you pay $200,000 for an asset that makes $100,000 a year in net profit. You then incorrectly list debt service costs as the sum of P&I, when it is only I (interest) and any associates fees. Paying back principal is not an expense under any accounting regime. Go ahead, try to expense it with the IRS. If paying back principal was an expense, loans would be income, and they're not. These are basic accounting concepts. But ignoring that. You're only investing $200,000, not $1,000,000. Your income off that $200,000, even with your incorrect expensing of principal, is $23k, a yield in excess of 10%, which is pretty good. Using actual GAAP accounting under your loan scenario with my assumption of 20% down since you didn't indicate a down payment... You'd pay ~240k interest over the life of the loan, that obvious is front loaded but we'll just average it to $2,000 a month for 120 months. Or $24,000 a year. So in reality, your debt serving expense is $24,000 a year, not $77,000 a year. Putting your net profit at $76,000 a year, off an initial investment of $200,000. That gives you a yield of 38%. You understand, you get a higher yield by using leverage? You'd have a yield of only 10% if you had paid cash, but by using other people's money you have a yield of 38%. You increase your risk of course, but you definitely increase your yield. I am genuinely alarmed you don't understand this considering your resume.
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  • @TomMacPherson Tom - thanks for adding to the discussion. (I'm assuming by above, you mean the comment below?).

    Without a traditional M&A background, I can only go off what's really happening in the space which I work in - typically transactions between $100K and $5mm.

    Things have changed drastically since I produced this, especially with regards to valuations. An internet business in this space on average (n.b. averages can be dangerous, as it lumps the distressed transactions in with the better ones), sold for approx 2.7x EBITDA in 2013 and that continues to rise.

    You can see the transactions that this average was based upon in the 2013 Website Buyers Report - http://centurica.com/website-buyers-report
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  • What I originally found most daunting about this industry, coming from the offline world, is it's like somebody woke up one day and thought all that stuff cash flow discounting, or net book value which people have used for years and years on thousands of deals - no longer applies!It's like they just started again!But actually there is some logic to the way businesses are valued in this industry and we'll take a brief look into where Web business valuations stem from in order to get to where they are now.
  • Most people confuse a site's value - the core things which make it desirable to a buyer - with the valuation or price - a $ amount.The main difference is that value is anchored to real tangible assets like traffic, or revenue valuation is ultimately a made up consensus of what a site is worth based on what people are willing to paySorry to disappoint – first thing to understand
  • Value internal; built into the site before decision to sell rarely affected by the sale process.Valuation external – perception of that site's worth affected by external things like.Before we understand how valuations are derived and ultimately how to hack a site's valuation to get more than the next seller, we need to go back a little - back to the reason this opportunity even exists and probably the reason why we're all here today.
  • Bricks and mortar organisations have been sold since the dark ages; advantage of hindsight. We've got enough historic data for almost any industry to assess what people are likely to pay.HairdresserPharma company
  • And this works on the idea that an offline business is a pretty constant entity. You're always going to have things like
  • I know guys at Price Waterhouse Cooper who would have me killed for trying to break business valuation in five minutes, but ultimately - it's that simple. And it's a reinforcing theory; if company X ……eventually get recorded. …The next company comes alongguess what the broker will say ....
  • When smaller sites began sell publically, it happened on Forums in the mid - late 90s with Sitepoint being the main focus. Most if not all the sites were generic affiliate or Adsense ones and so they had very few assets and very few moving parts.
  • The only thing to separate one site from another was Revenue. expenses low – revenue = profit. Traffic. generic adsense or affiliate site, traffic proportional to revenue so ultimately if you knew revenue then this factor didn't matter so much. The domain.
  • Assuming an average domain, it really all came to down to revenue de facto way to value a site - as a multiplier of its revenue. Back then, someone, somewhere, decided it should be around 4 months and that reinforcing theory just seemed to stick. it later increased to 6 months as demand increased
  •  However we've still got this huge gap between the valuation of an offline business and the valuation of an online one. Some of this stems from perceived risk and some of it stems from investors having little historical transactions to go by, and many of those transactions following the 4- 6 months revenue model. Here's a real example:
  • This price was technically a good result in the online world, but given two businesses that generate about the same amount, one having less liabilities than the other, which would you go for?
