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This is more complicated than you might think. So this post is going to dig into the complexities of online business valuations, in order to better prepare you before you pursue one. An accurate valuation is not only necessary should you decide to sell, it will also help you identify areas where you can maximize the value of your business.

Either way, it’s worth spending some time getting familiar with the valuation process and methodology.

One of the big challenges emerging entrepreneurs face is the wide range of business valuation advice available online. Many entrepreneurs do some quick research, ask some friends for advice, and find an online tool that can spit out a reasonable-looking figure, at least for a rough estimate. Unfortunately, these tools are often inaccurate.

For one, different online business models should be valued in different ways. At the time of writing, my market-leading mergers and acquisitions advisory firm, specializing in online businesses, has valued tens of thousands of businesses and brokered the sale of over 750 online businesses.

Based on what we’ve learned along the way, I’ll show you the general methodology for valuing an online business, followed by considerations for some of the most common business models.

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Valuing an Online Business: The Methodology

There are several different approaches that can be used in business valuation, and generally, the size of the business’s revenue will determine which is best to apply. Here are the main methods:

Discounted Cashflow Analysis (DCF)

DCF analysis is one of the most robust ways of determining the value of a business. The aim is to create an estimation of what money will be received from an investment, and adjust this figure for the “time value of money.” In short, time value of money refers to how money that’s available now is worth more than money that’s available in the future (because of its greater earning potential).

DCF considers factors like assumed future sales growth and profit margins. Along with some other key factors, this allows you to determine the future cash flows of a business and therefore one can extrapolate the current business value. The present value is determined using a “discount rate,” which is where the name comes from.

DCF can be a great method for appraising older, stable businesses (10 years old or more), but for online businesses, which often grow rapidly and are subject to sudden changes in cashflow, it can be less reliable. For this reason, it is often used as a point of comparison or ignored entirely in online business valuations.

Precedent Transactions

This method is heavily dependent on having access to transactional data for similar businesses that have sold. With access to the right data from other acquisitions, you can look for comparable metrics, including multiples of earnings or revenue. Once these are obtained, they should be easy to apply to your own business—and they can be used as a quick check against your DCF findings or the results of any other valuation calculations.

Unfortunately, most announcements of small business sales keep this data private, so it can be hard to find a good comparison. Therefore, small to medium-sized online businesses often turn to online business brokers and M&A specialists for help with their valuations. After working on dozens or hundreds of acquisitions in the online space, they are likely to have lots of data to work with. This is the primary methodology we use and it has got more and more accurate as we sell more businesses and have more data to compare.

Multiple-Based Approach

Using revenue multiples has become popular in the online business world, as they can forgo a full picture of a business’s financial history (something that is often a problem for online businesses). There are a couple of different ways to do this.

With businesses that are likely to be valued at less than $10 million, you would multiply the Sellers Discretionary Earnings (SDE) by a set multiple to arrive at a valuation. (A “multiple” is a number that you will multiply the business’s annual revenue by to achieve an approximate valuation)

The SDE is calculated by taking a company’s net profit and adding back (effectively removing) some non-essential, owner-related expenses in order to better reflect a company’s true earning power. These expenses include the owner’s salary, depreciation, amortization, owner health insurance, charitable donations, one-time expenses (such as for damage to buildings/accidental breaking of equipment) and more. Remember, the factors that one counts as “discretionary” can be subjective, so determining an accurate SDE will be subject to some debate.

A full explanation of how to calculate SDE accurately is beyond the scope of this article, but to learn more about SDE and how it should be calculated you can read a thorough breakdown here.

If the business is predicted to be valued over $10 million, then you would generally use a benchmark of earnings before interest, taxes, depreciation and amortization, or EBITDA. This is due to larger companies having more employees and management personnel, and a more fragmented ownership structures, among other things. It is calculated by adding the operating profit to any depreciation or amortization expenses. Using this EBITDA figure will better represent the underlying earning power of the business. For a fuller explanation of what EBITDA is and how it is calculated, you can read this article.

(Bear in mind that many public and larger companies will use other valuation metrics, but they won’t be so relevant to this article).

Once you have this figure for “net income” from either the SDE or EBITDA method, you can begin to worry about what multiple the business might receive. Your multiple will be applied to your EBITDA or SDE figure to provide your final valuation.

Below, you can see a list of some of the different factors that can affect your multiple.

It’s a lot to take in, and these are just some of the most important valuation drivers. All of these factors must be weighed against one another to determine an appropriate multiple.

Once a multiple has been determined, it can be applied to the SDE or EBITDA figure and you should have a good sense of how your business will fare if you decide to sell.

The process of arriving at accurate SDE figures, EBITDA figures, and multiples will vary from business model to business model. Following this section are some brief summaries of specific things to look out for in some of the most popular online business models.

