How-To

2 Ways to Value a Business

by

We continue to post chapters from our upcoming ebook guide, How to Sell an Online Business, to help business owners prepare for a sale. In this second chapter, we look at different approaches to value a business and which one is right for your online business in approximating its worth.

business valuation

2. Valuation & Financials

The first step for many digital business sellers is to understand the value of their business. There are many different ways to value a business, from asset-based and market-based approaches, to an assessment of historic and future earnings. Different approaches are favored based on the size of the business, its growth trajectory, the profile of the buyer, and the state of the business. For buyers of smaller, closely-held companies, a few useful methods are: (1) the multiple of earnings method, and (2) the market value method.

Multiple of Earnings Method

For an owner-operated, digital business, the metric often used as the number being multiplied is “Seller’s Discretionary Earnings” (SDE). SDE is typically calculated by subtracting the cost of goods sold and operating expenses from annual gross income, and adding back non-recurring, non-cash and discretionary expenses. Operating expenses are the necessary costs to running the business and are non-discretionary.

Examples of expenses that are often added back to the businesses’ earnings include owner’s compensation, depreciation, charitable contributions and personal vehicle expenses. For larger businesses where the value is less tied to owner benefits, the metric often used as the number being multiplied is “Earnings Before Interest, Taxes, Depreciation, and Amortization” (EBITDA).

ebitaFor businesses that are rapidly growing, have recurring revenue models or have high value to the buyer, “Revenue” is often used as the number multiplied. Since our industry focus is owner-operated, digital businesses, we will use SDE as our example metric, however many of the same principles apply for other metrics. Multiples for smaller website, and similar businesses usually range from 1.5x to 4.5x SDE.

Determining where a business falls within the range is tied to the predictability of future earnings and the effort required to maintain and increase them. Businesses that require more advertising to gain traffic or have a less reliable customer base will typically have a lower multiple. More predictable revenue businesses will command a higher multiple. Some thoughts for further consideration:

  • What is the digital business category (e.g. lead generation, content, membership/subscription, e-commerce, or software/SaaS)?
  • Where does the business’ traffic come from? Organic vs. Paid?
  • What is the customer retention rate?
  • How stable are the earnings?
  • How vulnerable is the company to new entrants in the field? Is the business easy to replicate?
  • How quickly is the business growing?
  • How easily can the assets be transferred to a new owner?

Market Value Method

Reviewing “comps’’ can be a great way to check whether your valuation assessment is on target. Comps can be obtained through brokerages and marketplaces online. The Hatchit Marketplace is a good place to start. As a first step, conduct a thorough search for business listings similar to that which you’re assessing. Next, narrow down the group, identifying the 5-10 digital businesses closest in type and size to yours.

Add these businesses to a spreadsheet, calculating a multiple of SDE or Net Profit for each (be careful to ensure that the figures being multiplied are “apples to apples”). You may want to include notes for each on your spreadsheet, as their unique attributes may help to further refine your range (e.g. “does not include inventory valued at $10k”, or “includes 5 patents”). Lastly, remember, the purchase prices you source online are “asking” vs. “selling” prices – you may need to take this into account when negotiating with a seller.

business comp table

Choose Someone to Value the Business

To further support your offer, you might consider engaging a professional for a third-party opinion on the value of the business. CPAs, appraisers, and business brokers are all good candidates to help with a valuation.

In addition to the Multiple of Earnings and Market Value method, a business valuation might employ other approaches including discounted cash flow, asset based, or capitalization in earnings. Make sure you understand the assumptions behind each approach before presenting the result to the seller.

Once the valuation is complete and you have decided to move forward with a sale, the next step is to organize your financials. Most buyer’s will want to see 2-5 years of financial statements that document your cash flow, balance sheet and profit and loss statements. In addition, buyers will want to understand the detail around any adjustments you have made to your financials when calculating the business’ SDE or adjusted EBITDA, since these inform the valuation and provide information about the cash available post-transaction.

financials

Take the time to develop a spreadsheet that lays out your financials so that they can be easily compared across the years provided, and clearly spell out any adjustments. Make sure you understand any inconsistencies or noteworthy occurrences in the figures, so you can explain them adequately. Be prepared, also, to show how your reported figures tie to your tax returns. Numbers tell a story and you want to control that narrative as much as possible. If you are selling for-sale-by-owner, it is advisable to engage a professional to help.