  • Investors are realising this every day and they're coming from all walks of business - property being one of the most common recently, and they are ready to acquire 'good' businesses because they know that even at 26X monthly profits it's still a fraction of the cost of acquiring an offline one, typically at 3 -4 years net or 24 - 48 months profit.In fact, I usually get laughed at by people from outside this industry when I explain I'm using a value multiplier based on months and not years!But just as with offline business where there are factors like IP, management teams or stock that can nudge a valuation above the norm, internet businesses have their own factors which do pretty much the same things.
  • <<slide>>*The key comes from understanding that a site's valuation is about more than just its core value. Butthe two are linked, and if we can't increase the value, we can increase one of more of the 'Auxiliary factors' to get the same end result, So then it becomesless about going against industry defaults or norms and more about knowing what to do to add value in the eyes of a buyer.
  • * I’d like to go over each one of factors in a site’s valuation so we can see how they all fit together.
  • Going back to our definition, CoreValue is usually about something internal or something the seller has done prior to selling the site. Three examples -
  • *... And this site has none of the above, which is why if it does sell, (there's always someone eager to part with their money so don't rule it out!) it will be for a very low valuation, one that's unlikely to even cover the selling fees. With the exception of the latter, all of these sites have a core value and it's usually something we can put a $ amount on. The core value of a site will usually be pretty constant. So if you have two sites in the same niche with no difference other than one is doing twice as much net profit as the other, then the latter will be worth twice as much.
  • In reality though, every site tends to be different in many ways and this is where the ‘auxiliary factors' come into play.
  • * If you remember our grossly oversimplified valuation modelthen you'll also remember that the valuation can be changed not just by changing the core value, but also by tweaking, adding or removing any of these auxiliary factors.If we're looking specifically at internet business, then we can actually break them down into 15 key areas and we'll look at each one in more detail in another session. This gives us a system to not only assess a purchase by, but one where we can look at our own assets and see what's missing.
  • Each one of these areas contribute to a site's overall valuation; very few people understand all of them and their role in increasing or decreasing the valuation of a site. Those that do build businesses that are ... to quote someone else ... 'bought rather than sold' as in people crave it as an asset and are more likely to pay something nearer to 26 months profit rather than 4 -6.Doesn’t have to be naturalI treat it like an MOTIt's a list of things whereby understanding each one will add a little extra value to an asset you own or you're about to sell, and we'll take a more in depth look at each one a little later this weekend.
  • Now just as a side note, I've been reluctant to use the word psychology because 1) business people usually switch off at that point and 2) It generally makes me sound like I'm trying to be smarter than I actually am, but unfortunately it was the most concise way of getting the point across and I promise this is all relevant, so stay with me.
  • There are some key areas out of our 17 which are like motivators, so their presence increases a site's value. Some key areas are like hygiene factors, so their absence decreases a site's valueThe 'hygiene factors' work on the idea that not having something like varied sources of traffic means more risk if the main source, for example Google, makes a change and that traffic no longer exists. As an experienced investor you may decided the risk isn't worth the investment and ultimately pull out of the bidding / withdraw your interest. Less potential buyers means less competition and ultimately less bids / interest to fetch a higher price.
  • Usually comes with experience knowing this is essentially a shortcut for exampleLack of traffic diversification
  • Now, Although we’ve only mentioned Core Value and Auxiliary factors contributing to a site’s valuation there is also one more thing which we need to consider and that’s context
  • *There's a show we stole or imported from you called pimp my ride and for anyone that hasn't seen it, each week they take a battered old car and add the craziest modifications and upgrades to it. Imagine you've got a sports car that's worth $50K and you add $10K worth of TV, DVD, Alloy Wheels, Leather Upgrades and Audio.Now Imagine you've got a $500 family sedan that's 15 years old and you add exactly the same $10K of equipment.Do you think the increase in value is going to be the same for both cars despite the upgraded equipment being identical?Clearly not; the second car has a ceiling that no amount of upgrading will break and it's the same with looking at the value of sites.
  • A site with a core value of $200 with every auxiliary value ticked from our list won't see an increase anywhere as much as a $20,000 one with the same areas of value added to it.This why it's important as a investor to buy at your upper limit - Applying $5K of changes over 3 months will have a much more substantial increase on a site's valuation if the site is worth $20K than if it's only worth $5K.This is also why it's generally much more difficult for sub $5K sites to break that double digit valuation ceiling.
