The Top 5 Financial Risks of Buying an Online Business
Updated on October 11, 2023
There are many benefits to be gained from buying an online business.
You’re not a slave to an employer. You have the freedom to work from anywhere in the world. And you have greater control over your income, schedule, and lifestyle.
But before you get too excited scrolling through our marketplace for your next acquisition, it’s important to consider the financial risks involved with buying an online business.
While these risks shouldn’t deter you from becoming an online business owner, it’s important to be aware of these money pits so that you can ensure your entrepreneurial success.
1. Overvaluation
The first financial risk of buying an online business is one that you’ll encounter right out of the gate – paying too much for the business.
Overvaluation puts you on the back foot from the get-go and makes it that much harder to make a meaningful return on your investment.
Overvaluation can happen when buyers don’t have the full picture of the financial performance and potential of a business. It’s like a mirage in the desert – the numbers might look good on the surface, but in reality, they’re not what they seem. This could be due to misleading traffic or revenue figures, or not fully understanding the costs involved in running the business.
So, how do you avoid this trap? The answer is simple – do your due diligence!
Review the financial statements, evaluate the business’s growth potential, and conduct market research to understand the competitive landscape. Don’t be swayed by emotion or unrealistic expectations. And be wary of sellers who push for a quick sale – they might be trying to offload an overvalued business.
Remember, the current market conditions can also impact the perceived value of an online business. During a seller’s market, a seller may be able to command a higher price. That’s why it’s essential to compare the business you’re interested in to similar businesses that have recently been sold.
You’ve got a lot of money on the line so don’t be afraid to get a second opinion or ask pointed questions to the seller about how the business value was determined.
You could even use our free valuation tool to get a rough idea of how much we think the business is worth.
2. Legal Liabilities
Before you sign on the dotted line, you need to make sure that the business you intend to buy is squeaky clean when it comes to legal issues.
Here are some of the legal problems that could trip up unsuspecting buyers.
Intellectual Property Violations
One of the most common legal issues online businesses run into is intellectual property infringements. This refers to the unauthorized use or reproduction of someone else’s creative work, such as music, images, writing, or inventions, without permission or proper licensing.
Sometimes, these violations go undetected for months or even years! In these cases, the business (aka you) is held responsible, so you could end up paying a financial penalty for a product you had no involvement in designing.
To avoid getting hit with a hefty financial penalty, it’s best to work with an experienced lawyer to review all the business’s contracts, legal documents, and warranties to ensure that they comply with all applicable intellectual property laws and regulations.
Data Privacy Violations
If you’re thinking of buying an online business that collects personal data from customers, like their name, email, and phone number, you need to make sure that the business is complying with data privacy regulations.
These regulations include the General Data Protection Regulation (GDPR) or the California Consumer Privacy Act (CCPA), which govern the collection, storage, processing, and sharing of customer data.
The violation of data privacy regulations could leave you on the hook for any legal action taken against the business.
The first step to protecting your customer data is to ensure that you have strong cyber security software in place and purchase cyber insurance. This type of insurance policy can provide coverage in the event of a data breach or other data privacy incident.
To double down on your protection, get a legal statement from the seller stating that the business is in compliance with all applicable data privacy laws and regulations.
Employment Law Violations
An issue that sometimes hides beneath the surface of online businesses is employment law violations.
This refers to legal problems that can arise when an employer mistreats their employees. Examples of violations include discrimination, wage, and hour violations, and wrongful termination. These issues can lead to lawsuits, fines, and even reputation damage.
As a buyer, you can take several steps to protect yourself from these issues. Start by conducting a thorough investigation of the seller’s employment practices, including hiring, promotion, and termination procedures.
Employment laws can vary widely between countries and states, so if the business employs international or remote workers, consider working with an experienced employment law attorney to ensure that you comply with local regulations.
Contractual Obligations
Before buying an online business, you should be aware of any existing contracts the business has, and the obligations that come with them.
Contractual obligations are legally binding agreements that parties make to perform certain tasks or duties as specified in a written or verbal agreement. They could include things like payment terms, delivery schedules, quality standards, or any other specific requirements that the parties agreed on.
To make sure that you don’t get caught up in any contractual catastrophes, carefully review all the relevant documents outlining the terms and conditions of the business’s relationships with its customers, suppliers, partners, and employees.
You should also make sure that the seller has fulfilled all their contractual obligations and that there are no disputes or legal issues that could impact the business’s operations or reputation.
If you’re not sure about any of the contractual agreements, it’s worth consulting an experienced attorney who can review them, identify any potential risks or liabilities, and negotiate any necessary changes to the agreements. They can also help you understand any automatic renewals or cancellation clauses that could impact the business’s cash flow or profitability.