Additionally, it is advisable to speak with your CPA or financial advisor to understand what terms are acceptable for your personal and financial situation. Deal structures can vary widely, with implications on your income post-transaction. Also, selling your online business can result in a substantial tax liability:

  • Do you require all cash or are you open to the buyer financing part of the purchase?
  • What is the minimum amount of cash that you require a buyer to put down?
  • Are you open to seller financing if the buyer can’t secure a third-party loan?
  • Is your business set up as an LLC, S-Corp, or C-Corp, and what are the tax implications of selling the business’ stock vs. its assets?
  • Are you open to staying on during a transition period?

It's best to get these questions answered as early as possible so you don't waste time with an unqualified buyer. 

Regardless of whether you decide to sell through a broker or on your own, the process remains essentially the same.  We hope you took away a few insights that will help you value a business and yield the most money for it. Email us with any comments, suggestions, or insights of your own.

Quick Answer takeaways: 

  • Most web-based businesses use SDE for calculating a valuation.
  • Comps are a useful way to reality check your number.
  • Fast growing SaaS companies often use a multiple of revenue.
  • Predictability of future earnings can increase your valuation multiple.
  • Prepare 2-5 years of financials that include a balance sheet, cash flow and profit and loss statements.
  • Be prepared to tell the story behind your numbers.

Read the next chapter in the Seller's Guide on Marketing Materials.   

Images from Pixabay

Where to Sell an Online Business

by

In our comprehensive seller's guide, How to Sell an Online Business, we help business owners prepare for an exit. Selling online businesses requires the right platform and assistance. In this first chapter, we look at the differences between selling for-sale-by-owner and going through a business broker. If you want a more professional looking and complete e-book with images and graphs, you can download the PDF. 

Where to sell a digital business1. Where to Sell an Online Business?

How you engage with buyers will be an important determinant of your selling experience. If you elect to work with a broker, you will want to clearly understand your respective roles. If you elect to sell your online business on your own, you will need to wear many hats and be well versed in the process. You may also want to lean on other professionals to help with elements of the transaction.

Working with a Business Broker

Engaging a business broker can be a great first step when considering a sale. Many business brokers will offer a complimentary valuation, even before you decide to hire them. This often includes taking steps to normalize your company’s income statement, then applying an appropriate multiple to the adjusted earnings – a process described below that requires some experience. Equally important, a website broker will know whether your Internet business is a candidate for a strategic acquisition, and how to price it accordingly. A broker can also help you assess what you can expect to net from a sale after all fees and expenses, which can be helpful when making the decision of whether or not to sell.

working with a business broker

Once engaged, a broker can help develop compelling marketing materials, leverage the firm’s resources and network to attract the right buyers, manage information exchange and negotiation, and work with you and your team to close the transaction and transition the business. Top brokers who specialize in digital businesses maintain websites with powerful domain authority and large networks of tech buyers – valuable assets to prospective sellers.

The cost of hiring a brokerage firm can vary with the specifics of the assignment, size of the company, and other factors. However, most brokers are primarily commission-based with back-end fees that can range from a few percentage points, to upwards of 15% of the transaction value. Some brokers also charge upfront for the valuation and development of marketing materials. There are a number of business brokers that focus mainly on digital businesses, including:

Some questions to ask a broker before engaging their services include:

  • Who will manage my listing?
  • Do they have experience in my niche?
  • Have they sold businesses similar to mine?
  • Where will my listing be marketed?
  • What will they need from me?
  • What is their fee?
  • What timeline do they anticipate?

Keep in mind that brokers have their own vetting process. If a broker won’t take on your web-based business, find out why so that you can address the issue and be a better candidate in the future. Broker feedback may be an important litmus test for the salability of your business.

Selling For-Sale-By-Owner

If you have experience with business transactions, or can lean on other professionals such as your CPA, attorney, or financial advisor, you might choose to sell for-sale-by-owner (FSBO). In addition to saving the brokerage fee, taking this route puts you in control of the process and perhaps enables you to more easily build rapport with prospective buyers.

selling fsbo

That said, if you sell an online business on your own, it can be a time-consuming and challenging task, particularly if you are simultaneously running the business. Be sure you have the skill set and bandwidth available to ensure a beneficial outcome. Additionally, without the benefit of a buyer network, you will likely need to invest in marketing your opportunity. There are a number of online marketplaces and platforms that can help market your listing:

