How to Value E-Commerce Businesses
Understanding how buyers value your business is paramount to achieving a satisfactory exit. It is wise to apprise yourself of what aspects of the business are taken into consideration when a valuation is done so that you can work to maximise these areas of your business and optimise its value.
How is the Value Calculated?
The ‘consideration’ — the total value you receive for your business — is calculated by following a basic formula. It may look confusing at first, but in the next section, we break down each facet of this formula in order to help you better understand what is included in this valuation. The formula to find the value is:
Consideration = SDE Valuation Multiple + Inventory
SDE stands for Seller’s Discretionary Earnings and is a standard e-commerce terminology for adjusted profit, and once calculated, it allows you to see your profitability but from the buyer’s perspective. SDE is important because it will enable prospective buyers to predict expected cash flows and compare your company to others with greater accuracy.
EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortisation, is a term often used more frequently for larger businesses. In a nutshell, EBITDA is basically the same number as SDE, but is usually applied in the context of larger organisations with more complicated tax and depreciation schedules.
There is also a basic formula to help you calculate the SDE of your business:
SDE = Revenue – Cost of Goods (COG) – Operating Expenses + Add-backs
Now that we’ve seen why SDE is important, it is always prudent to be looking to increase this figure to help enhance the value of your business. Here we have several top tips on how to increase your SDE or EBITDA:
- Improve the supply chain: It is a great idea to consider enhancing your supply chain to improve SDE. For example, a great idea is to try and eradicate as much air waste and packaging as possible while at the same time keeping packing work done by Amazon in the FBA warehouse to a minimum. Making these changes can allow a business to gain back numerous margin points.
- Improve the brand: A great way to grow your products is to consider your Product Detail Page (PDP) and how you can enhance its conversion rate through imagery and text content. PDP’s give the consumer further trust in the product and can include photos, colour options, measurements and sizes. With an e-commerce business, shoppers obviously cannot touch the products; therefore, it is invaluable for the retailer to provide as much information as possible to help the consumer understand what they are going to buy. This establishment of trust between consumer and buyer can help boost the conversion rate. A desirable conversion rate is around 15%.
- Consider new products and marketplaces: Many businesses expand into new markets when trying to improve their SDE, but it is essential not to go into it blind. Sensible businesses consider both Amazon search trends and competitor analysis to work out the next marketplace to break into. Additionally, an Amazon Pay Per Click (PPC) investment can also be an advantageous way of accelerating the launch of a new product.
- Consider a marketplace away from Amazon: Our final tip is one to consider when exit planning. Be aware of direct-to-consumer (DTC) marketplaces as they add value to your SDE (by cutting out the middle-man in wholesalers and retailers).
A valuation multiple is a financial measurement tool that considers one financial metric as a ratio of another. This is done to make separate companies more easily comparable. A multiple is the proportion of one financial metric to another and is utilised because it is a simple way to compute a company’s value as well as the ability to compare it with others. Your business will be valued based on a multiple of your SDE, and this multiple is often reliant on growth speed, margins and earnings consistency.
A fantastic way to enhance your valuation multiple is to engage in a competitive auction process. It is vital that the most suitable buyers are at the table, so do enlist the help of an experienced exit advisor if you want assistance.
The final part of the consideration formula is, of course, inventory. Now, buyers value inventory at the landed cost, defined as the total cost affiliated with getting a shipment to where it needs to be. Therefore it can include taxes, fees and cost of shopping and a range of extra factors.
When selling, you should also expect payment for any excess inventory that can be sold. The majority of buyers will want an appropriate inventory level so that the transfer of the business goes by smoothly and without a hitch. If a seller has a sales cycle of 30 days, then any inventory that is extended past this time should be paid for. If you would like an insight on when is the best time to sell your brand.
A Note on Add-Backs
It is also important to mention add-backs as it is an expense considered when calculating the SDE. In layman’s terms, an add-back is an expense regarded as discretionary for the seller or that the buyer is not responsible for after buying the business. Therefore they do not transfer over to the buyer. Any expenses that are removed increase your net profit, so it can be a good idea to view an add-back as adding money back to the bottom line. It is essential to be aware that an expense can be recorded as an add-back if it is not crucial to running the business. Examples of add-backs include travel and vehicle expenses, no-longer-used services, salary, and one-time expenses.
Working out how the value of your e-commerce business is calculated is hugely beneficial to understand. Once you have greater clarity as to how the value is decided, you can take steps to enhance this value and make yourself more appealing to a potential buyer. The valuation of your business is determined by several factors, including SDE, valuation multiples, inventory, and add-backs. While it can be complex to understand the formula for how the value is determined, it is worth putting the work in to make your business stick out from the crowd. It can be helpful to consult an expert about your business valuations if you have any queries and get advice as to how your particular business can increase its value and become more attractive for a potential buyer. It may also be worth looking over our tips on how to maximise your exit if you would like to optimise your business with a view to potentially sell.
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