Tax Obligations
As a buyer, you don’t want to inherit someone else’s tax problems, so it’s essential to do your due diligence and investigate any potential tax liabilities.
For an online business, tax obligations can include things like sales tax, income tax, employment taxes, and more, depending on the nature of the business and where it’s located.
Before you buy the business, do your homework. Take the time to investigate the business’s financial records, tax returns, and any correspondence they’ve had with tax authorities. It’s also worth reviewing any contracts or agreements related to taxes, like sales tax or VAT agreements.
3. Declining Revenues
A business may have steady or growing revenue when you buy it, but unfortunately, it doesn’t always remain that way.
Revenue is the lifeblood of a business, so you want to prevent any downward revenue trends before you buy the business.
Decreased revenue happens for a variety of reasons. Market changes and economic downturns may influence consumer spending habits. A change in brand voice or management style may result in a loss of key customers. Technological advancements may make your product or service redundant.
Sometimes buyers struggle to transition into business, taking time to come to grips with the systems and processes that are in place. This can stall growth and cause the business to lose traction.
In other cases, unexpected expenses like inventory cost increases, infrastructure upgrades, or compliance and certification costs could take unsuspecting buyers by surprise and make a large dent in your bottom line.
To avoid falling prey to these problems, it’s essential to do your research before making a purchase. Thoroughly evaluate the business’s financial performance, customer base, traffic sources, marketing and growth strategies, and competition.
Where possible, create a growth roadmap before you take over the business. Look for quick wins to take advantage of that will help you boost revenue or add a layer of protection to the business to buy you time to adjust to your new role as the owner.
This includes strategies like adding display advertising to an affiliate site or expanding a Shopify store into additional sales channels like Amazon FBA, Etsy, or Walmart. These strategies protect your business by diversifying your revenue streams while also opening up new avenues for growth.
Let’s take a closer look at why diversifying your revenue streams is so important.
4. Dependence on a Single Revenue or Traffic Source
Relying on a single source of revenue or traffic is a risky move. All your eggs are in one basket and if that basket drops, the consequences could be disastrous.
It’s not unusual for service providers like Amazon or display advertising networks to penalize businesses for a perceived violation of their rules. Whether you’re at fault or not, your account could be suspended for the duration of the investigation. If that is your only source of revenue, your business won’t earn a penny until the situation is resolved.
With multiple revenue sources to lean on, you’re spreading your risk. If one source takes a hit, you’ve got backups to keep your business going.
Diversification can also stabilize your revenue by reducing the effect of seasonality on your sales cycle.
The same rules apply when it comes to diversifying your traffic. You never know when the next Google algorithm update or paid advertising price hike could threaten the flow of traffic to your business.
Diversifying your traffic sources not only gives you more options to tap into when times get tough but also allows you to connect with a more diverse range of consumers. Why limit yourself to only one type of customer when you can cast a wider net and connect with a bigger audience?
When it comes to traffic, take advantage of SEO, paid advertising campaigns, and social media. Building an email list is also a great way to create a traffic source that you can control and own.
5. Technical Issues
The online business you’re considering buying may tick all the right boxes, but you should check under the hood for any technical issues before you commit to the purchase.
For example, the business may be heavily reliant on outdated or obsolete software or technology that needs to be updated or replaced. This can be expensive and could impact the business’s profitability.
As you try to grow the business, you might encounter scalability issues. The business’s technology infrastructure may not be able to handle increased traffic or user demand, leading to system downtime, slow performance, or loss of revenue.
Additionally, a weak or vulnerable technology infrastructure could make the business a target for cyber attacks or data breaches, resulting in financial losses or damage to the business’s reputation.
If you’re not familiar with the software or tech stack that the business uses, it can be difficult to know what to look for so consider hiring a technical expert to review the business with you.
Another problem to consider is that you may not have the technical skills to maintain the business’s technology. This problem is particularly relevant to SaaS businesses or websites that are built on custom-coded platforms.
In this case, you either need to take away from the business to learn new technical skills, or you have to incur the additional costs involved with outsourcing maintenance and development.
Don’t Let These Risks Stop You from Buying an Online Business
Buying an online business can be a great investment opportunity, but it’s not without its risks.
Thankfully, with great risk comes great rewards, and there is a fortune to be made from online businesses.
These financial risks certainly shouldn’t be ignored, but don’t let them deter you from buying an online business either. With a bit of caution, thorough due diligence, and guidance from experts, these financial risks can be mitigated.
Don’t have access to experts? Don’t worry, we’ve got you covered! Our business analysts, vetting specialists, migrations advisors, and customer service experts will guide you through every step of buying an online business.
To get started, register an account to unlock your own buyer dashboard that will help you make the most of our marketplace.
