The Top 5 Financial Factors to Consider When Buying An Online Business
There’s a reason online businesses as investment assets have been getting a lot of hype over the past 5-10 years. It’s because entrepreneurs and business buyers have been making substantial amounts of money building and buying sites and online businesses.
The online business mergers and acquisitions industry has been getting more and more attention every year. Now, it’s getting even more attention from investors and the like who have never owned or worked with an online business.
The barrier for these people to get started is understanding what they’re putting their money into.
That’s why we’ve written this article—to help you understand the financial design of online businesses so you can know exactly what to consider when making an acquisition.
By the end of this article, you’ll know how to identify a financially-healthy business, what the financial risks are, and the levers of growth you can pull to generate a considerable return on investment (ROI).
The first financial factor to consider when buying an online business is its revenue.
Revenue is the lifeblood of a business, so when you’re assessing a business asset, you want to find out what sources of revenue it has.
For example, if you’re looking at a blog that’s for sale, you would see which affiliate networks it’s connected to, any businesses it has private affiliate deals with, plus any other monetization systems like paid advertising or sponsored posts.
It’s better if a business has multiple revenue streams so it’s protected against the risk of one of the streams becoming closed off due to unforeseen circumstances or a policy violation.
Once you know about the revenue sources, you can dive deeper into them to assess their security.
For a business that earns considerable revenue privately with small businesses or firms, you should investigate the payment contracts. Also, check the transactional history to make sure the source has paid consistently and on time to the business. Even large platforms like Amazon can make mistakes in paying merchants, as we found out in episode 78 of our podcast, the Opportunity Podcast.
It’s also worth asking the seller of the business whether they’ve negotiated special commission rates with affiliates, or if they have been given exclusive rates by the sales platform and whether those rates will remain in place after the sale.
When you have a good idea of the revenue sources the business has in place, you can begin looking at the next area of its cash-flow system.
Revenue is nothing until it turns into profit. Many businesses generate plenty of revenue but don’t necessarily turn a correlating profit if any at all. That’s why we value businesses on their profits, not their revenue.
Good knowledge of the business’ revenue streams will give you an understanding of its profitability.
For example, if you’re looking to acquire an ecommerce business that generates revenue through Amazon’s fulfilled by Amazon (FBA) program, it’s important for you to know that Amazon charges for its fulfillment services, and its fees are taken straight from topline revenue. These fees aren’t static—they vary based on a number of factors, including storage requirements and order volume.
Healthy profit margins vary from business to business. Most ecommerce businesses listed on our marketplace have a profit margin between 25-35%, whereas affiliate sites on our marketplace have margins between 90-97%.
Knowing the average profit ranges is good for weeding out low-profit businesses from your searches. Once you see a business that’s in a healthy profit range, you can dig deeper into its income and expenses.
You first want to check all of the regular expenses to make sure they look normal for the business type. For example, typical expenses for a software as a service (SaaS) business include:
- Software maintenance (unless the owner is doing all of the maintenance)
- Website hosting and maintenance
- Business management software accounts
- Marketing software accounts
Another common expense is employee wages. If the employees are continuing with the business after the sale, be sure to factor their wages into your profit calculations.
Any expenses outside of the ones listed above may be add-backs, i.e. for services not required to maintain the business. Most of these expenses tend to be one-off payments. We list them as add-backs so the buyer can get an accurate view of the regular profitability of the business.
You also want to keep an eye out for any unnecessary expenses arising from poor business management. For ecommerce businesses, this would be expenses like late storage fees, perished goods, and product returns.
If you spot these, you can use them as a negotiation tool to bargain for a better price. They also represent an opportunity to increase the business’ profits if you’re able to improve inventory management.
Having a look over the financial history of the business will give you a clear understanding of its profitability. You can spot growth opportunities. Ask the seller how much they reinvest into growth, for example, how much they spend on marketing.
3. Marketing Profits
An indicator of a strong business is healthy marketing profitability.
The two key metrics of marketing profitability are customer acquisition cost (CAC) and customer lifetime value (LTV).
CAC is the calculation of how much it costs to acquire a customer. For example, if a business is acquiring customers through pay-per-click advertising (PPC) on Facebook, how much is being spent on the ads to get a customer?
Average PPC costs vary widely depending on the business model, niche, and product or service, but the CAC needs to be taken into account in relation to the LTV.
The LTV is how much revenue a customer spends on the business in their lifetime as a customer.
Many businesses compare CAC to their product or service price, without considering the fact that the customer will spend more than they do on their first purchase, especially for a business with a recurring revenue model, like SaaS.
If the business spends less money on CAC than it generates in LTV, then its marketing is profitable. How profitable the business’ marketing can be is mostly subjective. If you’re a highly-skilled marketer, you may look at a business’ marketing data and creative campaigns and identify ways to increase profitability considerably.
If marketing isn’t your strength, you may consider hiring an expert individual or agency to increase profitability, which will increase the profitability of the whole business.
A red flag to look out for is if CAC is higher than LTV because then the business is losing money on its marketing.
