Monday, August 29, 2016

Lesson #243: What is Your Digital Business REALLY Worth?

Posted By: George Deeb - 8/29/2016

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I was recently reading a great blog post from Digital Exits, a business broker based in Los Angeles that has expertise selling digital companies.  Their president, Jock Purtle, has been compiling exit data from 712 digital businesses that were sold over the last four years.  In Jock's post, which he graciously allowed me to reshare with all of you below, I found the results very eye opening.

Most of the time, we are talking about high flying, venture capital backed startups shooting for the moon and "Unicorn level" valuations.  Even when we are doing early stage venture financings, big multiples like 10x revenues can be used to value early stage businesses.  But, what happens if you don't raise a lot of capital and you are growing a lot slower, or are running a lifestyle business.  The exit multiples for digital businesses are materially lower.

In Jock's analysis below, we see that the average sale multiple for the digital businesses he studied was only 2.4x profits (not revenues).  And, it ranged from 2.0x to 3.4x based on the type of digital business you had, where software businesses with recurring revenues getting a lot more than a simple mobile app business, as an example.  This reflected the full gamut of companies from $0 to $10MM in revenues, where a small business would average around 2x profits and a large business could get closer to 4x profits, showing size clearly matters.  Only 17 of 712 businesses were sold for over 6x profits (yet alone revenues).

Wow!  What a reality check.  If you don't strike it big, which you most likely won't as a risky startup, make sure your expectations are clearly managed in terms of what your business is really worth.  The only silver lining here:  If you are thinking about pursuing a rollup strategy, there could be a big arbitrage opportunity between the 2x-3x revenue multiples most successful, big digital companies achieve, and the 2x-3x profit multiples they could be paying for acquisitions along the way.

Thanks, Jock, for sharing your wisdom with our readers.



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JOCK'S POST BEGINS HERE

The first question a seller asks us as a website broker when looking to sell their online business is, “What is it worth?”. So in 2012, we started analyzing all online business transactions that we could find for the previous year and presented it in a report. Each year, we analyse the previous year’s sales to come up with industry averages. Fast forward to today and this article represents an analysis of sales data between 2011 and 2015.
You will see the term multiple a lot in this article.  We calculate the profit for the business using SDE (Sellers discretionary earnings) using this formula:
The profit of your business is calculated as = Total Sale – Cost of Goods Sold – Expenses + Owners Wage
What is also discussed and needs explaining is when it says a multiple of 2.44X. What his means is the amount paid for the business is a value of 2.44 times the profit. For example, a business that is doing $300,000 in profit per year sold for at 2.44X means ($300,000*2.44=$732,000) So $732,000 was the selling price. This works in reverse as well. If a business sold for $723,000 at 2.44X then (2.44=$732,000/2.4X means the profit was $300,000).

What are the market trends?

The market is growing, not only in terms of deals closed but demand from buyers. We are seeing around 10 buyers for every seller as a ratio. If you look at the total deals closed trends you can see that total deals closed went from $53 million to $112 million in 4 years. That is over a 100% increase. Our predictions, for 2016, is we will see another growth year again. As of writing this post we have 5 businesses listed and another 5 in the pipeline.

We Analyzed 712 Businesses From 6 Business Models

For this report, we analysed 712 businesses sold between 2011 and 2015. The above graphs breaks down what percentage of the total deals each business model represented. Below is how we categorised each business model:
  • Advertising – a website monetized through ads or affiliate offers
  • App – a mobile app, monetized through paid downloads, membership or advertising
  • Ecommerce – traditional e-commerce stores, drop-shipping and digital products
  • Lead Generation – websites monetized through selling leads
  • Service – websites monetized through providing a service
  • Software – SAAS (software as a service) and any other software application based business

What We Found From Our Analysis

This graph represents a snapshot of the total data. It will give you a better understanding of where your business sits in comparison to all the businesses analysed. The average multiple for all businesses sold was 2.44. The sum of transactions between 2011 and 2015 is $394 million giving us 5 years worth of data. I believe this represents only 10-15% of the overall market of traded web businesses.

What Is The Average Multiple Per Business Model?

Now we have 4 years worth of data we can see how the average multiple has changed yearly.
Here is my thoughts on why there is a differentiation between each business model;
  • Advertising – Demands a low multiple because it doesn’t create much value and you also don’t control the customer. Essentially, advertising websites drive people to their website with the goal to send them away to another source.
  • App – Personally, I struggle to see the value in app-based businesses. We have yet to sell an app business in the 5 years we have been in business. I think the barrier to entry is too low and the ability to acquire customers is extremely hard.
  • Ecommerce – A consistent performer with a large volume of businesses selling. It is, in my opinion, the easiest business to understand and train a new buyer on. There is also the challenge of differentiation if you have a commodity product and it is only through a brand that you can combat this.
  • Lead Generation – A surprising performer over recent years. As more competition comes online it has been harder to generate leads for businesses and thus the higher demand for leads.
  • Service – Again, a consistent performer and also easy to understand business. The main value in a service based business is the book of clients which if can be transferred easily and they stay on as clients can lead to a decent return for a buyer.
  • Software – Still a very highly demanded business model and the biggest winner in 2015. There seems to be a large gap between low 6 figure valuations and million dollar valuations for software businesses. I think the market is finally starting to wake up to the value of recurring businesses and pay the multiples that they deserve. We did a podcast on this if you are interested in hearing it.

Are Smaller Or Larger Businesses Worth More?

We can see from the last four years the consistent trend of multiple at each price point. The larger your business the higher multiple you can demand. For example, in 2015 the average multiple for a business that sold between 0-$250,000 was 1.9X. However, if your business was worth $4m the multiple was 3.8X.
How to interpret this graph: If your business is generating:
  • 0-$125k per year in annual profit = valuation range of 0-$250,000
  • $125k-$200k per year in annual profit = valuation range of $250,000-$500,000
  • $200k-$$380k per year in annual profit = valuation range of $500,000-$1,000,000
  • $380k-$650k per year in annual profit = valuation range of $1,000,000-$2,000,000
  • $650k-$2m per year in annual profit = valuation range of $2,000,000-$7,000,000
This will give you a pretty accurate range of where you business sits in the valuation spectrum.

How many transactions occurred at each price point?

This graph represents the total number of transactions that occurred in each price range. For example in 2015, there were 122 transactions in the $0-$250k range. Subsequently, there were 43 transactions in the $250k-$500k range.
This data represents the volume of transactions at each price point. Obviously, there is less supply of businesses at a higher valuation range.

What do the multiples look like on a scatter graph?

To get a true appreciation of averages you need to look at the dataset as a whole. This scatter graph represents each transaction and what multiple it sold at of profit.
You can see the massive variation in multiples from 0.2X to 9.7X earnings. What you do notice is the majority of transactions falling in the 1.8X to 3X valuation range. This data backs up the premise that all small businesses sell for 2-3 times earnings.


For future posts, please follow me on Twitter at: @georgedeeb.

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