  • Hatchit.us
    • Focus (>80% of listings): profitable website businesses <$2 mil in annual revenue (AR)
    • $0 listing fee
    • 0% success fee
  • Acquire.com
    • Focus (>80%): SaaS startups <$500k in AR
    • $0 listing fee
    • 0% success fee
  • Flippa.com
    • Focus (>80%): auctions and fixed price sites & digital assets <$200k in AR
    • $49 listing fee for online businesses
    • 5%-15% success fee
  • MotionInvest.com
    • Focus (>80%): micro sites <$50k in AR
    • $0 listing fee
    • 15%-20% success fee in marketplace

Regardless of whether you decide to sell an online business through a broker or on your own, the process remains essentially the same.  If you are still a few years out from selling, we suggest reading our article on preparing your business for a sale. We hope you took away a few insights that will help you decide how to sell your web-based business. Email us with any comments, suggestions, or insights of your own.

Quick Answer takeaways:

  • A valuation is another important data point in deciding whether to sell your business.
  • A broker can help prepare your business for sale.
  • A broker can help market and sell your virtual business.
  • Investigate business-for-sale marketplaces before listing your business.
  • Make sure you have the time and professional experts on hand to help sell your business on your own.

Read the next chapter, 2 Ways to Value a Business, in the upcoming Seller's Guide.

Disclaimer: This page contains affiliate links to Hatchit’s broker-partner sites. If you choose to buy or sell a business through a brokerage site we link you to, Hatchit may receive a referral fee at no additional cost to you. Thank you.

How to Close on a Business Purchase

by

In the sixth and final chapter of How to Buy a Digital Business, we look at the much-anticipated purchase agreement and business sale closing. You'll gain an understanding of what to expect in the final step of the business purchase process as well as the seller's obligations. If you want a more professional looking and complete e-book, you can download the PDF.

Shake my hand6. Business Purchase Agreement & Closing

Depending on the complexity and size of the transaction, a purchase agreement template can be very simple or very complex. While a simple transfer of a digital asset may only require a bill of sale, the acquisition of an income-producing business is typically accompanied by an Asset Purchase Agreement (APA) or Stock Purchase Agreement (SPA).

Most acquisitions are asset purchases, meaning that the buyer transfers the tangible and intangible items owned by the company from the seller’s corporate entity into a different corporate entity owned by the buyer. These items generally include everything from the website, customers, and inventory to trademarks, patents, and goodwill.

By contrast, in a stock purchase, the buyer acquires the seller’s business entity itself, which includes all of the assets and liabilities contained within. In either case, you will want to work with an M&A attorney and CPA to help you decide which route is best for your situation based on the legal, financial, and tax implications of your purchase. Since most owner-operated web-based business transactions are asset purchases, we will focus on things to consider when drafting your APA. 

asset purchase agreement

Image from Pixabay

Asset Purchase Agreement (APA)

The APA is generally a far more robust document than a Letter of Intent, often 20-40 pages, addressing many of the same items as the LOI but in greater detail. The key elements of an APA include a complete list of the assets being purchased (and not being purchased), liabilities assumed, the purchase price and how it will be paid and allocated for tax purposes, details on the closing and post-closing adjustments, seller and buyer representations and warranties, and the handling of disagreements post-transaction.

There are typically schedules attached to the APA, including financials, organizational documents, contracts, permits and other key items upon which the purchase decision was based. Lastly, there are often separate agreements simultaneously signed at closing that handle elements of the transaction that fall outside of the APA, such as non-compete or consulting agreements. A few things to consider when working with your attorney to draft an APA:

  • Be specific when identifying included assets – detail domains, content, subscriptions, plugins, contracts, inventory and all other components of the business
  • Confirm that the seller owns the assets you are buying and that they are transferable to the new corporate entity.
  • Think through how you can retain some leverage with the seller post-transaction. A seller note or escrowed funds will leave you in a stronger position if, for example, the seller does not deliver on training or other promises.
  • Consider language where you have recourse if the seller does not deliver on promises (e.g. the seller note is reduced accordingly).
  • Optimize the asset allocation and explore creative ways to minimize taxes on the deal – with different depreciation schedules, some asset categories are more tax friendly for the buyer than others (e.g. “Personal Goodwill”)
  • Small deals do not need big contracts – speak up if you feel the template your attorney is working from is overkill.

