How does one determine a fair market value for a website? In many cases, what the seller believes is a fair market value for their website and what a buyer is willing to pay may not coincide. The seller has already accepted risks and has intimate knowledge of their website and its profitability. Whereas the buyer is now accepting all the risk without the familiarity of the know the business and at a cost typically far greater than the buyer’s first year’s profits. In this respect, a buyer has to be very confident that the profitability outweighs the risk and the investment provides a return.
There are website appraisers, but determining market value on a website is in general based on the seller’s discretionary earning and a multiplier to predict the business value. This is called the Valuation Method. The multiplier is partly made up of the Return on Investment (ROI). The multiple used in the valuation method calculation will vary dependent on the risk involved in the investment. The higher the risk, the lower the multiplier used in the calculation.
Other factors that will provide input into the multiplier used in the valuation method for the sale of a website are the market conditions. Market conditions consist of customer interest, how well the market is doing and if the website appeals to a broad range of customers or a small niche. The banking and finance industry influence market conditions as well. Current interest rates and investment products affect potential earnings.
The website’s current and historical conditions will contribute to the multiplier as well. If the website has a long-standing history of strong sales and customer retention, this will influence the risk vs reward that a potential buyer will take. The stronger and more positive the website’s profit history, the more a potential buyer will be willing to spend on the investment. The goal of the seller is to make the buyer feel confident and believe in his investment decision.
How the website compares to its counterparts will also influence the multiplier and potential market value. Comparison of strengths and weaknesses between competitors can help determine a website’s ability to withstand economic shift changes and customer loyalty.
All of the above multiplier conditions boil down to risk. When selling any business, including an internet business, the website’s sellability is determined on if the risk of the investment is outweighed by the potential for its return on the investment. The greater potential for return, the higher the multiplier.
Risk factors that a potential buyer will have to consider include long-term earnings, investment of time and money, confidence in the investment, unknown risks and/or downfalls. Depending on how young the website is, it may not have had to weather many storms and create a system that provides for handling ‘bad weather’.
How can a seller effectively work to increase their business’s multiplier?
Most buyers want to be confident in their purchase. A buyer wants to believe in the long term profitability of their investment. Buyers typically pay out at greater cost than the business’s annual return. They want to know their investment will provide a greater return than its cost. Having a solid and strong history of sales and customer retention is one motivating factor to a buyer.
And data. The more data you have available that provides true and verifiable facts and numbers, the more confident a buyer will feel. Being able to show a positive return of investment, the ability to recoup quickly after economic dry spells and an ability to retain customer loyalty all provide positive reinforcement for a higher multiple.
The other part of the formula is the seller’s discretionary earnings. The definition of discretionary earnings, is simply stated as earnings (profit) from the company that is spent at the expense of the owner at the owner’s discretion. This does not include items such as the owner’s salary, interest, asset depreciation or amortization of assets, taxes paid on tax returns, etc.
The reason these expenses are included in the earnings, are these expenses will and/or may change for the potential buyer.
The simplest way to calculate discretionary earnings is to begin with business’s gross earnings and add back all the non-operation expenses but subtract non-operation income. Add back the expenses that are not recurring and subtract the income that is not recurring. Include the depreciation and amortization expenses as well as the interest expense, but subtract any interest income. Add/include business owner’s salary.
Gross earnings + Non Operation Expense – Non Operation Income + Non-recurring expense – non-recurring income + depreciation expense + amortization expense + interest expense – interest income + Owner’s Salary = Discretionary Earnings.
When calculating discretionary earnings, if there were any compensation the business owner received that would have been paid to someone as a salary or compensation had they not been the owner, this compensation should also be included in the discretionary earnings.
To summarize, selling a website is determined by a calculation that takes into account the current owner’s discretionary earnings and the potential risk and reward that the buyer feels confident is true and the buyer is willing to accept. The multiplier is influenced by factors such has profit history, customer retention and customer base. It is also influenced by outside factors which include the current economic state, interest rates and investment products. The business’s competitors will also influence the multiplier, as it takes into account the strengths and weakness of both the potential investment and its counterparts.
A strong history of verifiable data to provide potential buyers showing a stable and upward profit growth will drive your multiplier higher. Investors like tangible facts and a history that accurately reflects the data given. Remember, what the buyer is willing to pay for any investment is directly influenced by how confident they feel in the investment choice and its potential for long term success.