Guide to buying an online business

Jun 25, 2018 | Publisher: Techcelerate Ventures | Category: Technology |  | Collection: Mergers and Acquisitions | Views: 6 | Likes: 1

A definitive guide to the successful purchase of an internet business GUIDE TO BUYING AN ONLINE BUSINESS Official Partner Foreword i Thank you for downloading this 'Guide to Buying an Online Business'. This book has been put together to help inform, educate and advise individuals interested in potentially acquiring an online business. Over the following pages we take an in-depth look at the reasons to invest in an e-business, what investment options are available and what buyers should look for in any acquisition. The book then shifts focus to the practical aspects of executing a business purchase, giving best practice advice on business search, structuring an offer, conducting due diligence and closing the deal safely and successfully. We hope you enjoy reading it and find the information found within these pages useful for your business dealings in future. If you have any questions, comments or feedback please don't hesitate to get in touch. The Brokerage Team FE International Why Buy An Online Business? Why Buy An Online Business Versus Offline? Build Or Buy A Business? Investment Options Choosing The Right Business Model What To Look For In An Online Business How To Buy An Online Business The Buying Process Working With A Broker How Do You Value An Online Business What To Ask Before Making An Offer Completing The Deal Financing an Acquisition Due Diligence Legals and Escrow Transferring the Business About Us ii 3 4 13 17 18 27 31 32 39 43 54 58 59 66 74 77 81 Table of Contents Chapter 1 Why Buy An Online Business? 'For business, our internet love affair was a gift from the gods.' - Gary Vaynerchuk Why Buy An Online Business Versus Offline? SIX REASONS TO BUY AN ONLINE BUSINESS Tap into the explosive growth of the internet, across mobile and desktop Leverage remote working to realize significant operational cost savings Make instant changes in marketing strategy and track customers real time with unrivaled granularity Generate a passive income stream and create the freedom to pursue other things Relative ease of scalability Own a high return asset with liquidity Investors looking to acquire a business typically start the process contemplating what business model is right them, which sector(s) they want to invest in and what they want to get out of the experience personally and financially. Every buyer is different but there are some common investment objectives across the market such as strong profitability, good growth potential and operational flexibility. Though there are many options in the traditional offline business-for-sale market, an increasing number of investors are starting to realise that benefits offered by online businesses could actually be superior on all fronts. This section explores the rapid growth of the internet and the rise of the online business. It explores some of the operational and financial advantages of e-business models and how investors can reap significant benefits through investing online. WHY BUY ONLINE VS OFFLINE? 4 The explosion in growth of internet users and usage in the last decade is remarkable. It was estimated there were 2.7bn internet users globally in 2013 (39% of global population), up more than 6 times on 10 years ago. The demographic has switched significantly too, in 1996, 66% of internet users were from the US and now that figure is just 13%, with Asia and Europe accounting for nearly 70% of all internet users. Increased penetration of smartphones and tablets has been a major driver of both internet adoption and average usage time. Multi-device ownership is incr easingly becoming commonplace in developed markets with 1 in 4 smartphone owners in the US and Western Europe also owning a tablet. Early signs from these markets indicate that multi-device has not served to cannibalise desktop browsing but instead complement it with overall usage time rising. SECTION 1 INTERNET FACTS The number of internet users globally has increased six-fold in the last 10 years The proliferation of smartphones and tablets has served to double overall usage Global eCommerce is forecast to grow from $1.5 trillion to $2.4 trillion in 2017 Digital advertising revenue is now worth $37bn in the US alone, rising 5x faster than any other medium $7.7bn was spent on banner advertisements alone in the US in 2012 Percentage of internet users located in US vs. RoW (1996, 2012). Source: ComScore (2012). 0 25 50 75 100 1996 2012 87 34 13 66 US Rest of World 8% 9% 14% 27% 42% Asia Pacific Europe North America MENA South America WHY BUY ONLINE VS OFFLINE? 5 Percentage of global internet users by region (2013). Source: ComScore (2013). But what does all of this mean for online businesses and for a buyer looking to acquire one? Firstly, the number of consumers online is growing significantly each year and as the internet becomes an increasingly popular purchasing channel, eCommerce businesses will continue to experience explosive growth. According to eMarketer's latest forecasts, worldwide business- to-consumer eCommerce sales will increase by 20.1% this year to reach $1.5 trillion, up a staggering $400bn from 2012. That growth is coming primarily from the rapidly expanding online and mobile user bases in emerging markets, increases in mobile commerce as well as improved shipping and payment options for customers. Interestingly, the latest research indicates online consumers are more valuable than offline ones. In a recent comprehensive study of European consumers, the consultancy firm McKinsey found that 38% of online buyers had household income of >40,000 versus just 25% for offline channel buyers. Secondly, the attractiveness of the internet as an advertising medium for major brands continues to rise with the growth in internet adoption and value of the eCommerce market. Digital advertising revenue is now worth $37bn in the US alone, second only to TV, and rising at 15% per annum (5x faster than any other medium). Don't think that it is just search engines benefiting from increases in advertising spend, though, $7.7bn was spent on banner advertisements alone in the US in 2012 . Website owners with authoritative content in the right niches and of course the right traffic can command a good price for onscreen real estate. 