It is important to make a separation between an online business and simply a website. When you are buying an online business, additional items should be included in the sale than just the website.
- The stock of products or the production equipment that the business is selling
- Computer hardware and other goods
- Office space (even if it’s rented)
If none of those are included, you are not buying an online business, but merely a website. To learn how to evaluate a website, read this article. Sometimes you may only want to buy a domain, for that check this guide.
Evaluating an online business is no different from evaluating a physical business, and most businesses are a combination of online and offline business. However, if you want to evaluate a Start-Up, especially one that is still pre-revenue, other things must be taken into account.
- An extremely well-established and steady business with a rock-solid market position, whose continued earnings will not be dependent upon a strong management team: a multiple of 8 to 10 times current yearly profits.
- An established business with a good market position, with some competitive pressures and some swings in earnings, requiring continual management attention: a multiple of five to seven times current yearly profits.
- An established business with no significant competitive advantages, stiff competition, few hard assets, and heavy dependency upon management’s skills for success: a multiple of two to four times current yearly profits.
- A small, personal service business where the new owner will be the only, or one of the only, professional service providers: a multiple of one time current yearly profits.
The guideline is quite clear. However, people still have problems interpreting it. Mostly they again evaluate themselves too high and put in the wrong category.
Majority of online businesses (and businesses in general) fall into category 3 and 4. I personally do not recommend buying type 4 business, unless some valuable assets are included, such as a popular website or physical goods included in the sale that will cover the price of the business, because it’s often cheaper to start from the scratch, as you are the only person in the company anyway.
Type 2 and 3 companies are the ones we are after if we are looking to buy a business. It’s hard to make a difference between them since the borders are not obvious. Typically type 2 company is making at least $1M in sales, while type 3 is somewhere in six figures.
Type 1 businesses are typically near the range of public companies, making at least over $5M in sales. The one with which you could rely on making passive income without ever working yourself. So unless you are looking at one, the seller is overvaluing his company by a lot and in reality, it’s 2 or even 3 type company.
I commonly use revenue as an example, but make sure not to rely on it completely. A very talented business consultant or a lawyer could earn $1M per year, but it would still be only type 4 company if even that, as he is the company himself.
Remember that business owners often overvalue their company, so as a golden rule assume, that he is asking 2-5 times more the real value and that heavy bargaining needs to take place.