It’s common knowledge that SaaS (software as a service) businesses can attract high valuations, even before they have turned a clear profit. Due to the innovative nature of some SaaS businesses and the rapid growth of many high-profile SaaS companies (e.g. Dropbox, Salesforce, and Slack), appropriately valuing a SaaS can be a daunting task. There is a lot of conflicting information online, especially considering the modest revenue and market share of many small to medium-sized SaaS businesses.

SDE or EBITDA?

SDE is more useful for smaller business valuations, but SaaS businesses can grow rapidly, and many have large upfront costs to cover that minimize early profitability, so they may not always be appropriate.

As a general rule of thumb, you can ask yourself these three questions:

● Is your SaaS reliant on its owner?

● Are revenues growing slower than 50% year over year?

● Does the business generate less than $1 million in revenue per year?

If you answer yes to any of those questions, then SDE is likely to be your appropriate baseline.

If your business is faster growing, is not profitable, has low revenue churn and in a hot industry, then sometimes a revenue multiple is more appropriate. But this is very uncommon if your revenue is below $1 million in annual recurring revenue.

Finding the Multiple

Once you have a revenue figure, you will need to determine how many times to multiply this figure to reach your SaaS valuation. There are thousands of “value drivers” that can affect a SaaS business’s multiple. I have gone into some depth on the most important of these in my article on how to value a SaaS business, but I will summarize the most important factors below:

Business age:

While younger SaaS businesses are certainly sellable, more than two years of operation is the preferred scenario, with businesses at over three years of operation receiving higher multiples.

Trends:

A SaaS business that is growing revenue consistently is likely to be in a strong position for a higher multiple. No one wants to buy a business that is declining, but rapid expansion can also be a red flag. Buyers will want to know if your business is a flash in the pan or if it has sustainable growth.

Churn:

For SaaS businesses, churn (the percentage rate at which customers cancel their recurring subscriptions) is one of the most talked about metrics during valuation. Low revenue churn rates bode very well for a business operating on a subscription model. You can expect churn to be closely monitored when your SaaS is valued, and it is particularly powerful if you can show net negative revenue churn (you’re growing faster than you’re losing revenue).

Owner involvement:

Many entrepreneurs will take pride in their level of involvement in their SaaS businesses, but this could be a negative factor when calculating your business valuation. People looking to buy your SaaS will, for the most part, be looking to generate passive income. The less work they would have to do as a new owner, the higher the likely multiple. The smaller your business, the more relevant this becomes. If you are making $100,000 a year working 60 hours a week, it will be a factor. If you are making $1 million a year working 40 hours a week, it won’t, particularly if you are paying yourself a reasonable salary.

Summary:

In my experience, small SaaS businesses (less than $1 million in annual revenue) typically receive multiples of 3x to 4.75x their annual profit (SDE). As businesses grow beyond $1 million in annual revenue, multiples can get as high as 10.

Valuing Ecommerce Businesses

SDE or EBITDA?

Similar to SaaS businesses, valuing an ecommerce business will begin with determining the business’s earning power, so that you can then apply this to a multiple to arrive at your valuation. Again, businesses with a rough revenue of under $10 million should use the SDE method, and those higher than $10 million should use the EBITDA method.

For most ecommerce businesses, either SDE or EBITDA will be appropriate. However, some fast-growing businesses with plenty of capital, which make large investments in technology and growth, might find that neither method provides a representative valuation. If this is the case, you can try to forecast future earnings based on revenue and growth, even with your heavy expenditure. Just beware that buyer demand is likely to be very limited if you cannot at least show a clear path to profitability.

Any forecast based purely on growth will be less reliable. They should be avoided if the SDE or EBITDA methods are viable. Sometimes, however, they can be used in tandem with SDE or EBITDA to create a comparable valuation.

Finding the Revenue Multiple

Of the many factors that will affect your business’ revenue multiple, the most critical factors are:

Business age:

Generally, buyers won’t be interested in ecommerce businesses under a year old, and many will look for a minimum of three years of operation. Steady growth over five years will attract a higher multiple.

Financials:

This is a complex topic, but to summarize: A company with thorough financial records will be in the best position. Potential buyers will also be interested in the concentration of revenue across different customers, products, and suppliers. High concentration in either area would be perceived as a risk.

Seasonality will also be considered, along with chargebacks, returns, and refunds, which can often eat into profits with some ecommerce businesses.

Traffic:

Another complex factor requiring careful due diligence is the quality of traffic to your site. Your multiple will be affected by trends in search traffic, concentration of search traffic into specific sources, your backlink profile, and overall traffic quality. Traffic quality will be determined by metrics like pages per session, average session duration, bounce rate, and conversion rate.

Reorders:

Ecommerce businesses generally lack any form of recurring revenue, but a business that can show customers ordering multiple products over a specific period of time will generally attract a higher multiple. It shows the product has a loyal following and signals that the quality of products being sold is high.