  • And if we’re looking at context, we also need to look at the buyer;Imagine a triangleEach stage needs to be satisfied in a buyer's mind before moving onto the next. Basic WantsRegardless of the niche, type of site or price bracket, there are some things that all buyers want. To list a site without demonstrating that you have these covered is like committing ‘virtual suicide’, and it’s unlikely a buyer will move on without these being met.
  • Loss ProtectionThe primary concern - part with their cash and have nothing in return. This can either be at the start (e.g. through fraud / scams) or after (e.g. a drop in search rankings ). The sites that fetch the higher valuations are the ones...Growth PotentialMost sites fortunately have a mechanism for growth as standard (e.g. more seo to get more traffic) Those that have a limit on their capacity or a model that means it becomes unprofitable to grow are penalised in their valuations when savvy buyers realise and back out.Golden ParachuteIn some ways, this is loss protection too. Buyers often want to know ... (This is why it’s important to go niche, but not so niche that you will always struggle to find buyers).
  • *By removing things that are likely to put buyers off, and adding things that buyers would potentially not buy without, you include the maximum amount of people in your auction.
  • Providing all the basics needs have been met, and you've managed to create and maintain attraction, buyers usually look for some personal value from your site to finally motivate them to buy. This can be as simple as the core values like traffic or revenue, but sometimes it's something that's unique to that individual or organisation.Sites have different values to different buyers, and what affects that value depends on a lot of factors like their strategy, timeframe, skill set and resources available.
  • Generates car insurance leads 10,000 visitors each month. Current owner receives £25 per lead converts at 1% giving 100 leads or £2,500 in revenue.
  • Buyer B is a happy buyer as she'll pay the same amount for the site as buyer A, but ultimately earn a lot more. Furthermore, if she includes her sales and the methods for generating those additional sales into the business, the value of the business will increase significantly even if she sold just months after buying.Buyer B will put a higher valuation on the site than Buyer A and this illustrates our final key concept
  • Wild West - Things wont always be this way - Already moving to more conventional valuation systems as more online businesses keep formalised accounts - strike whilst the iron is hot and take advantage of the opportunity that’s out there
  • Valuations for Buying and Selling Websites

    1. 1. First, forget everything you know about conventional valuations
    2. 2. Value, Valuing and Valuations• Most people confuse a sites value with the valuation or price.• Value is anchored to real tangible(ish) assets like traffic, or revenue.• Valuation is ultimately a made up consensus of what a site is worth.
    3. 3. Value, Valuing and Valuations• Value is something which is internal• A Valuation is external
    4. 4. Businesses have been bought and sold for …. ever
    5. 5. Offline Businesses• Premises - an office, shop or factory• Physical Tasks - and hence employees or at least 1 person who takes a salary of some kind• Connections - websites, phone numbers and addresses• Accounts - usually audited
    6. 6. Offline Valuation Adjustments• IP, or unique technology• Valuable staff or a solid management team• Contracts, leases and agreements• Good or bad recent financial performance• Stock and Inventory etc.
    7. 7. Internet Businesses wereoriginally quite simple entities So the valuation process was simple too
    8. 8. Website Assets – Circa 2004• Revenue• Traffic• The Domain
    9. 9. Reinforcing Theory kept prices around 4x monthly revenue
    10. 10. How is this even relevant to what were doing today?
    11. 11. Sites have become more complexFrom
    12. 12. Sites have become more complexTo
    13. 13. The 4 – 6x monthly revenue model isnow a little too basic to work with by itself
    14. 14. One idea that hasn’t changedCore elements still affect a site’s value and valuation:• Profit (not so much revenue now)• Traffic• The Domain
    15. 15. All very simple things to assign a $ value to
    16. 16. Two Similar Bathroom Supplies Businesses•Held stock for about 20% of the •All Items dropshipped – no stock items sold held •Annual Net Profit £32,000 •Annual Net Profit £33,000 •Sold for £155,000 •Sold for £62,000 •Two members of staff •No staff •Three years remaining on •No lease or agreements – run from warehouse lease home
    17. 17. Two Similar Bathroom Supplies BusinessesAnnual Net Profit £32,000 Annual Net Profit £33,000 Sold for £155,000 Sold for £62,000Valuation Multiple of 4.84x Valuation Multiple of 1.88x Or 23x monthly net
    18. 18. Web and Online businesses typicallysell for 50 - 80% less than an equivalentoffline one. That creates an opportunity to buy now while prices are still relatively undervalued. But theres another overlooked opportunity...