Takeaways: How to Close on a Business Purchase

  • Have I carefully read the Asset Purchase Agreement draft?
  • Have I confirmed asset ownership by the seller?
  • What am I asking of the seller post-transaction?
  • Does the agreement fit the deal being signed or do I want something simpler or more complex? 

For a secure closing and asset verified transaction, visit our affiliate escrow agent Escrow.com. 

We hope you took away a few insights that will help you successfully complete a business purchase transaction. Email us with any comments, suggestions, or insights of your own.  

Download the complete buyer's e-book or start reading from the beginning.

How to Finance an Acquisition

by

In the fifth chapter of How to Buy a Digital Business, we look at the options in regard to financing an acquisition. You'll gain insights on acquisition finance in cash, debt financing, leveraged financing, and private equity. If you want a more professional looking and complete e-book, you can download the PDF.

how to finance an acquisition

5. Acquisition Financing 

How you choose to fund your business acquisition could set you up for success or be a drag on your bottom line. While nearly half of business purchases are made in cash, looking to leverage your purchase with another funding source or two might give you a better return on your investment. A few questions to keep in mind when reviewing your options:

  • How much cash do I have available for a business purchase?
  • How much debt am I comfortable taking on?
  • How much free cash flow do I need the business to generate to cover my loan payments?
  • Might the seller consider a seller note?
  • Am I comfortable leveraging my home or retirement savings?
  • Am I comfortable with an equity investor?

Depending on how you answered the questions above, some of the following options will appeal more to you than others.

Seller Financing 

Sometimes sellers will allow buyers to finance a portion of the company purchase through the profits of the business over time. This can help close a deal more quickly, especially if you are not a good candidate for a traditional loan. The amount a seller will allow you to finance is usually not more than 60% of the purchase price. The length of the contract is often 5-7 years and can feature a balloon payment at the end. Of course, if other buyers are offering all cash, you will likely be at a disadvantage.

home equity loan

Home Equity Loan 

If you have more than 20% equity in your primary residence, this could be a source to consider. You will want to allow a cushion in case your home’s value declines, but generally your interest rate will be competitive, if not better, than what traditional lending sources such as banks can offer. HEIL and HELOC lenders will look at your credit score as well as your debt-to-income ratio as part of a decision.

Traditional Bank Loan

If you are considering more traditional financing, you should speak with a local bank, credit union, or online bank. Getting financing for an existing business is often easier than for a startup, but it can still be challenging. An existing business will need a good track record of strong cash flows and assets. You’ll also need a very good personal credit score and may need to put down up to 30% of the purchase price in cash. A line of credit for your business is also a possibility, if you don’t need to finance the whole purchase and just need help managing the cash flow. For example, you may be asked for a business valuation, a record of your business experience, and a business plan. Lenders will likely want to see the following:

personal finances

Personal Finances

  • Personal credit score
  • Business credit score (if you already own a business)
  • Tax returns
  • Cash flow statement
  • Outstanding debts

Finances of acquired business

  • Balance sheet
  • Business tax returns
  • Profit margin

TIP: An SBA backed loan makes a bank more likely to lend.

SBA Loan

Some business sellers will advertise that their business is eligible for a Small Business Association (SBA) loan, meaning that the seller has pre-qualified the business for an acquisition loan. An SBA guarantee will get you a lower interest rate with a bank, because the government agency is shouldering some of the risk of the loan. If a business is not advertised as SBA qualified, you can still apply for one through an eligible lender. The SBA has high standards for qualifying a business and a purchaser, so while desirable, it is not easily obtained. Here is a summary of the main loan types:

  • Standard 7(a): Up to $5 million, 5-10 business day turnaround, 75% guarantee for loans over $150,000, 85% guarantee under $150,000, up to 10-year line of revolving credit.
  • Small Loan 7(a): Up to $350,000, 5-10 business day turnaround, 75% guarantee for loans over $150,000, 85% guarantee under $150,000.
  • SBA Express: Up to $350,000, 36-hour turnaround, up to 50% guarantee, up to 7-year line of revolving credit.