Logistics and Fulfilment:

Ensuring that logistics and fulfilment are well organized and streamlined will help attract higher multiples. Things to bear in mind include: the type of fulfilment solutions being used, the ease of inventory management, and supplier relationships.

Technology:

Technology can obviously be extremely important to an ecommerce business, and new owners should not have to face a large burden. Using established and well-known software to run your business (like Shopify or Magento) can be seen as a plus during valuations. Ensuring that coding best practices are always followed will also work out in your favor.

Legal and Escrow:

This is another complicated area to consider, but some of the important things to consider are any intellectual property, work-for-hire agreements, and non-compete agreements. Appropriate legal counsel should also be sought to ensure all these details are accounted for.

Summary:

Depending on all these factors, most ecommerce companies will garner a revenue multiple of between 2.5x to 4x. So, an ecommerce business with $2 million in annual net earnings and a 3x multiple achieves a valuation of $6 million.

Valuing Apps

SDE or EBITDA?

Once again, we make use of SDE or EBITDA to express the app’s annual earnings before applying a revenue multiple. Apps that are likely to be valued at under $5 million should use the SDE method, and the EBITDA method can be used for anything above. This can apply to mobile apps, but also other applications that may be built on third parties. There are a lot of similarities with a SaaS business, but generally app businesses lack recurring revenue.

Finding the App Multiple

As with other business models, there’s a wide spectrum of factors that affect an app’s revenue multiple, so it’s essential to ensure you implement proper analytics and documentation from the moment you start your app business. This will help to create an accurate valuation and make your business more sellable.

The non-exhaustive list of valuation drivers that will affect an app multiple are listed below.

App age:

Some apps may see exponential growth early on, but this isn’t enough to get a high multiple alone. A lot can go wrong as a business ages, so one year of operation is seen as a bare minimum to sell a business. Two years is a better target. It is very common with apps to be popular for a short period of time and then die down.

Growth:

Is your analytics track record showing an increased ability to attract visitors to your app who then convert into paying customers?

Reviews:

How well your app is reviewed online by third parties/customers will affect your business valuation and ultimate sellability.

Quality of code:

If your app has to be carefully coded, with all best practices being used, and the work has been carefully documented, you should have nothing to worry about. Buyers will want to understand if a business will be easy to take over from a technical perspective, particularly if the person(s) who originally wrote the code are no longer with the business post-sale.

Concentration of earnings:

If your app depends too heavily on a single product, service, or method of monetization, there may be a greater risk for a potential buyer. A new competitor could quickly reduce profits, so extending product features and revenue streams will help attract a higher multiple.

Traffic:

Does your app’s associated website receive predominantly organic traffic? What are the trends in the traffic to your website? Do you completely rely on traffic via a third-party marketplace like the Apple App Store?

Summary:

Small to medium-sized apps can expect a multiple of between 3x to 5x your SDE. Once you have this multiple, you multiply it by your annual net earnings figure to create the final valuation.

Affiliate (or advertising) businesses are popular online business models because they are often cheap, easy to set up, and largely driven by the content they produce (often referred to as content businesses). They usually require the owner to produce some interesting written or video content within a set niche and to enroll themselves in an appropriate affiliate program or ad network to start generating revenue.

Finding the Affiliate Business Multiple

Many factors affecting an affiliate or content business’s revenue multiple will be the same as other online business models. Some of the factors that are more unique are listed below.

Content quality:

Long, unique, high-quality content will generally help a site rank in search results and encourage engagement from third-party sites, which makes a company more valuable.

SEO and links:

Many affiliates will attempt SEO tactics and link-building strategies that actively try to manipulate Google search results. While these tactics can create short-term gains for a business, they are best avoided for long-term success. You must ensure your site uses white hat SEO and has an organic-looking backlink profile to achieve higher multiples.

Product category:

Evergreen niches are generally seen as more valuable than hot and trending niches. Buyers want to know your business will be around for years to come.

General risk factors:

How long has the business been a member of their affiliate program? Will the terms of agreement be transferable to a new owner? How well established is the affiliate partner?

Summary:

Depending on the strength of the above drivers, among others, the affiliate business’ multiple will tend to fall somewhere between 2.25x to 3.25x.

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Final Thoughts

There is a lot of misinformation about online business valuations and it is easy to use online tools or inexperienced brokers without understanding the potential downsides.

Once you have an accurate valuation of your business, it will help you make better decisions now and in the future. It may be that the valuation you would like to reach for your company is further away than you expected, or it may be closer than you think.

Even if you have no intentions of selling now or any time soon, being armed with an understanding of what your business is worth is always helpful.

Remember to use a reputable advisory firm to complete your valuation; many will offer free valuation services with no pressure to sell.

Any questions? Please leave them in the comments. I’d be happy to answer.