    19. 19. Internet Business Valuations 4 – 6x net profit = Business Core Value (Cash Flow, Traffic, Domain) +/- Auxiliary Factors
    20. 20. 1. Core Value2. Auxiliary Factors 3. Context
    21. 21. 1 .Core ValueExample A - Cash Flow
    22. 22. 1. Core ValueExample B - Traffic
    23. 23. 1. Core ValueExample C - Domain
    24. 24. 1. Core ValueExample D – none of the above
    25. 25. 1. Core Value2. Auxiliary Factors 3. Context
    26. 26. Internet Business Valuations 4 – 6x net profit = Business Core Value (Cash Flow, Traffic, Domain) +/- Auxiliary Factors
    27. 27. Auxiliary Factors for Internet Businesses• The Core Basics • Trust and Transparency• Lists and Members • Links• The Content • Sales Partners and Affiliates• Cash Flow • Reputation and Brand• Critical Mass • Legally Sound• Traffic Diversification • The Niche• Revenue Diversification • IP, Software and Products• Documented Systems • Scalability and Redundancy
    28. 28. Buyer Psychology in Three Minutes• Sorry for using the ‘P’ Word• It’s like NLP in relation to selling online business• Important to understand that it’s not only ‘tangible’ factors which affect a site’s valuation
    29. 29. Buyer Psychology in Three Minutes Fredrick Herzberg (1923 - 2000) Two Factor Theory
    30. 30. Buyer Psychology in Three MinutesStaff need two types of factors for job satisfaction: Motivator Factors
    31. 31. Buyer Psychology in Three MinutesStaff need two types of factors for job satisfaction: Hygiene Factors
    32. 32. 2. Auxiliary Value Similar thing happen with buyers Motivator Factors IP or Unique Software, Lists and Members or Documented Systems Hygiene FactorsTraffic diversification, being Legally Sound or lacking The Core Basics
    33. 33. 2. Auxiliary ValueBy understanding what buyers look for and how they attribute those things to value, you can •See value or problems that other bidders / parties might miss in an asset and •Know where to add value to an asset you already own to increase the valuation
    34. 34. 1. Core Value2. Auxiliary Factors 3. Context
    35. 35. 3. Context – The Site
    36. 36. 3. Context – The SiteNot all sites are created equallyEvery site has a ceiling attached to its Core Value
    37. 37. 3. Context – The BuyerThe buyers opinion on a purchase naturally has an effect on the valuation too.
    38. 38. 3. Context – The Buyer Basic Wants Loss Protection Reduce loss over maximising gain Growth Potential Golden ParachuteIf all were to fail, what can I recoup?
    39. 39. 3. Context – The Buyer Attraction More Potential Buyers= More Bidders / Interested Parties = More Competition = Higher Sale Price
    40. 40. 3. Context – The Buyer ValueBuyers attribute their own personal value to every site they look at Consider this example …
    41. 41. Computerquoteinsurance.com10,000 visitors that convert to leads at 1% = 100 leads per month £25 per lead = £2,500 in revenue
    42. 42. Computerquoteinsurance.com Buyer A New to Insurance but familiar with Lead GenWill receive same arrangement as the previous owner - £25 per lead or £2,500 in revenue
    43. 43. Computerquoteinsurance.com Buyer B Owns a price comparison engineWill earn £25 per lead too but also £275 over that customer’s lifespanSame site now has a $30,000 per month value to B
    44. 44. Sometimes, valuations rely more on the buyer than the business.
    45. 45. Putting it all together
    46. 46. Putting it all together1. There is no calculation that can tell you what to pay for a particular site, or what it’s ‘worth’ …. Sorry!2. Your best starting point is from historical transactions – what have people paid in the past for sites with similar core values
    47. 47. Putting it all together3. Increase or decrease your valuation based on auxiliary factors4. Use those same factors to spot things which other buyers may miss to seize opportunities5. Use those factors as a systematic way to increase a site’s value
    48. 48. Putting it all together6. Consider the site in context of its core value7. Consider the personal value to you as a buyer – can you extract value in a way that others currently aren’t?
    49. 49. Opportunity out of Chaos
    50. 50. Thanks for watchingwww.flipfilter.com/blog Twitter.com/flipfilter

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