401k Business Financing 

This type of financing is known as ROBS, Rollover for Business Startups. Offered by Guidant Financial and others, it allows you to use your IRA or 401k assets to invest in a new business. Essentially, the retirement fund becomes an investor in your new enterprise by buying stock in a newly formed C Corp. You can then use that cash to help buy the business or manage your cash flow like a line of credit. You will need at least $50,000 in your retirement account to qualify. This type of financing is often used as a second or third tier when needed. The danger is that if the business fails, your retirement savings will be jeopardized.

investor funding

Investor Funding

To avoid the burden of debt and share the risk of an acquisition, some buyers will look to take on investment partners. An investment partner could be a family member or friend that wants to help you get into business, or it could be a partner, angel, institutional investor or crowdfunding partner seeking a return or fee related to their investment. Partners may want equity in the business, a share in the profits, or a simple monthly loan payment. Most small business investors opt for a debt payment, because there is less risk involved. If you have a fast-growing e-commerce business, then an investor may opt for an equity investment or convertible note that could convert to equity in lieu of repayment. This allows the investor to get an interest payment at a fixed rate for a fixed period and also enjoy the benefit of upside if the business does well. The Small Business Investment Companies SBIC has a venture capital program consisting of equity and debt that includes SBA dollars along with private funds. The basics are:

  • Debt: $250,000 to $10 million loans; 9% to 16% interest
  • Equity: $100,000 to $5 million investments
  • Debt with equity: $250,000 to $10 million; 10% to 14% interest

Whichever path you choose, make sure you have a written agreement and that you are comfortable with the terms of the transaction. Having an attorney review it is always advisable. Also, depending on the situation you may be required to get an exemption under federal and state securities laws (e.g. Reg D) or register as a private offering with the SEC.

Lastly, you will need some cash on hand to run the business and to ensure that any loan payments are manageable. Weighing the pros and cons of each option before moving forward on an acquisition will put you in a stronger position for the future. Owning a business can provide a nice income and lifestyle, but you have the best chance of success when you secure the right funding mix for your deal.

Takeaways: Questions to Consider

  • Do I plan to pay cash for the business or to finance it?
  • What finance options give me the best terms?
  • Do I want to use more than one finance source?
  • Can the debt payments for the purchase be met by the cash flow of the business? 

Read the next chapter, How to Close on a Purchase or download the complete e-book: How to Buy a Digital Business. 

Images from Pixabay

How to Conduct Effective Due Diligence

by

In the fourth chapter of How to Buy a Digital Business, we look into the ins-and-outs of comprehensive due diligence and preparing pro-forma financials.  This discussion should help you create your own due diligence checklist and evaluate risk. If you want a more professional looking and complete e-book with images and graphs, you can download the PDF.

puzzle shapes

4. Due Diligence and Pro-forma Financials

Once a letter of intent or similar document has been signed, the next steps are for the buyer to conduct a more formal due diligence and to develop pro forma financials. The main goals of due diligence are to confirm that the target company is in fact as presented, and to gain a clear understanding of the risks and opportunities associated with the business. The high-level areas of focus for due diligence are legal, financial, business operations and market. Gaining a clear understanding of these items will allow you to develop a thoughtful set of pro-forma (forward-looking) financials, so you can get a read on how the business’ financials will look post-transaction.

Your Team

Depending on the size of the business and the skill sets you have personally, it may be advisable to hire others to help with due diligence. For larger business acquisitions, an attorney will typically drive legal due diligence and a CPA will drive financial due diligence. You might also consider engaging a broker, buy side advisor, financial advisor, or industry consultant to help you assess business operations and build knowledge of the industry.

When choosing team members, look for individuals with mergers and acquisitions experience and with as much specific knowledge of the space as possible. In addition to becoming knowledgeable about the business operations and industry, you will be the project manager through due diligence. Create a master list of all items you wish to address through due diligence, assigning them to team members and checking them off as they are accomplished. Professional assistance is expensive, so use your team members judiciously to get the information you need.

legal

Legal

The purpose of legal due diligence is to assess whether the company you are acquiring is in good legal standing and whether there are items that could present future risk to you as the new owner. The key areas to address include:

    • Corporate Structure – review the corporate structure, capitalization, organizational documents and general corporate records of the company in order to ensure that everything is in order.
    • Taxes – review historical income tax liabilities and assess any tax carry forwards and their potential benefits.
    • Intellectual Property – understand the company’s technology and intellectual property, as well as its protection.
    • Assets & Liabilities – scrutinize the value of the assets that will be transferred with the sale, whether tangible or intangible, as well as all debts and liabilities against them. Your attorney can help with a lien search.
    • Contracts – review all contracts and commitments of the company. Remember, if you are purchasing the company’s assets (vs. it’s stock) you may need to update the contracts to reflect your new corporate entity as the signatory.
    • Compliance & Litigation – probe any pending, threatened, or settled litigation, arbitration, or regulatory proceedings involving the company and whether the company has faced any regulatory or compliance issues.

