New Venture Lab: Equipping Christian Entrepreneurs

Question

I am considering buying an e-commerce site and have several questions prior to moving forward with the deal. The site has been built, supplier relationships have been established, but the site has not really had a lot of meaningful business yet.  The owner is willing to consult with me after the sale to help me learn the business.  Because solid financial statements are not available, what is the best way of determining how the business is performing?  How much stock should I put in what the seller says about his business?  Since the business has minimal sales history and consequently no historical earnings, how should I think about its value?

Answer

In terms of figuring out how the business is performing, I would recommend constructing your own P&L (Profit and Loss) statement by obtaining all records of transactions that occurred over the period of one or two of the most recent months. This would include information such as:

• Credit card transactions made through the site
• Credit card processing charges
• All supplier invoices
• All advertising expenses
• All website hosting fees

By building up your own P&L from all of the receipts and expenses of the business, you will get a good understanding of the business.  And, asking the seller for all the info for only one or two representative month's should not be too much of a due diligence burden upon them.  But this is only a starting point.  From there you will be informed enough to starting asking other detailed questions.

In addition to the exercise, it would be wise to contact the supplier(s) with the following questions:

• What is the standard markup percentage?
• Does this fluctuate depending on certain products or the size of purchase?
• Are there volume pricing reductions?
• What are the typical payment terms?

In terms of how much you should believe what the seller is telling you, I often joke that P&L stands for "Pretend and Lie" when someone is selling their business.  In every business that I have acquired, things never turned out to be as good as the seller’s description and there is no way that you can possibly find out everything about the business during your due diligence prior to purchase.  As you bring errors or inconsistencies to his attention that surface while carrying out your pre-purchase research, be sure to gauge his response. Whether or not a seller endeavors to cover up such things or whether he opens up and is honest with you is a good indication of how confidently you can do business with him.  Getting past all of the blue sky and building a trusted relationship is important for both sides.

In terms of valuing an e-commerce site that has been built, but has had very little meaningful business, one suggestion is to categorize the main aspects of the business and apply a reasonable value to each. In this particular deal, it sounds like there are three buckets of value:

• The website development and domain name.  How hard would it be for you to replicate the site?  How well does the site perform?  How scalable is the site?  How memorable and powerful is the domain name?  The better the site and the better the domain name, the more valuable.
• The seller has established connections with suppliers and negotiated pricing, terms and drop ship arrangements - how hard would it be for you to replicate these relationships?  The more suppliers, the more difficult.  The more products and terms to be negotiated, the more difficult.  The more difficult this would be to accomplish, the more value you should ascribe to this category.
• The seller's expertise and consulting advice.  How much time will he commit post-closing?  Is he truly an expert?  How much would you have to pay someone else to get a similar level of expertise?

Once you've worked through the different buckets of value you should be able to estimate a reasonable value to each category and consequently the business as a whole.