A big mistake buyers make when they first acquire a business is to kill the marketing channels to save on expenses. But, as soon as you stop the customers coming in, the business loses revenue.
A big mistake entrepreneurs make is building all of their marketing channels on customer acquisition, but not on customer nurturing.
Remarketing is one of the most effective forms of marketing there is. Be sure to ask the seller if they do any marketing to their current customer base. If they don’t, that’s a great opportunity for you to boost profits rather quickly.
A business can also have organic marketing channels for which they don’t pay to advertise to new and existing customers. These channels include Google and email.
However, bear in mind that although the business might not spend money to advertise channels directly, it may be spending on marketing through these channels by hiring writers to produce content for the website or paying for an expensive email service provider to manage email campaigns. There’s also the amount of time spent on these channels to consider.
Marketing is one of the best ways to make a healthy ROI, so understanding all of a business’ marketing channels is a great way to set you up for success.
4. Financial Growth Potential
When assessing how to generate a return on investment (ROI) when you buy an online business, you need to look at how you can reduce costs and increase revenue.
An effective way to reduce costs, that applies to most business models, is cutting out unnecessary expenses. For example, if an ecommerce entrepreneur isn’t managing their inventory well and is having to spend considerable capital on air-shipping inventory when, with effective inventory management, it could be sea shipped for much lower costs, then you’d be able to reduce costs significantly.
It’s important to note that when you reduce costs, you want to avoid doing so in ways that could negatively impact the business. For example, using cheaper product materials. This would result in low customer satisfaction and will reduce sales.
Increasing revenue comes down to making more sales from new and existing customers.
Remarketing to the business’ current customer base via email is one of the best ways to do this, as for every $1 spent on email marketing businesses make $36 in returns.
To acquire new customers, you can consider increasing advertising spend to reach a larger audience or upping content production to increase website traffic.
With an online business, there are numerous quick-growth and long-term growth levers you can pull to generate an ROI.
Some of the quick growth opportunities that apply to most business models include:
- Small website redesigns to increase sales
- Negotiating better supplier or affiliate rates
- Increasing advertising spend on successful campaigns
- Remarketing to the customer base
- Increasing product or service pricing (if feasible)
Some of the long-term growth opportunities include:
- Full website redesigns
- Launching new software features
- Introducing new pricing packages
- Launching new products
- Expanding into new marketplaces
- Optimizing the supply chain efficiency
- Targeting new shoulder topics and niches with content
- Building new audiences
When assessing the financial growth potential of an online business, you also want to consider how much time will be required for you to run the business. If it requires 25+ hours per week to run, then you’re not going to have much time to spend on scaling, limiting your ROI potential.
Outsource tasks that don’t require your expertise to employees, contractors, agencies, or software tools. When you have free time to use your skills in the business, you’re able to scale it to generate a healthy ROI.
The last financial factor to consider when buying an online business is its debt.
Debt isn’t necessarily a reason to walk away from a deal, but you should understand its nature.
Firstly, you want to find out how much debt is owed and to who. Then, you should ask the seller about the repayment terms as this will tell you how the debt affects profitability, though the debt should be included in the profit and loss statement.
Don’t hold back on investigating the debt; learn how much and how often repayments need to be made, late or early payment penalties, and whether the debt is tied to the business or to the seller.
If you feel the debt is manageable, you may be comfortable taking it on with the business. Otherwise, you can request the seller to pay off the debt before or as part of the sale.
Now you know the main financial factors to consider when buying a business, you can focus on finding the one that’s right for you. Which raises the question: “how do you find the right business to acquire?”
Finding the Business That’s Right For You
Since we’ve been listing out factors throughout this article, it won’t hurt to list out a couple more.
The main factors to consider when choosing a business to acquire are your budget, experience, and time availability.
The first factor is pretty self-explanatory; make sure you’re paying the right price for the business and allow yourself some capital to invest in the growth of the business.
As for the second factor, you probably want to choose a business model you have experience with, either as an entrepreneur or an online employee.
However, if you’re looking for a new challenge either with a different business model or this is your first time working with an online business, there’s nothing stopping you from being successful with your acquisition, even for a complex business model like SaaS.
As long as you understand the fundamentals of the business model, its industry, and of online marketing, you should be able to learn everything else you need to know to be successful with an online business.
However, if you’re not familiar with the online business acquisitions industry, you should seek help.
This is where an online business broker can help you find a business that matches your budget and experience.
At Empire Flippers, we verify all of the business’ financials before listing them on our marketplace. Our vetting team helps produce the P&L so the income and expenses sheets are accurate. We pull them from the Amazon dashboard or wherever the business’ financials are recorded, not screenshots or spreadsheets completed by the sellers. We also ask the seller to confirm any debt associated with the business
However, it’s still up to the buyer to do their due diligence. You should ask the seller about the business’ financial history and investigate yourself when you’re given access to the business’ data.
If you’d like to find a business within your budget and preference in seconds instead of days scrolling through marketplaces and Facebook groups, create a free Empire Flippers account and create a favorites list with our 40+ search filters.
And if you ever want a professional opinion, schedule a free business acquisition call with just a click in your account dashboard.