Financial

Similar to an audit, the purpose of financial due diligence is to verify that financial statements presented are accurate, and to gain a clear understanding of items that could impact the future financial performance of the company. For larger acquisitions, a CPA or other third party can prepare a Quality of Earnings (QoE) report to detail the components of the company’s revenue and expenses. The extent of financial diligence performed, and the quality of information available will vary considerably with the size of the company being acquired. Some exercises that can help gain clarity on the business and its financials:

    • Review 12 months of monthly and 3-5 years of annual profit & loss, balance sheet, and cash flow statements.
    • Examine 3-5 years of tax returns.
    • Trace bank statements to bank reconciliation, and reconciled statements to tax returns / general ledger; if possible, trace affiliate statements and/or merchant processor statements to bank statements.
    • Review past Accounts Receivable and Accounts Payable balances against subsequent deposits and payments.
    • Study customer and supplier concentration risk by reviewing sales and profit by customer and supplier.
    • Perform a trend analysis of sales, COGS and expenses by category and year over year to understand trends and fluctuations.
    • Confirm tax and payroll filings are current.
    • Assess sales and use tax requirements and confirm compliance.

TIP: Verify what has been presented and potential risks to the business.

business operations

Business Operations

The purpose of business operations due diligence is to gain an understanding of the business’ people, assets, technology, and processes. For online businesses, some of the most important assets are often the business’ sources of traffic, its platform, and its reputation.

  • People
    • Most importantly, can the seller of the business be trusted? You might consider a background check to determine if there is a criminal record and to confirm the validity of education, employment history and other activities from the owner’s past. Determine what duties the seller performs at the business and whether you or your staff will be able to assume these.
    • If the size of the business warrants it, create an org chart for the company with a short bio for each employee. Are there areas where experience is thin, potentially requiring future investment in training or additional staff? Are there areas of overlap with your skills? What changes do you envision over the next 5 years and how might that impact the financials? For larger businesses, you will want to review policies and procedures, assess employee benefits, plans, compensation and bonuses, and make sure the business is in compliance with all HR related requirements. With larger businesses, you might want an HR expert to help with this effort. Finally, work with the seller to understand all contractor relationships and make sure you have their contact information. Remember, if you create a new corporate entity, you may need to put new employee and contractor agreements in place for your new corporation.

  • Digital Assets –

    • Traffic – A key component of due diligence for an online business is understanding the nature of its traffic. Start with Ubersuggest, Google Analytics (GA4) or other similar tools to analyze the traffic coming to the site. Google Search Engine Console is a good way for webmasters to check the indexing status of the site and its visibility. How many users does the site have per day, month, year? What is the engagement rate (ideally >50%), user behavior, site return rate, and how have these numbers changed over time? Where is traffic coming from and are the sources paid or unpaid (e.g. direct search, paid search, social media, referral, organic)? Make sure you understand the backlink profile, the specific sources of referral traffic, whether the sources are paid or unpaid and whether paid traffic is appearing on the company’s financial statements. An untrustworthy seller could take advantage of a buyer by paying for, and not accounting for or disclosing, traffic and backlinks, artificially improving the site’s search engine ranking.
    • Platform – It is important to gain an understanding of the platform upon which the business is built to ascertain whether it is a viable solution for the business as it grows. This requires an assessment of the platform itself as well as the plugins and extensions used. Is the technology likely to be viable and supported over the long term? Will the current set up allow for growth? Similarly for software and SaaS businesses, you should have the code reviewed to ensure that it is proprietary and of high quality.
    • Reputation – Understanding a business’ reputation, both online and offline, is a critical component of due diligence. Check out reviews, message boards and other online venues to see what customers are saying about the business and its products/services. Sometimes owners will allow a buyer to conduct a customer survey, perhaps posing as a marketing consultant. The seller may be persuaded to allow this if you agree to provide a written report of the results and remind the seller that the information will be useful to the business whether or not the transaction consummates. Similarly, are there posts from current or future employees about working at the company? This can be valuable information. As a final step prior to closing, the seller may allow you to meet with the employees. If you receive this permission, you can inform them about the sale and determine if they plan to continue with the business post-transaction.
    • Other Assets – While we have emphasized traffic, platform and reputation given our online focus, there are of course a wide variety of assets that can be conveyed as part of a business acquisition – tangible and intangible. Whether inventory, equipment, real estate, patents, domains, or insurance policies, you should have a clear understanding of the items included in the sale, their value, and confirmation that the seller is the owner of the items. For larger businesses with inventory, it is common for a third party to conduct an inventory assessment to assess its quality and whether its value has been captured accurately in the financial statements.
    • Technology – In addition to the business’ platform, you will want to understand the broader technology infrastructure, and the level of IT investment that will be required to maintain and grow the company. This means an assessment of the company’s network, software, databases, computers, mobile devices, outsourced relationships, subscriptions and other IT-related items. With larger businesses, a third party assessment can be helpful. With smaller businesses, it is important to understand the seller’s role in maintaining the IT infrastructure. If you are stepping into the seller’s shoes, is this a role you are comfortable doing?
      • Processes – Lastly, you will want to ensure you have an understanding of the business’ internal processes, both to assess whether they present any risks to you as the new owner, but also to equip you with the knowledge you will need to run the business. Questions will vary widely depending on the type of business you are acquiring, but examples of questions include:  How does the company acquire customers? How are products sourced? How do customer orders flow through the company’s systems? How are orders ultimately fulfilled and recorded? What is the flow of customer communication? How is financial record-keeping handled? How are employees’ schedules managed? How are personnel issues addressed? Consider gaining an understanding of company procedures by interacting with the company as a customer – order a product, send an email to customer service, or subscribe to the newsletter.