0 0.75 1.50 2.25 3.00 2012 2013 2014 2015 2016 2017 2.3 2.0 1.8 1.5 1.2 1.1 SECTION 1 US total internet time spent (billions of minutes). Source: ComScore. B2C eCommerce sales worldwide, 2012 - 2017, trillions. Source: eMarketer (2014). 0 225 450 675 900 2010 2013 115 0 308 63 467 388 Desktop Smartphone Tablet WHY BUY ONLINE VS OFFLINE? 6 'Domain names and websites are Internet real estate.' Marc Ostrofsky Superior Operating Margins? An often cited benefit of the online business model are the potential cost savings. There are typically much lower start-up costs when creating and running a website. Without physical assets there is no large capital outlay and instead the focus for many online businesses is on creating relevant content and outreach (not always the case with SaaS or Software etc). With so many e-business models and unique monetisation methods, accurate studies on the differences in cost structures between on and offline businesses are somewhat sparse. One good comparison is an analysis of profit margins between retailers, e-tailers (click-and-brick operations) and pure eCommerce stores. Matt Carroll at FailHarder has written extensively on the economics of each. His analysis of the average profit margin achieved in the apparel niche (he models the sale of shoes) shows retailers on average achieve 51% gross margins whilst eCommerce achieve 65% through charging for shipping. Note, gross margin doesn't then take into account the savings in operating expenditure for the online model (rent, utilities, employees) which can take the typical net margins of eCommerce stores to ~30% versus ~10% for offline equivalents. Asides from eCommerce, there are a number of e-business models that offer very attractive profit margins to business owners. Using data from the sale of over 150 online businesses over the last four years at FEI, we have compiled the net margin comparison table below for the most common business models: SECTION 1 EBITDA margin percentage comparison for the most common online business models. Note: owner's salary excluded. Source: FEI (2014). 0 25 50 75 100 AdSense Affiliate eCom Lead Gen SaaS Software Subscription 60 50 50 80 30 80 80 WHY BUY ONLINE VS OFFLINE? 8 Online Provides More Marketing Insights Great marketing is at the heart of many successful businesses and the online space is no different. What is interesting about internet marketing is that whilst it requires a slightly different skill set to traditional businesses it offers a number of major benefits versus marketing in the offline world. The tools and strategies for marketing to consumers online provide much more data to the marketer in terms of customer engagement, relationship building and fine tuning of the conversion funnel. Make changes on the fly Marketing online allows business owners to instantly split test new landing pages, site layouts, order forms, email sequences, newsletters, all within the click of a button. Track real-time results With internet traffic, webmasters often have enough of a customer sample to observe the impacts of changes in just a few days or a week allowing analysis and decision-making in a comparatively short time period and with low operational impact on the business. Target specific demographics for marketing The rise in social media as a platform for marketing has enabled internet business owners to target specific demographics and customer profiles (e.g. age, gender, ethnicity and location). Paid- traffic campaigns can be run on specific locations to expand awareness in particular areas (local and national) as well as driving the right traffic to the business. Variety of methods in marketing online Online marketing strategies are increasingly adopting a multimedia approach to create and develop relationships with consumers, embracing content across email, audio, video, blog, social media and newsletters. E-mail marketing has been shown to be a powerful tool to help raise brand awareness, build relationships and generate revenue. SECTION 1 "The aim of marketing is to know and understand the customer so well the product or service fits him and sells itself." Peter Drucker WHY BUY ONLINE VS OFFLINE? 9 SECTION 1 Online Provides More Freedom One of the major draws of the online business model is the ability to operate from home and in fact anywhere in the world. With more people looking to supplement income from their main jobs, the attraction of an online business as a means of passive income is on the rise. Latest figures show 1 in 6 people in the UK alone (8m people) are operating an online business from home as a way to do this. Without employees and infrastructure to manage, the owner time commitment on a well-established online business can be very low. Using the same transaction data, we have compiled an estimate of the average owner time commitments for the most common online business models: Ease Of Scalability Operating an online business can require little in the way of ongoing costs and a generally lower time requirement can often mean it is easy to own and run several e-businesses simultaneously. Comparatively speaking, with an eCommerce business versus a traditional offline retail business, it would be significantly more onerous to acquire or open another physical store. It may take years to raise the funds and find the right location with enough footfall and a lengthy lease could be required to secure the premises. Operating online is somewhat simpler in this respect; owners can take a model in one niche and apply it to another with relative ease if they have the relevant experience and knowledge. There is little or no physical presence required and there is often opportunity to synergise staffing. Buyers can use their skills and resources across their entire portfolio, significantly increasing their ROI and financial independence. Average hours per week spent by owners on the business. Source: FEI (2014). 