Flipkart Acquired!by walmart! Think before acquiring online Business

How to evaluate an ecommerce business?

Once you have located a couple of interested business buying opportunities, it’s time to do a full-on analysis on the business. When you are directly approaching the sellers, you will need to get a list of questions answered by the sellers in order to do a thorough initial analysis on the business.

Either way, make sure you get the following information:

1. Seller interview questions and answers
2. Google Analytics read-only access
3. Profit and loss statement with monthly stats.

Seller interview questions and answers

You will want to know some basic information about the sellers before you seriously consider buying a business from them. After all, a trustworthy seller is one of the most important and the most ignored metric in online business buying.

My suggestion is to always validate the information you get from the seller and ask follow-up questions when you get answers. You’re more likely to uncover hidden details and potential opportunities in the business.

The list of questions you should ask sellers are:

1. Tell me a bit about yourself.

When you you are working directly with a seller, it is important that you do a background check yourself. Search their name on Google, ask for their LinkedIn profile and social media profile. Make sure the seller is not using a fake identity. If you are working with a seller from overseas and it’s very hard to find his or her identity information online, stay away from such opportunity, especially when the opportunity looks exceptionally appealing

2. Tell me about the history of this business.

When was the business founded and why? Is the current business owner the original owner of the business? Who are the business partners and what are their roles?

In general, ecommerce businesses with a longer history are more attractive than younger businesses. Most ecommerce businesses are affected by seasonality. In order to do a proper analysis on the impact of seasonality on a business, the business has to have at least 12 months of history. The longer history it has, the better you can analyze its historical data and trends. An ecommerce business with shorter than 6 months history could be too risky to take over. It won’t have enough information on the seasonality of the business, and it has much less predictable metrics for you to base your valuation on.

An ecommerce business with shorter than 6 months history could be too risky to take over. It won’t have enough information on the seasonality of the business, and it has much less predictable metrics for you to base your valuation on.

If you find an ecommerce business buying opportunity with less than 6 month’s history, a very high growth rate during the first 6 months, and a relatively low purchase price, you would want to question why the seller is selling it. Be aware of the type of ecommerce businesses that were created for the purpose of selling.

3. Why are you selling it?

Why the business owner wants to sell the business? If the reason for selling is that the business has encountered adversity, the owner might not want to tell you the real reason. You need to dig into the business data and ask follow-up questions during your conversation with the seller. Other reasons for selling could be certain life or career changes, other time commitments, new startup opportunities, or lost of interest in the businesses.

4. What other businesses do you own?

If the business owner owns multiple businesses and he or she is only selling one of them, you need to evaluate how much this business is related to the other businesses.

For example, if the business owner owns multiple websites or ecommerce stores in a competing niche, be aware of the potential competition from the seller’s other businesses after you acquire it. If the owner cross-promotes products from the business for sale with other businesses he or she still operates, you need to evaluate the potential loss of customers after you take over the business and they stop the cross-promotion effort. It’s better to buy the entire portfolio of web businesses from the same seller if the businesses are highly associated and the operations are inseparable.

5. How do you operate the business?

What types of tasks do the current owners do to operate the business? How many hours does it take the current owner each week to perform those tasks? Are there any expenses related to the operations?

Depending on the business model, major operational tasks in an ecommerce business could include marketing, advertising, customer support, supply management, inventory management and logistics (if it’s inventory-holding ecommerce). Some businesses have more established and automated processes than the others. Make sure you ask how the business is currently operated and how many hours it takes for the owner to do each task. Also ask the owner if there are any expenses associated with the tasks. You can find out more about common ecommerce business expense items in the Operating Expenses section of the guide.

When you evaluate the operations of the business, think of the following 3 questions:

1. Are there Standard Operating Procedures (SOPs) already documented and ready to be taken over? If not, this is something you should consider working with the business owner on post-closing to ensure a smooth take over.
2. Are there any special resources required to accomplish the tasks? Will you be able to perform the tasks as well as the current business owner? For example, if the current business owner has a special marketing channel (free or below-the market cost of access to social media influencer networks, ad networks, etc.) that is not transferrable with the sale of the business, taking over the business means losing that marketing channel.
3. If some tasks are outsourced, will those contractors stay onboard after you take over the business? Will you be able to take over the business’ current contracts with its main partners, suppliers, etc. with the same contract terms?

Those questions can help you evaluate whether you will be able to run the business as well as the current owner. If some part of the operations are not transferable to you, you need to think about how to replace it with other resources and how much more or less it will cost, and take that cost into account when you do the valuation of the business.

Google Analytics Access

Ask the seller to grant you Google Analytics access so that you can evaluate the website’s traffic.

When evaluating the traffic stats, you want to find out:

1. Are the traffic stats authentic?
2. What’s the traffic trend and what’s the reason behind that?
3. Is the traffic organically sustained or does it require paid acquisition?