market

Market

Market due diligence is unlike other aspects of due diligence in that information is gathered from outside of the company rather than from within, with the purpose of understanding industry trends, the competitive landscape, and the buyers and vendors in the market. When buying an online business, it is important to investigate the underlying market, not just its category. For example, if you are conducting due diligence on an eCommerce business that resells fridge and HVAC filters, your due diligence should include learning about the market for fridge and HVAC filters. What opportunities or risks might be on the horizon? How, for example, will “smart” refrigerators and IoT connected HVAC systems impact the market?

In addition to conducting secondary market research from written reports and materials and on the web, you will benefit greatly by conducting primary market research – talking with individuals who are intimately involved in the market and can answer your questions. For example, you might reach out to staff members with an industry association, individuals who work with similar (non-competitive) companies, consultants in the space, or visit a trade show to meet industry participants. What changes are happening in the market? Are there competitors that could pose a threat? What opportunities might not be obvious?

Similarly, you can learn a lot about the competitive landscape in a market by understanding the customer’s perspective. Try ordering a fridge or HVAC filter from Amazon and Lowe’s and compare the experience with that of ordering from the company you are evaluating. What are the positives and negatives of each experience? Lastly, research the company’s suppliers. Are they large, reliable vendors, or is there product availability risk? Are there substitute suppliers, or do they hold power over their customers?

man in a mission

Pro-forma Financials

An important exercise for any buyer, regardless of the size of the business being acquired in an m&a deal, is to develop a set of pro-forma (forward looking) financials. The goal of pro-forma financials is to assess your income, cash flow and balance sheet after the transaction, taking into account the new expenses you will have as a buyer and removing expenses that are no longer relevant after the sale. Your pro-forma financials will ideally include monthly figures for the first year, and annual figures for 2-4 years following. It is important to include monthly figures for the first year, as that is when the business is at its most vulnerable from a cash flow perspective.

While you are learning to operate the business, you may also be paying off debt, making investments, and perhaps paying the seller under a consulting agreement. Your pro-forma financials will help you assess the amount of debt you can afford to take on with the purchase, understand the amount of working capital you will need, and gauge your return on investment under different assumptions. You might consider working with your CPA on pro-forma financials as part of your financial due diligence exercise. A few items to think about when developing the document:

  • Start with the company’s historic financials – add back expenses no longer pertinent (e.g. the former owner’s salary) and include new expenses (e.g. your salary).
  • Include your debt service – interest payments should be included as a pre-tax expense while principal payments are an after-tax expense.
  • Take into account the timing of cash flows, particularly for the first year – when will you actually get paid and when will payments actually be made?
  • Include your expected capital expenditures.
  • Make sure fixed and variable expenses are properly categorized.
  • Develop conservative, moderate, and aggressive forecasts.
  • Include a row on the spreadsheet that tracks your cumulative cash to assess the months and years in which the company is at its most vulnerable – ensure you have sufficient working capital (money) to cover these stretches of time.