0 10 20 30 40 AdSense Affiliate eCom Lead Gen SaaS Software Subscription 20 10 20 5 10 5 5 WHY BUY ONLINE VS OFFLINE? 10 SECTION 1 Greater Liquidity Than Offline Any prudent investor should be mindful about the liquidity profile of their investments and buying an online business is no exception. The good news is that a website is typically a much more liquid asset than an offline business. Given most online businesses are geography-independent and quite often simpler from an operational standpoint, there is a lot of investor demand and shorter due diligence periods during sale. At FEI, depending on the size and complexity of the asset, we typically see websites sell within 24 hours of listing to 3 months with the average being somewhere in the middle. Many offline businesses can take 6 or more months to sell with 3 of those in due diligence alone. Businesses That Help The Environment Whilst probably not a deciding factor in a decision to make an online vs offline business acquisition, being environmentally conscious is becoming increasingly important in this day and age. An online business offers significant carbon footprint savings with fewer employees, remote working (thereby no transportation costs) and no requirement for utilities like water and heating. Information is processed electronically and stored online too which helps to save paper. Research shows that approximately 65% of total emissions generated by the traditional retail model stemmed from customer transport. Accordingly, online retailers use 30% less energy than traditional retail operations. Clearly though the internet does present more demand for power consumption but research conducted by the ACI found that eCommerce will still achieve a net reduction of 1 billion tons of greenhouse gas emissions per annum, constituting 11% of US annual oil imports. Online Versus Offline: The Key Is Getting The Right Fit Operating in a high growth environment with superior margins and often a reduced time commitment, an online venture should be an attractive alternative to a traditional offline business. That is not to say there aren't other considerations though. Some businesses will require more work than others and that may be of a technical or bespoke nature. It's important as a buyer to approach any business acquisition taking due consideration of background, skill set and acquisition goals. WHY BUY ONLINE VS OFFLINE? 11 'Fools build houses, and wise men buy them.' Proverb FOUR REASONS TO BUY AN EXISTING BUSINESS The business model has already proven itself, a buyer can enjoy positive cash flow right away Gain existing assets, years of customer data, supplier relationships, intellectual property, that can be leveraged for growth Improve the business from a fresh perspective and with different knowledge, contacts and resources Leverage the existing knowledge of seller BUILD OR BUY? Build Or Buy A Business? The decision to build a business or buy an existing one is an important one investors should take from the outset. Three important considerations for the decision are time available, funds for investment and resources accessible to the buyer. This section explores some of the benefits and drawbacks of buying an online business versus building one from scratch and looks at how investors can make a quick decision based on their personal situation and business objectives. 13 SECTION 2 Advantages Of Acquiring An Existing Online Business There are a number of advantages to acquiring a business versus building one from scratch. The business model has already proven itself, a buyer can enjoy positive cash flow from day 1 Being able to hit the ground running is one of the most attractive things about buying an established business. From day one, the business will be making a new owner positive cash flow and has a proven business offering. Gain existing assets, years of customer data, supplier relationships, intellectual property, that can be leveraged for growth Particularly where the business has a long history, the tangible and intangible assets associated with the business are very rich. For example, the intellectual property attached to a software business that has been developed and successfully monetised for five years is very high. Improve the business from a fresh perspective and with different knowledge, contacts and resources Often business owners are looking to sell because they have run out of inspiration or energy to continue to grow their venture. It is quite common for buyers with a different skill set and resource base to come in and add significant value right away. In the online space, this is most often seen with buyers who bring fresh sector or internet marketing experience that hasn't yet been employed in the business. The rate of the subsequent uplift in value can be startling. Increase an existing market position If the buyer already operates in the niche and is looking to expand the business' activities either directly or with a complementary offering, then strategic acquisition may make a BUILD OR BUY? 14 lot of commercial sense. Leverage the existing knowledge of seller Having access to the seller's contacts and experience is invaluable, especially if the buyer is acquiring a business with a long history. Sellers usually commit to a minimum period of transition assistance post-sale (see section "Transferring the Business" in Chapter 4) which is a valuable for buyers to master the operations of the business as well as learn some unique and beneficial market information. Disadvantages Of Acquiring An Existing Online Business There are also a few potential drawbacks to acquiring a business. Takes a significant amount of upfront capital Typically businesses sale for a multiple of their annual earnings (see more on this in the section 'How to Value on An Online Business') which for can be a significant capital outlay. Whilst this can be partially mitigated with creative financing there is an initial hurdle of upfront consideration that an investor should be willing to sacrifice for inheriting the