1. Are the traffic stats authentic?

Keep in mind that some traffic stats can be manipulated. Fake traffic is generated by bots or softwares and can be bought from 3rd party providers. They will inflate the traffic stats before the sellers put the sites up for sale.

The best way to identify fake traffic is to check the Audience Overview in Google Analytics.

Google Analytics Audience Overview gives you a nice overview of the site’s key performance metrics. Sites with very high or very low Bounce Rate (>90% or < 30%), very short Avg. Session Duration (<40 secs), low Pages/Session (<2 pages / session) are skeptical to fake traffic or traffic from untrustworthy sources. You can learn more about Google Analytics metrics through Google Analytics Academy if you are not familiar with some of the metrics I mentioned above.

Installing Google Analytics tracking code twice on a webpage can also result in very high or very low bounce rate. You can check that by viewing the webpage source code search for Google Analytics tracking code, usually starts with “UA-”. If the code appears twice on the same page, double check with the seller to see if this is an error. Once the duplicated tracking code is removed from the site, after 3 - 5 days you should be able to see the bounce rate stats going back to normal.

From the Audience Overview, you can also check the Language, Country, City as well as Browser to help you identify fake traffic. If the top language of the traffic doesn’t match with the top country, or if the site is mainly selling product to US customers while it’s Top Country is India, you should double check with the seller to figure out why. Top Browser is usually Chrome, unless the site is targeting a specific demographic group that prefers other browser such as Internet Explorer. Always ask yourself “does this make sense?” when you look at the traffic stats. This will help you uncover traffic from untrustworthy sources.

2. What’s the traffic trend and what’s the reason behind the trend?

In the Audience Overview, change the metric to “Users” where the default is “Sessions”. Users is a better indicator of how many unique customers visited the site.

Change the Date Range to view the traffic trend for the past 3 months, past 6 months, past 12 months and since the beginning of the traffic history.

You can also adjust the granularity of the traffic data to see the trend. First look at the graphic by month, then by week, by day. If there is a traffic spike during a certain time period, you might want to inspect that closely by narrowing down your Date Range to that specific time period, then look at the key performance metrics and traffic sources in Acquisition. We’ll discuss traffic sources in more detail later on.

Notice that when you adjust the Date Range to show traffic data from different time period, the key performance metrics like Pages / Session, Avg. Session duration, Bounce Rate, % of New Users could change accordingly. If you notice one of the metrics changes dramatically during certain time period, you might want to figure out why. For example, if Avg. Session Duration doubled when you adjust the Date Range from past 12 months to past 3 months, it probably means during the past 3 months, users spent a lot more time on the site on average during each visit session. This could be due to changes of site content and design, or due to changes of the traffic quality (perhaps more targeted traffic). You will want to ask the seller for possible explanations.

Some eCommerce businesses are strongly impacted by seasonality. For example, an eCommerce business selling gifts might have much a higher traffic and sales during the holiday seasons. If the site has over 12 months history, you can also spot the traffic seasonality trends by comparing the same time period across different years.

3. Is the traffic organically sustained or does it require paid acquisition?

You can go to Acquisition -> Overview to see the top customer acquisition channels.

Paid Search

This type of traffic comes from Google Pay-Per-Click (PPC) campaigns. If a big portion of traffic to the site is through Paid Search, make sure that all the details of the PPC campaigns are transferred to you after the sale, so that you can analyze the current ad campaigns and continue to manage them effectively. If you do not know how to manage ad campaigns, you might need to hire someone to do it for you. This should be counted as a part of your future operating expenses.

Ask the seller to share his PPC campaign data with you if possible so that you can analyze the ad expenses and match it with the Profit and Loss Statement you get from the seller. Analyze the cost per click as well as the goal conversion rate and conversion value from Paid Search (if the seller has set up Google Analytics Goal Tracking for checkout). If the cost per user acquisition is lower than the earnings from that user, the ad campaign is effective.

Paid traffic is more controllable compared to other traffic sources such as organic search traffic, because you can increase or decrease the paid search traffic by adjusting your ad spending. However, make sure you do proper due diligence to uncover how much ad spending has actually occurred. Internal factors like how you design and run your ad campaigns can influence the paid search user acquisition cost. That’s one of the reasons you should always get the PPC campaign data from the current owner as a part of the asset transfer if that’s an important part of the traffic acquisition. External factors such as competitions, market trends, can also influence the paid search cost in the longer term, that’s why you should also do some industry research and PPC cost research.

Organic Search

Organic search traffic comes from search results that aren’t paid for. You can use tools such as SEMRush to evaluate the website’s organic search traffic quality. It gives you an overview of what keywords the site is ranked for, and how much estimated organic traffic is going to the site because of which keywords.

