5 Risks of Buying an Online Business: What to Watch Out For

Buying an online business can seem like a lucrative opportunity and it can actually be VERY lucrative. However, while the potential for high returns is real, so are the risks. Understanding these risks before making an acquisition is crucial to protecting your investment and ensuring long-term success. In this post, we'll explore the specific risks associated with buying an online business and how you can mitigate them.

1. Dependency on Third-Party Platforms

One of the most significant risks associated with online businesses is platform dependency. This is particularly true for content sites and Amazon FBA businesses.

• Content Sites: These sites often have the most platform risk because they are heavily reliant on Google for traffic. With no physical or digital product to sell, they cannot leverage paid advertising effectively. A simple algorithm update or change in Google's policies can drastically reduce their traffic, and, consequently, their revenue. Without a diversified traffic source or a strong brand, these businesses are highly vulnerable to shifts in the digital landscape.

• Amazon FBA Businesses: These businesses also face considerable platform risk. They are at the mercy of Amazon’s fees, ranking algorithms, and processes. Moreover, Amazon has been known to produce its own products, often directly competing with sellers on their platform. This can lead to a sudden drop in sales or the complete obsolescence of your product.

It’s important to note that platform risk is NOT limited to these business models.

Mitigation Strategies:

• Diversify revenue sources.

• Ensure the product has enough margin to sustain ads (paid customer acquisition).

• Build a strong brand and customer loyalty.

2. Customer Concentration

Customer concentration is a risk particularly prevalent in digital service businesses. A heavy reliance on a few key clients can make a business vulnerable to sudden revenue drops if one or more clients leave.

• Example: I once encountered a business that provided legal writing services to law firms, where one client accounted for 60% of its revenue. This level of concentration poses a significant risk—if that client were to leave, the business would suffer a severe financial hit.

Mitigation Strategies:

• Analyze the customer concentration during due diligence.

• Develop strategies to diversify the customer base post-acquisition.

• Consider negotiating long-term contracts with key clients before completing the purchase.

3. Outdated Technology

Outdated technology is a common issue in app and SaaS businesses. It’s not unusual to find a SaaS product that has been profitable without any significant updates for several years. However, the emergence of new entrants with more advanced technology can quickly erode the market position of these businesses.

• Example: Imagine a SaaS business that hasn't seen a major update in over five years. While it may still be turning a profit, new competitors are entering the market with better, more user-friendly products. The seller may be looking to offload the business before these competitors gain traction, leaving you with a potentially obsolete product.

Mitigation Strategies:

• Conduct a thorough technology audit during due diligence.

• Budget for immediate upgrades and improvements post-acquisition.

• Stay informed about industry trends to anticipate potential technological shifts.

4. (new) Competition

Competition is fierce in the online business world, and it's often easy for competitors to replicate a business model and start competing. This is particularly true for businesses selling generic products or services.

• Example: I recently came across an online business that sold Excel spreadsheet templates. These spreadsheets were simple white-label PLR (Private Label Rights) products that any savvy entrepreneur could find with a bit of research. The business was driving sales aggressively through paid ads, but the very visibility of these ads could encourage others to enter the market, replicating the business model and driving down profits.

Mitigation Strategies:

• Differentiate your product or service through branding, quality, or unique features.

• Protect intellectual property wherever possible, such as through trademarks or copyrights.

• Continuously innovate to stay ahead of potential competitors.

5. Inventory Obsolescence

For eCommerce businesses that hold inventory, there is always the risk of obsolescence. A substantial portion of a business's inventory may become obsolete or unsellable, leading to financial losses.

• Example: Many eCommerce businesses find themselves sitting on inventory that will never sell, either due to changing consumer preferences, new product releases, or simply poor purchasing decisions. This dead stock ties up capital and can significantly impact the profitability of the business.

Mitigation Strategies:

• Conduct a thorough inventory audit during due diligence to identify potential obsolete stock.

• Implement strategies to liquidate obsolete inventory quickly.

• Consider diversifying inventory to include evergreen products with longer life cycles.

On that note…

Buying an online business can be a lucrative venture, but it's essential to understand the risks involved. From dependency on third-party platforms and customer concentration to outdated technology and fierce competition, these factors can all impact the success of your acquisition. By thoroughly assessing these risks and implementing appropriate mitigation strategies, you can make more informed decisions and protect your investment.

Before you proceed with any acquisition, take the time to evaluate each of these risks carefully. Remember, the key to a successful acquisition lies in not just identifying opportunities but also in understanding and managing the risks that come with them.