assets and associated goodwill. Inherit the previous owner's issues Not always obvious is the potential to inherit the previous owners operational problems when taking over the business. This could be for example poor quality content and backlinks, lack of customer service, soured relationships with suppliers or haphazard internal processes. It is always highly recommended to conduct proper due diligence to avoid purchasing something with insurmountable faults. Risk of loss As with many investments, there is potentially a risk of losing some or all of the initial consideration when purchasing an existing business. Many times a loss comes from a lack of work by the buyer so its important to correctly assess the time and skills required to run the business being acquired. Buyers should look to actively manage this through exercising cautious business judgement from the outset, conducting extensive due diligence during the acquisition process and employing a financing structure that matches their risk/return profile. BUILD OR BUY? 15 SECTION 2 Advantages Of Building A New Online Business It is worth taking a similar approach to analysing the merits and drawbacks if building a business from scratch. May cost less in the long run Typically online businesses have low startup costs and it is possible to create a new website with professional design, outsourced content and basic SEO for relatively cheap. In the initial stages then a build approach can be comparatively much less expensive. Naturally though, building a compelling value proposition and marketing it to customers can take substantially more time and money. Buyers should always aim to compare the cost of building vs. buying on any new acquisition opportunity. Gain first-hand knowledge and experience Either through success of failure, entrepreneurs will always know more at the end than the start. Full control over the quality Starting an online business from scratch means that important things such as SEO, monetization strategy and testing, products and services, customer service, direction to take the business, etc. can be under control from the outset. Disadvantages Of Building A New Online Business Takes a significant amount of time and resources There are no guarantees of success in business and this especially stands true with starting a business from scratch. Just as in the offline world, a high percentage of online businesses struggle to take off, remain consistently profitable or worth the owner's effort. An established business can help solve these issues from the outset. Final Thoughts Clearly there are a wealth of advantages and disadvantages to both building and buying with only a handful of these considered in these pages amongst the array of other factors that are personal to each particular buyer. For most investors it seems in principle to be a trade off between time, inclination and knowledge. As a buyer you should carefully consider these in your decision and see how buying versus building may be a better fit. If you remain interested, Chapter 2 overleaf goes in-depth on what potential options are available. BUILD OR BUY? 16 Chapter 2 Investment Options 'Know what you own, and know why you own it.' Peter Lynch Choosing The Right Business Model The internet has become a breeding ground for imaginative ways of making money, from software services delivered through the cloud to products sold through eCommerce websites to channeling customers onwards to affiliate networks. There are a wealth of e-business models to invest in and many online ventures are an amalgamation of two or more monetisation styles. As an investor, it pays to have a good understanding of each model, its strengths and weaknesses and suitability for the buyer's own background, time requirements and risk appetite. This section explores a range of popular e-business models, discusses their strengths and weaknesses and classifies them into seven common categories. 'Opportunities multiply as they are seized.' Sun Tzu SECTION 1 INTERESTING MARKETING FACTS Email opens on smartphones and tablets have increased 80% over the last six months (Litmus) By 2016, more than half of the dollars spent in US retail will be influenced by the web (Forrester) The average yield for email marketing is $44.25 for every dollar spent (OptiMind) Consumers who receive e- mail marketing order 28% more often than others (OM) Blogs are 63% more likely to influence purchasing decisions than newspapers (OM) 1. Advertising The web advertising model is one the simplest and most popular e-businesses. It is the internet's digital extension of the traditional media broadcast model. Effectively a website provides content, usually for free, interspersed with advertising messages in the form of banner ads or other ad placements. Naturally the value of this type of business is in the volume of traffic that the site has, the demographic of visitors and usually the niche it is in. Content sites come in many forms including blogs, forums, news and informational sites etc. Webmasters of these sites have a range of advertising payout models to adopt (see box overleaf). CHOOSING A BUSINESS MODEL 19 ADVERTISING MONETISATION Pay-Per-Click: advertising revenue is generated by users clicking on the web advertisement. Pay-Per-Lead: advertising revenue is generated when users click and sign up through a web advertisement. Pay-Per-Action: advertising revenue is generated when users click and purchase something through a web advertisement (the site owner receives an agreed % commission of the sale value). Pay-Per-Impression: advertising revenue is generated by users viewing the web advertisement. This is usually paid per thousand impressions (CPM). There are two common avenues for monetising content via online advertising: 1) through an automated advert delivery platform and 2) via direct adverts. Google AdSense is by far the most common ad-delivery network and generally speaking is one of the best paying for the average webmaster. Second tier alternatives include Media.net, Chitika and Matomy. The other option is to organise advertising relationships directly with relevant product/service sellers. This more hands-on approach requires some time investment from the site owner but often translates into improved advertising terms. High quality content sites with a strong traffic profile are typically very attractive to buyers as they offer relatively secure income with low maintenance requirements. 