Organic traffic is free, hard to fake, and it’s relatively stable and predictable (exceptions are mentioned below). Thus, organic traffic is usually considered as a favorable traffic source. The best type of organic traffic is when the site ranks for many relevant keywords and the traffic from different keywords are evenly distributed. Imagine if a site ranks well for only one keyword that brings in 90% of the site’s organic traffic, when a competitor beat that ranking one day, the organic traffic to that site could drop dramatically overnight.

Although organic traffic is relatively stable, keep in mind that organic traffic could change suddenly when there are search engine algorithm changes or penalties. A general rule of thumb is that search engines will always prioritize high quality original contents. If a site has consistent organic traffic history over a long period of time, it means the site’s content is relatively riskfree from algorithm changes. If a site uses a lot of black hat SEO, it could be vulnerable from algorithm changes and penalties. You should use tools such as ahrefs.com to look up the site’s backlinks and do proper due diligence on the site’s SEO methods when organic traffic is the main traffic source.

Referral

Referral traffic comes from other websites that link to the current website. Click on Referral from the Acquisition Overview to inspect the referral traffic details. Add Hostname as the Second Dimension to inspect referral spam traffic. If the hostname doesn’t match the website’s domain or any services relevant to the site that has Google Analytics tracking code installed (such as Youtube, email service provider, etc.), it’s likely referral spam traffic. Sites with less traffic usually have a relatively higher portion of referral spam traffic (unless the seller already filtered out those traffic on GA). Keep in mind that it’s common for websites to attract referral spam traffic. What you need to do is to filter them out when you are evaluating the site’s referral traffic, if the referral spam is a relatively large portion of the current traffic volume.

If the site has legitimate referral traffic from article mentioning and backlinks, make sure to check out the referral sources, read the articles where the referral links appear and see if the content is legitimate, and find out whether there is any expense related to the referral traffic in case the store owner paid to get featured/ mentioned in those articles or did something in exchange. You can do a thorough backlink check using Ahrefs.com if the sites has a large amount of referral traffic. You can also ask the seller to elaborate on their referral partnerships when you spot a large amount of referral traffic coming from certain websites.

Social Media

If the site has a large chunk of traffic from social media sites such as Facebook, Twitter or Instagram, you will want to do proper due diligence on how the site’s current social media accounts are operated and how much it costs to maintain the current social media marketing strategy.

First, you want to assess the existing social media account followers. Find the social media accounts related to the site, the number of followers for each account, and assess how engaged the followers are with the posts. The more engaged the followers are, the better. Keep in mind that fake social media followers and likes can be bought from 3rd party providers. You can usually spot the fake followers or likes by checking the profiles of the people who liked or commented on the posts.

Second, you want to understand how much money is being spent on social media marketing. There are two types of social media costs. The most common one is sponsored posts where you pay the social media networks directly to gain targeted impressions. You should ask the sellers whether they have done paid social media marketing, and if so, ask them to share the advertising reports with you so that you can check the performance. Same with PPC campaigns; you will want to keep the ad copies, creatives and all other settings when the seller transfers the social media accounts to you.

The second type of paid social media advertising is when the site owners pay social media influencers or 3rd party social media ad networks to promote their products. In that case, they’re not directly paying the social media networks to sponsor their posts so it might be harder to discover. You can usually find it out by doing a search of the site’s domain or brand name on the social media network website to see if there are posts promoting their products from other social media accounts. If the posts don’t look organic, ask the seller to disclose the costs associated with the promotion, and provide relevant invoices to prove the expenses amount for your confirmatory due diligence.

In rare cases where the site owners have access to large social media influencer accounts where they can promote their own products for free, you will want to assess how much that will cost you once you take over the business without access to those accounts. Add the cost to the current business’s Profit and Loss statement to evaluate the actual profit you can earn without those non-transferable resources.

Direct

Direct traffic usually comes from users directly typing the URL of the site into their browser. There are other cases where the traffic is also counted as direct traffic. This is the least controllable traffic source and the easiest to fake. Ecommerce sites with an established brand, great PR and word-of-mouth can get a lot of direct traffic. If direct traffic is the main source of traffic to the site, make sure you ask the seller enough questions to figure out if that makes sense.

Summary

A couple of points to keep in mind when you are evaluating the traffic profile:

1. Focus on the traffic sources that have the most impact on the business’s bottom line. Don’t spend too much time digging into a small volume of traffic you couldn’t explain that has minimal impact on the business.

You can check Acquisition -> Overview to see the % of each traffic source:

In this chart, Organic Search traffic appears to have the most volume.

When you go to Acquisition -> All Traffic -> Channels, you might see something like this:

If the current Google Analytics setting tracks eCommerce revenue, you can see some revenue numbers attached to each channel. As you can see, although Organic Search has the most volume, Direct traffic source actually generates the most revenue.

