E-commerce

Preparing an eCommerce Company for Sale and Maximizing its Value – Digital Commerce 360





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Businesses are typically valued as a multiple of EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization). EBITDA is a shorthand for pre-tax cash flows. Theoretically, it may not be correct to use EBITDA, but it is the industry standard.
EBITDA multiples can range from a low of 2x-3x to 15x-20x or above. Most profitable e-Commerce businesses sell for between 5x and 15x EBITDA.
What drives the difference?
Businesses are valued on many dimensions, but four characteristics stand out:
Industries that are expected to see growth are more highly valued than slow growing, mature industries. Also, non-inventory service businesses are valued more highly as the marginal cost of goods can be practically zero. A company which sells widgets must have and ship widgets. That is a real cost of goods.
Size is valued for several reasons:
Acquirers buy the future. That’s why growth is important. 5%-15% sales growth is “normal.” However, 20%-30% growth per year is exciting to buyers.
Isn’t this why we are in business?
Proprietary products are important to e-Commerce businesses because they provide a barrier to competition from the likes of Amazon and others. Price comparisons are more difficult if the products are not the same.
A strong management team provides comfort to the acquirer that the business is not overly dependent on one individual.
Strong and accurate financials, both past and present, provide the basis for confident forecasts of future performance.
A large customer database that can be remarketed to drive LifeTime Value (“LTV”).
A large source of qualified prospects provides confidence that the business can continue to grow.
Repeat business drives LTV as a company remarkets to customers. Prior customers typically respond better and spend more than prospects.
High search engine rankings are important, but they are out of one’s control. SEM, emails, snail mail, and paid marketing are in a company’s control, and therefore are valued. As the budget for marketing increases, sales and scale should presumably increase accordingly.
High average order value typically enables significant spending for customer acquisition.
Strong reviews and high net promoter scores are nice selling points.
Working Capital Requirements
Businesses that carry and ship product have inventory and fashion risks. Also, as a company grows, investment in additional working capital eats into available cash flows. Furthermore, obsolete or slow-moving inventory typically penalizes the purchase price.
Poor Information Systems
Information is needed to invest. Poor systems reduce the confidence in the numbers. Furthermore, it points to needed future capital investments.
Concentration
Vendor or customer concentration (typically greater than 25% of purchases or sales) creates risk that changes made by 3rd parties will affect sales and profit.
Remember, too much reliance on Amazon and other marketplaces is problematic. Amazon is a competitor, not your partner.
What is the effect of drop-shipping inventory for those companies that use drop ship as a strategy?
There are two conflicting philosophies:
Once a contract is executed with an Investment Bank, the process really begins. Over the course of the next four to eight weeks, the Investment Banker will prepare three key items:
Seller’s Quality of Earnings reports (“Q of E”) are quickly becoming the norm for well run processes. An accounting firm is hired by the seller to review the financials, make adjustments, and examine the ongoing expenses. Buyers will typically perform a Buyer’s Q of E during due diligence. Therefore, in recent years, sellers have been going on the offensive by preparing a Seller’s Q of E to anticipate likely issues raised by a Buyer’s Q of E.
Once the Teaser and CIM are complete, the Investment Banker will reach out to the prospective acquirers via email, phone, and snail mail. The Banker will use the Teaser, and phone conversations, to entice the potential buyer to sign an NDA. The NDA specifies that the potential acquirer will keep the information and potential transaction confidential, and to use the information only for the purpose of evaluating the acquisition. Typically, the acquirer is allowed to share the information with its advisors, if the advisors agree to abide by the NDA. After 1-2 months, the Banker asks for preliminary bids in an Indication of Interest. After IOI’s are submitted, several potential acquirers are invited to meet management, tour facilities, and ask questions directly of the seller. This management meeting is a precursor to asking for a Letter of Intent (“LOI”). Not everyone who submits an IOI is invited to these management meetings. Only those with “acceptable” IOI’s are invited.
After management meetings, the Investment Banker will ask for Letters of Intent from the interested parties. Here all the key business terms are laid out, including price, type of consideration, key representation and indemnity principles, and sources of capital. The Investment Banker and client will negotiate with those that submit LOI’s to increase value and improve the terms for the seller. It is quite usual to create an auction where one buyer tries to outbid the other. Eventually, an LOI is signed with one potential acquirer. The LOI spells out the key terms but is not binding. Diligence must be performed to verify all the data presented and to uncover all the known and unknown liabilities. The LOI is like a formal handshake agreement.
Diligence can be very exhausting. First, all the facts of the business, including sales, profits, marketing, current liabilities, costs, and payroll are confirmed and examined. Secondly, all the legal documents are examined. Contracts, corporate documentation, and employee benefits must be up to date and complete. Lastly, all the liabilities and assets are reviewed. Tax liabilities, environmental conditions, information systems, and inventory quality are all examined in detail. Diligence enables a buyer the opportunity to perform an extremely thorough examination of every nook and cranny of the business. There are several areas of diligence that consistently arise as issues for e-Commerce companies.
Diligence may also include a Seller’s Quality of Earnings report. Other reports prepared by expert third parties (accounting, tax, employee, and HR) are typical. The buyer wants to know exactly what they are buying.
Concurrent with diligence is the preparation of the definitive documents. Purchase and Sale documents (“P&S”), employee contracts, and non-compete agreements are all legal documents required to close the transaction. The P&S is the key document. In it, aside from the price, are the conditions and warranties agreed to by the buyer and seller. Using an experienced M&A lawyer is just as important as using an experienced Investment Banker.
Closing is the fun part. Documents are signed, sometimes over a dozen of them, and the payment is wired. Congratulations, your company is sold!
However, a good Investment Banker will increase the realized value of a business in a few ways:
Expect to pay an Investment Banker both retainers and success fees. A good Investment Banker will charge monthly retainers. This lowers the bank’s risk and ensures that an owner is serious about selling. Without a retainer, do not expect a robust process. However, the success fee should be 80-90% of the total compensation. The Investment Banker “makes money” only if the deal closes. This arrangement aligns the interest of the potential seller and its banker.
Stuart Rose is a Partner at Mirus Capital Advisors. You can reach him at [email protected].
Copyright © 2022 Digital Commerce 360 | Vertical Web Media LLC
Copyright © 2022 Digital Commerce 360 | Vertical Web Media LLC

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