2. Affiliate An affiliate business model is one where the business exclusively sells other suppliers' products and services in exchange for a commission payment that is an agreed percentage of each sale. Affiliate marketers are effectively independent sales entities that are paid on a performance basis (i.e. when an actual sale is made). Websites use tracking codes which identify who referred the sale to them. SECTION 1 CHOOSING A BUSINESS MODEL 20 SECTION 1 eCommerce sites tend to be attractive to both online and offline investors as retail experience can often translate well into this model. The market is very large and growing with global eCommerce forecast to grow from $1.5 trillion to $2.4 trillion in 2017, mainly driven by mobile. Some of the major affiliate programs include ClickBank, Amazon and Commission Junction. In some cases affiliate marketers can receive c.50% of a sale (especially with digital products) but this usually ranges from anywhere between 5% to 75% depending on the product and the niche. Typically physical products are at the lower end of the spectrum and digital at the higher end of the payout range. Usually, there are higher tier payouts for those who send a high volume of sales. Successful affiliate marketing sites are ones that have become an authority product referrer, usually through building high quality content around the product or service being sold. 3. eCommerce eCommerce has been a dominant theme of the internet for the last decade and is one of, if not the most common e-business model. By definition, eCommerce is buying and selling of products and services over the internet. There are different types of eCommerce sites depending on the approach to inventory and CHOOSING A BUSINESS MODEL 21 One-third of people go online to purchase an item. Intent index (2013) distribution taken. Store - A store approach requires the site owner to hold inventory, ship the product and effectively take control of the entire supply chain. Dropship - Becoming more common is the dropship model where the eCommerce store acts as an online platform for selling goods but outsources the storage and shipping of the products to the original supplier. Naturally there is some margin reduction in a dropship model but it also cuts out the logistical burden of running a retail store and allows the owner to focus on internet marketing which is typically their core competence. Brokerage - Somewhere in between store and dropship is the brokerage model which brings buyers and sellers together, facilitating but not actively participating in the transaction. Marketplaces like eBay and Fiverr are good examples of this. eCommerce sites tend to be attractive to both online and offline investors as retail experience can often translate well into this model. The dropship approach is generally favoured as physical warehousing and responsibilities for logistics can for many outweigh the natural benefits of owning an online business. Buyers reviewing eCommerce businesses should focus on product margins, owner time involvement as well as traffic sources, trends and sustainability. 4. Lead Generation Lead Generation business models are those where a website is used to attract traffic and convert users into leads for a sellable service (e.g. car insurance). Typically the site owner creates a website of relevant content for the lead-type and then employs an internet marketing strategy to attract traffic to the site. User information is collected (usually through a customer form) and then the lead data is sold to companies interested in marketing to or selling to those collected leads. The quality of the lead (contact information, conversion rate) will correlate heavily with the price paid. An example of a lead generation business is LendingTree.com, where they use radio advertisements, Google Adwords, SEO, etc. to drive leads to the site and then sell these to banks and mortgage companies. Another good example is QuinStreet. QuinStreet works in a series of verticals to develop proprietary content sites, publisher partnerships, ad placements, email campaigns, etc. to develop a lead flow, and then sells that on to buyers at a higher price per lead than they are paying overall to acquire the leads. The main focus with a lead generation business is establishing a higher revenue-per-lead (RPL) than the total cost-per-lead. Owners of lead generation businesses can arbitrage paid traffic well if their conversion rate and RPL is higher than the CPC of CHOOSING A BUSINESS MODEL SECTION 1 Software and Software-as-a-Service (SaaS) businesses are popular with investors, particularly those that operate a recurring revenue model. running AdWords (or equivalent). Lead generation businesses can be very high margin (80%+ net margins) and relatively hands-off once established. Buyers reviewing lead generation businesses for potential acquisition should focus on traffic sources and sustainability, owner time involvement and of course conversion rates for both leads and sales. 5. Software Software businesses often spring up from hobbyists looking to create a relevant product within their niche. Usually the developer has created a niche software product and either opted to sell through word of mouth and referrals or to employ affiliates to sell it via an established partner network such as ClickBank. Software businesses can be set up with either one- time or subscription-payment types depending on the nature of the product and the customer base. CHOOSING A BUSINESS MODEL 24 SECTION 1 Buyers looking at software businesses should focus on the marketing strategy, traffic sources, quality and integrity of the software's source code as well as technical requirements for future upgrades. 