How to Value an E-Commerce Company?
To value an E-Commerce company, traditional valuation methods should be implemented alongside modern valuation methodologies. As the business marketplace evolves over the years, businesses are adapting to technology advances and new business and industries are being formed as a result.
The E-Commerce industry is a thriving industry that is now entered by established businesses as well as many new startups. A business can now hold no inventory or physical assets but still generate revenues in the millions of dollars, so how should they be valued then?
To derive an objective fair market business valuation, certain metrics can give an indication of a business' future earnings as well as growth potential. Thereafter, these information can be combined with specific valuation methods to come up with a valuation range.
Seller’s Discretionary Earnings method (SDE)
The SDE method is simply a cash-flow based measure of the business earnings. For most owner-operated business, the SDE method is a useful way to measure the value of an organization. In accounting, SDE is the foundation of business valuation for small businesses.
In valuations, the SDE method gives prospective buyers with a better picture of their expected return on investment.
SDE is typically the net income or loss + interest expense + depreciation expense + amortization expense + the current owner's salary + owner perks.
The result than can be applied with an average industry multiple. Generally speaking, a higher SDE will result in a higher business valuation.
Another quick method is to look at the EBITDA of the e-commerce business than to apply an appropriate multiple like the SDE method. EBITDA means Earnings Before Interest, Taxes, Depreciation, and Amortization and is a metric used to evaluate a company’s operating performance.
Revenue and Growth-Based Method
What if the e-commerce business has yet to turn over a profit? In such cases, the abovementioned methods may not be too suitable.
In cases where the e-commerce business is well-capitalized and invested heavily in R&D and technology, the metric to look at then would be future earnings. Future earnings would then be based on current ratios pertaining to revenue growth.
Whilst the revenue forecast method is considered as more speculative than other methods, there is good level of credibility behind it, which should be looked into especially for e-commerce businesses.
Therefore in many circumstances, a blended approach taking into account SDE or EBITDA is preferred to determine revenue forecasts.
Discounted Cash Flow Method
This is one of the more tried and proven ways of analysing e-commerce business valuation. It is estimated return on the investment done for purchasing the company deferred over time and accounts for inflation factor too.
However, the valuer should be prudent in utilising this method, and should consider blending it alongside other approaches.
Precedent Sales / Market Comparison Method
Another way for valuing e-commerce is by looking at the recent transaction price of other companies operating in the similar industry.
This method should be practised in an “apple for apple” manner as close a comparison as it can be. There are numerous factors to take into account such as relative companies’ size, years in business, annual revenue, to start off.
Size of Customer Base and Market Outlook
While valuing e-commerce business, it is also crucial to check the active customer base and the positive market outlook for a company because the company without active/recurring customers or a business that operates in a dying space would not have good prospects in the future.
An active customer base implies a company is experiencing repeat customers and buyers are purchasing regularly and business is recurring. It generally bodes well in valuation.
Web Store Traffic
An e-commerce business runs on web traffic; the more people that visit your online store, the higher the conversion rate generally speaking. Also generally speaking, an online business with high daily traffic is worth more than business with lower traffic. If we can make use of this figure to connect with the numbers of paying customers, that the data will be more beneficial in calculating the value of the e-commerce business.
There are certain variables, conditions and metrics to look at for e-commerce businesses. Traditional accountants are not experienced enough to perform valuations for such digital based businesses.
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