Takeaways: How to Conduct Due Diligence

What professionals will assist me during the due diligence process?

What due diligence can I conduct myself and what do I want a professional to do?

How will I recognize a red flag in the process? 

What do my pro-forma financials tell me about the business I’ll be running?

Read the next chapter, How to Finance an Acquistion or download the complete e-book: How to Buy a Digital Business.

Images from Pixabay

How to Structure a Deal and Present a Winning Offer

by

In the third chapter of How to Buy a Digital Business, we discuss how to structure a deal and present an offer.  A critical step in the acquisition process, getting to an agreement on a simple contract through careful negotiation will set you up well for a successful closing. If you want a more professional looking and complete e-book with images and graphs, you can download the PDF.

how to structure a deal and present an offer

3. How to Structure a Deal

The next step in the search process is to make an offer on a business. Remember, your goal is not to convince the seller of your viewpoint, but as a buyer, to identify a proposal that works for both parties. As such, there are a number of considerations beyond your analysis and value assessment to consider. Moreover, relationship-building and trust through your discussions are critical components. A few things to consider:

  • Manage the seller's expectations
  • Listen and understand the seller's point of view
  • Allow a third party to wear the "black hat"
  • Start with a simple, one-page term sheet

manage the seller's expectations

Manage the Seller’s Expectations

As you build rapport with a seller through discussions, it’s common to want to avoid discussion of what you think the company is worth. This can lead to a lot of wasted time. It’s best to manage the seller’s expectations right from the start, particularly if there is a significant discrepancy between an asking price and what you are willing to pay. Be upfront with how you plan to finance the deal, especially if you expect the seller to finance a portion of the deal.

As the deal progresses, make sure to specifically address anything “new” or not aligned with prior discussions, even if it’s something that seems trivial. It’s easy to lose trust or create animosity when there are surprises, so work to proactively head them off. In-person meetings or video conferences are generally better alternatives to phone, text, or email when addressing sensitive topics, and it’s often better to work through issues directly with the seller rather than through a team member.

seller's point of view

Listen and Understand the Seller’s Point of View

There are often personal factors influencing a business owner’s decision to sell, and specific deal points that are important to them. You will have a better chance of reaching an agreement if you understand the owner’s drivers and then tailor your offer and structure to address them.

Some sellers, for example, hope the sale of their business will allow them to retire. How much cash will they need to receive after taxes from a sale to make this possible?  Can you structure your offer to help get them there? Or maybe the seller has a family member involved with the business whose livelihood will be impacted with a sale. Is there a way you can keep this person involved post transaction?

wear the black hat

Allow a Third Party to Wear the “Black Hat”

Whether a CPA, an appraiser, a buy-side advisor, or other knowledgeable professional, it can be helpful to involve a third party when discussing sensitive topics like valuation. Involving a third party will help you to maintain a strong, cordial relationship with the seller while at the same time making a case for a more favorable deal.

Presentation of your position is key. Any written assessment of the business or its value should be clear, concise and easily understandable to the owner. The individual you work with should have a relevant background, present themselves professionally, and be able to articulate your position in a respectful way.

TIP: Listen to the seller and identify a proposal that works for both of you.

one page term sheet

The Offer: Start with a Simple, One-Page Term Sheet 

When conveying your offer, it is advisable to initially do so in the simplest way possible. Distill your offer to its key points and place them in bullet format into a one-page term sheet. Points conveyed should be the purchase price, payment terms, any personal guarantees, specifics on the assets or stock being purchased (and not being purchased), handling of accounts receivable, accounts payable and inventory at close, specifics on any non-compete or consulting arrangements, specifics on any property or other leases (or purchases), and any conditions to the offer.

Once accepted, you can develop a more formal letter of intent (LOI) to be reviewed by an attorney and signed by both parties. Self-drafting the LOI ensures the more formal, legal language of an LOI does not impede the seller's understanding of your offer, and helps to minimize attorney involvement.

Takeaways: How to Structure a Deal

How can I build trust with the seller?

How can I work with the seller to reach a fair transaction agreement?

What are the key points of my offer?

Read the next chapter, How to Conduct Due Diligence or download the complete e-book: How to Buy a Digital Business.

Images from Pixabay

Disclaimer: This page contains affiliate links to Hatchit’s broker-partner sites. If you choose to buy or sell a business through a brokerage site we link you to, Hatchit may receive a referral fee at no additional cost to you. Thank you.