6. Software-as-a-Service ('SaaS') Software as a Service or 'SaaS' is a business model where users pay a subscription to rent software hosted online instead of purchasing it outright and installing it locally on their computers. SaaS is at the core of centralised or cloud computing with the aim being that users can run their computer tools as online rented products. All of the processing work and file saving is conducted on the internet with users accessing their tools and files using a web browser. Users benefit from reduced upfront cost of ownership, quick and easy access with immediate upgrades, no need for additional hardware and often much better technical support as well as customer care. SaaS businesses are becoming increasingly popular for online acquisition as, like subscription businesses, they typically employ a monthly or quarterly billing model and enjoy a strong amount of recurring income. Again, acquirers should be focussed on the strength of the base, churn, monthly-recurring- revenue (MRR) and customer lifetime value (CLV). Often SaaS businesses are backed with a high amount of content marketing to get users into the conversion funnel and onto a subscription. They also require a strong technical support system in place for good customer care. 7. Subscription The Subscription business model is where users are charged a periodic daily, monthly or annual fee to subscribe to a service, commonly a content offering (e.g. Netflix, Listen.com). A number of these businesses combine free content with premium (i.e. member-only) content (referred to as a "freemium" model. Often converting customers into long-term billing relationships requires time and effective marketing so many successful subscription models have a well-refined internet marketing strategy and conversion funnel in place. Subscription businesses are attractive for online acquisitions as they typically employ a monthly or quarterly billing model and therefore enjoy a significant amount of recurring (vs. 'one-off') income which is held in high(er) regard. Acquirers should be focussed on the strength of the customer base, churn rate, customer lifetime value ('CLV') and the associated customer acquisition costs. Choosing The Right Business Model The internet has helped create a number of e-business models and investment opportunities for buyers. We have outlined seven of the main models we see, but many can fall into more than one CHOOSING A BUSINESS MODEL 25 SECTION 1 category or be rotated for fuller effect. Ultimately, the key to acquiring the right business (both on and offline) is for buyers to know their strengths and limitations, leveraging their experience and put these together into a growth plan for the business. Whichever business model(s) an investor takes a preference for, there are a few golden rules when it comes to reviewing a business for potential acquisition. The next section goes into detail on precisely this. 26 CHOOSING A BUSINESS MODEL What To Look For In An Online Business Purchasing an online business, particularly for the first time, can be a nervous experience for many buyers. With an online business, most of the assets are intangible and it can be hard to connect with the value of the purchase. It is therefore important as a buyer to understand what makes an online business valuable and viable for long-term growth to provide the comfort needed to conclude a business purchase. This section explores three of the most important aspects for buyers to look at when buying an online business. Understanding these will help save time and energy during the search process and help maximize return on investment, by starting with a strong foundation from the outset. 'What we see depends mainly on what we look for.' John Lubbock SECTION 2 Traffic is the life blood of most online businesses and buyers should be careful to audit it's sources and trends. TIPS FOR TRAFFIC VERIFICATION Diversity - ensure the business has a mix of traffic from the main sources: search, paid, referral, social and direct Backlinks - conduct a thorough audit of the backlinks for the site, especially if it relies heavily on search traffic Historic performance - analyse each traffic source historically and in detail. Take care to notice any spikes and overlay this with changes in search engine algorithms or other events Traffic Thousands of people may walk past a storefront, a few hundred may come in and browse, and some will purchase an item. Traffic that reaches a website is the equivalent of customers walking through the door, that's why it is the most critical component of a healthy online business. When looking at the traffic of a potential online business to purchase, buyers should pay attention to the following: Diversity Typically the most robust online businesses will have a mix of online traffic from the main sources: search, paid, referral, social and direct. Relying too heavily on one source of traffic is risky, particularly search where sites leave themselves at risk of algorithm changes by Google. Make sure if the site has a high percentage of search traffic that the site is compliant with Google best practices and be sure to audit the history against previous WHAT TO LOOK FOR IN AN ONLINE BUSINESS 28 SECTION 2 Google updates. Backlinks Google and other search engines place high value on the quality and quantity of natural backlinks to a website. Buyers should take a careful audit of the backlink profile of an online business, monitoring for any anomalies in links and link-building strategies. See the section 'Due Diligence' in Chapter 4 for more on this. Historical Performance Buyers should take heed to closely examine every source of traffic and look for trends as well as unexplained spikes. Was the site affected by a Google update, if so, why? Has referral traffic been on a decline as of late? Are there traffic sources that the current owner has yet to pursue? There are a number of useful sense checking metrics including time on site, pages viewed, which will help give a sense of the quality of traffic. See the section 'Due Diligence' in Chapter 4 for more on this. Financials & Growth Just like any business acquisition, buyers