1. If an ecommerce business has evenly distributed traffic through multiple acquisition channels, it’s usually a good sign, as the traffic is less risky compared to a site only has traffic coming from a few channels. Whether the current traffic mix makes sense depends on the business model. For example, an ecommerce business has an unique brand with lots of press coverage could have a large amount of direct and referral traffic, an ecommerce business selling less unique goods in a relatively competitive niche focusing on buying and monetizing traffic could have a large amount of paid traffic.

Profit and Loss Statement (P&L)

Ask the seller to provide you with a Trailing Twelve Months (TTM) profit and loss statement that shows you the revenue, operating expenses and net income per month for the past 12 months (or more if available).

A typical P&L for small businesses have 6 sections: Revenue, Cost of Goods Sold, Gross Profit, Operating Expenses, AddBacks, Net Income.

Revenue

The revenue stats can either be a sum of all revenue generated from the business, or can a breakdown by different revenue sources, distinct product categories, by customer segments, etc., depending on how the business owner record and analyze the revenue stats.

Cost of Goods Sold

Cost of Goods Sold section includes variable costs associated with the products or services sold through the site.

If the business has a high Refunds and Returns rate (Returns / Product Sales), you should be alarmed and inspect the reasons. Some causes are easier to be fixed than the others. Low product quality, poor product shipping and handling, misleading or wrong product descriptions on the websites could all lead to high refunds and returns rate.

Gross Profit

Gross Profit = Revenue - Total Cost of Goods Sold

With the Gross Profit number, you should be able to calculate the Gross Margin.

Gross Margin = Gross Profit / Revenue

Having a healthy gross margin is important for small to medium ecommerce businesses. A high gross margin generally indicates that the business has a good brand value, unique products or other competitive advantages that it can operate on a higher gross margin without losing to competitors.

Operating Expenses

Operating expenses includes expenses that occur during a certain accounting period. Depending on the business, the expense items could vary. Most small ecommerce businesses are run by the owners and they do not take salary from the business.

Marketing and Advertising expenses are typically a large portion of the total operating expenses for ecommerce businesses. Make sure you double check the Advertising expenses in the P&L and match it with the advertising network reports such as Google AdWords report and Facebook advertising report.

Some marketing and advertising expenses might be harder to track down. For example, if the business owner has direct advertising partnership, sponsorship or referral partnership with other websites, there might not be an expense report you can track down or match. In this case, you should closely inspect the Google Analytics user acquisition sources, and ask the seller whether they have paid for any of them. Sellers hiding certain marketing and advertising expenses and leaving them out of the P&L is one of the most common reason of dispute in online business buying and selling.

There could also be hidden cost in marketing and advertising, where the business owner also owns other resources they can utilize to promote their products for free. If you do not have similar resources, you will likely have to pay for those types of user acquisition. One example is that the business owner also owns a social media influencer account with 1m+ followers, where he or she can promote products without paying for the traffic.

Higher marketing and advertising expenses can also drive up the sales. Some sellers might deliberately increase their marketing and advertising expenses before they put up the site for sale to generate more interest from buyers. You can calculate the expense ratio to avoid being misled by the absolute numbers. Calculate the Marketing and Advertising expenses to Product Sales ratio and inspect how that changes month over month. The ratio could increase due to decreased market demand (such as during slow seasons), increased competition, penalties or policy changes from advertising networks. If you noticed a big change in the advertising to revenue ratio, you should ask the seller about the reasons behind it.

When you’re buying a Shopify eCommerce business, one of the most common operating expenses is the monthly recurring subscription fees paid to Shopify apps installed in the eCommerce store. Make sure to double check it with the seller if that’s not in the P&L.

Add-Backs

Since most small ecommerce businesses are operated by the business owners, their reported earnings could be kept low for tax purposes. We will want to see an adjusted P&L which tells you how much Seller Discretionary Earnings the business is making in order to fairly judge the available cash flow and returns on investment of the business. We can do that by adding back some one-time expenses or expenses that are not likely to occur after the change of ownerships.

Net Income

After the Add-Backs, we can get to the Net Income using Seller Discretionary Earnings (SDE) method. This will be the number you use to base your valuation on. We will talk more about valuation in the following section.

The Net Income could go up and down for many different reasons. Besides looking at the Net Income numbers and trends, you should also look up the reasons for the trends from the P&L - whether it’s due to the increase/decrease in revenue, or increase/decrease in cost. External factors such as seasonalities, competitions, changes in market trends as well as internal factors such as changes of product suppliers or changes of operating processes, can all contribute to the changes of Net Income.

A thorough analysis of the P&L can help you discover a lot of information about the business, choose the right questions to ask the sellers, and find opportunities for improvements in the business.