should take care to review the financials of the business in depth. For online specifically, investors should look for the following: Trends Check for trends in the revenue over the lifetime of the business. Did it peak after its first year and has been trailing off over the last 6 months? Is it a seasonal business that sees higher revenue during the holidays and slower elsewhere? Always ask to see financial data in monthly increments to clearly see the direction the business is heading. If it's moving downward, fully understand what would be required to revive it. Expenses Every online business has expenses such as hosting, domain renewals, web content, and marketing, but not every online business owner spends intelligently. Look for overspend in stated expenses that could by cut or reallocated right away to increase profit. The biggest culprits are usually hosting and marketing. It's also important to look for expenses that seem unreasonably low or the owner failed to mention for the business model, such as payment processor fees, refunds for software products or on-going writing requirements for content sites. Growth Potential It should be a priority for buyers to develop a strong growth strategy for the business they are acquiring unless it is a purposely passive investment. There are numerous ways to increase revenue from existing traffic as well as build new traffic channels. Examples include hiring a Conversion Rate Optimization (CRO) service to audit the site for improvements in the conversion process, starting or increasing expenditure on paid traffic or starting a social media marketing campaign. WHAT TO LOOK FOR IN AN ONLINE BUSINESS 29 SECTION 2 Personal Fit Its very important for buyers of all backgrounds to be sure about taking a business on that they have the time to properly manage and the confidence or experience to take it to the next level. Even if making an acquisition of a passive investment, it should still ideally align with a buyer's personal strengths, interests and investment strategy. A useful exercise to run through is to envision working on the site considering the skills and experience required for the business model and the niche. Consider the after sale training and support and whether this as well as any third parties can fill in the gaps. Most importantly, does the business generate excitement and interest. Time No matter how passive an online business is, there is still some level of planning involved to maintain stability or growth in the dynamic online environment. Buyers should determine a realistic amount of time they are willing to spend per week running a business and allow for additional time in the weeks following an acquisition to embrace the inevitable learning curve. Budget As with any other investment, it is always good advice for buyers to only invest an amount which they are comfortable with. Investing too much from the outset can cloud a buyer's judgement post-sale and also potentially leave to little working capital if required to grow the business. Conclusion With strong conviction on the traffic, financial and personal perspectives of a business opportunity, it is time to turn attention to the process of actually buying an online business. WHAT TO LOOK FOR IN AN ONLINE BUSINESS 30 Chapter 3 How To Buy An Online Business 'Knowledge is power.' Kofi Annan The Buying Process The process of acquiring an online business is similar to a traditional offline M&A process. A potential business buyer should be sure to follow the steps closely to ensure success at each stage. It also pays to understand some of the subtle differences to procedure that accompany an online business purchase. As a general rule, it is advisable to work with a well- established online business broker when making a business purchase. A quality broker will help guide buyers through the process and invariably represents the best quality businesses in the marketplace. This section outlines the process of working with a broker through the acquisition process, discussing the steps from business identification through to making an offer, conducting due diligence and closing the sale. 'Perfection has to do with the end product, but excellence has to do with the process.' Jerry Moran SECTION 1 The business acquisition process should follow a set of discrete steps that help buyers methodically identify, evaluate, value, due diligence and ultimately purchase a business successfully. BUYING PROCESS 1. Identify acquisitions opportunities through a variety of qualified channels 2. Review each opportunity methodically against specific criteria 3. Learn more about the business and formulate an offer 4. Conduct extensive due diligence on all aspects of the business 5. Seek professional counsel for drafting and reviewing the contract 6. Use a secure payment service for the transfer 7. Arrange for training and post sale support Identifying the Opportunity It is important to only use high quality channels for sourcing acquisition opportunities. Buyers should spend time researching brokers that have a multi-year track record and a good reputation online. Once established, review the broker's business listings and contact them directly to discuss criteria and interests. If it is first time enquiry, most of the time a buyer will be asked to complete a non- disclosure agreement (NDA). This protects the seller's information and allows a broker to share information on all future listings. In some cases, buyers may be asked to further qualify eligibility for information, including documented proof of funds or experience acquiring businesses. THE BUYING PROCESS 33 SECTION 1 A professional broker will prepare a very detailed prospectus for buyers to examine the business. The document typically includes information on business operations, growth opportunities, market trends, traffic, financial performance and continuing obligations. Reviewing the Business A professional broker will prepare a very detailed prospectus for buyers to examine the business. Transparency is very important so if the prospectus is light in detail or confusing, be sure to investigate further. The document typically includes information on business operations, growth opportunities, market trends, traffic, financial performance and continuing obligations. The prospectus also usually includes a detailed seller questionnaire covering a number of topics including day-to-day operations, sale rationale, customer base, products/services and marketing etc. Having reviewed the marketing materials it is wise to ask questions of the broker and arrange a call to discuss the business with the seller before proceeding forward with offer discussions. THE BUYING PROCESS 34 CREATING AN OFFER 1. Consideration Describe explicitly what the offer structure is. What is the split between upfront consideration vs. holdback and/or seller financing? What are the conditions attached? 2. Owner financing Does a portion of consideration need to be financed by the seller? On what terms? 3. Non-compete Make sure to ask for a market standard non-compete agreement of 1-3 years. 4. Exclusivity A period of no marketing may be agreed to by the seller if the terms of the offer are very competitive, the business is very complex or the seller has a high level of confidence in the buyer's ability to execute. 5. Timetable Buyers that can proceed through due diligence into closing in a timely manner will be more likely to have their offer accepted from the outset. Making an Offer Once satisfied with their research into the business, the buyer should be ready to make an offer. Investors formalise this with a letter of interest (LOI), which is a standard-form non-binding agreement between buyer and seller to proceed forward with certain offer terms on a good-faith basis. Note, it is not legally binding but changes to its terms later in the process without reason or mutual agreement is heavily frowned upon. There are a number of things to think about when writing an LOI (see right). Due Diligence If the offer is accepted, the transaction proceeds into due diligence (DD). Due diligence of an online business is slightly different from a brick-and-mortar company. Naturally, the principle of fact-checking is still the same but without significant tangible assets and a very different customer acquisition process, due diligence is usually focused on 3 main areas: Traffic Buyers should focus on checking the traffic sources, the backlink profile and metrics for visits to make sure everything looks appropriate (see more 'Due Diligence' section in Chapter 4). Most established brokers will provide access to Google Analytics (or another service) to enable the buyer to carry this out. SECTION 1 THE BUYING PROCESS 35 SECTION 1 Financials Traditional investors often expect to see audited books or tax returns for the business during the sale process. In reality, the majority of online businesses are owner-managed and having audited statements is quite rare. A good broker will perform extensive pre-listing due diligence on the financials and then provide all the supporting documentation (merchant statements, invoices, credit card statements etc.) to the buyer during due diligence. As a second step of verification, buyers should arrange for a live screen-share with the seller to walk through the back-end of the website and associated payment platform(s). This will authenticate ownership and verify the financials further. Maintenance Many online businesses (even relatively large ones) have grown out from hobby websites or family businesses, and as such are very often owner-run. As such it's important for investors to analyse the business owner's daily, weekly, and monthly tasks to be able to properly account with the cost and effort of outsourcing or taking on those work streams. It's particularly important to evaluate and understand the difficulty of the tasks that the current owner is performing if they are going to be kept in house. With comparatively few physical assets to examine or a large amount of audited statements to review, due diligence for online businesses usually takes 1-2 weeks depending on the size and complexity of the business. Legals In tandem with the due diligence process, the broker will usually prepare the Asset Purchase Agreement (APA) for the transaction. This typically works from a standard-form template and is then tailored to suit the specifics of each transaction. Within the contract, buyer and seller formalise amongst other things: the consideration terms, the assets to be transferred, the breadth of the non-compete and the training and support for the buyer post-sale. Both buyer and seller should always have their legal counsel independently review the contract before signing. Transfer & Escrow Most well established brokers will use Escrow to facilitate the funding of the transaction and transfer of assets. Buyers should be extremely cautious about transferring funds outside of an Escrow service. Reputable brokers will be officially partnered with an independent Escrow service. The Escrow process typically moves in the steps described in the box overleaf. THE BUYING PROCESS 36 Many first-time buyers often ask what protection is afforded to them during this process. Its important to point out that at no point are buyer funds released to the seller without the buyer's consent. In the very rare case that assets have been misrepresented or not transferred in entirety, the buyer can notify Escrow during the inspection period. Generally speaking though, disputes pertaining to misrepresentation are rare. In the 160+ transactions completed by FEI since 2010, only one has been disputed. Using a dedicated Escrow service gives buyer and seller a formal process for mediation and remedies. Escrow.com will conduct their owner internal domain checks before funds are released and in the case of a disagreement, will seek remediation through the America Arbitration Association which is a relatively quick and cost effective dispute resolution service. Training & Support After the transaction has closed, there is typically a four-week period of training and supp

Guide to buying an online business

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