The Key to Valuing Small Online Businesses: Understanding Earnings Multiples

In this post we’ll help you get clear on how to value a small online business that is established &profitable.

This most specifically applies to businesses with revenue ranging from $100,000 - $10,000,000, and that are generating profits — just like the businesses I source for the AcumenWire and look to acquire myself.

Businesses that are in a state of high growth or are distressed will use other valuation methods, but as a buyer I prefer to focus on businesses that are stable and profitable.

The most common method will be a valuation multiple based on monthly earnings

which is simply known as ‘the earnings multiple method’. This model looks at the average profits over a period of time and multiplies that by a multiple to get the total valuation.

For example, a business that generates, $10,000 in profit per month and is valued at a 40x multiple will be valued at $400,000.

Now within that, there are a few factors that need to be determined and are ‘variable’…

a. the time period used to calculate the profitability.

b. the multiple assigned.

We’ll break each of these down.

How long of a time period should be used?

I like using an average of the last 12 months. In my opinion businesses that don't have 12 months of earnings are too risky to buy. It's not uncommon that you'll see a business 'mooning' (growing super fast) and the revenues grow exponentially every month so the seller wants to use a valuation of the last 6 months. In reality this growth rate is unlikely to be sustainable and often these businesses fall as the advantage they are exploiting is arbitraged away.

An example would be a Shopify ecom business selling a luxury shower head. They catch quick traction with Facebook Ads and have scaled apending $10,000 per day on ads to make $40,000; in just 4 months. Great numbers and they rake in the revenue and profit , but sooner or later the audience will be exploited. In other words, there was huge pent up demand for the shower head, but soon everyone in the immediate market will have purchased one and ad performance will fall. And a new owner will be left holding the potato

The Range Of Valuation Multiples For Online Businesses

For a profitable online business the valuation will likely be in the range of 24x - 60x. I know that’s a broad range considering the example of a business with $10,000 monthly profits could be worth $24,000 or $600,000.

Let’s get into the nitty gritty.

Primary Factors that effect valuation multiple

Brand

I’m starting off with this one for a reason.

This is often not spoken about in valuations but consistently businesses that have established brands sell for higher valuations and as a buyer I would pay more for a brand. Here’s why, a business that has established a brand will exist without any channel risk, platform risk, or the need for advertising. This is powerful and highlights the robustness of the business.

In my opinion a brand is more powerful than operational efficiency or superior products and often sellers / brokers undervalue the brand.

That said, most online businesses never become a true brand that people seek out.

Related: How to Assess the Brand Value of an Online Business

Moat / Competitive Advantage

Businesses that have something that is tough to duplicate will command a premium in the valuation multiple. This could be an ecommerce business having a patented product (or one that is just difficult to product), a SaaS business with proprietary software (cough cough not a GoHighLevel business), or an infoproduct course having professional accreditation

Risk

When it comes to online businesses you typically run in to the following ‘risks’:

Channel/Platform Risk: The risk from a traffic channel like Google effectively punching your time card.

Obsolesce: the product just becoming outdated and not as valuable.

Competition: Competitors taking market share, driving up customer acquisition costs, and eroding margins.

Businesses that can mitigate those risks will command a higher premium.

I have further elaborated on the risks to watch out for when buying online business in this post.

Profitability Trend

It’s a easier to scale up a tail wind, than it is to overcome a headwind. For that reason businesses that are experience a (stable) growth in profitability skew higher in the valuation multiple.

When you look at it mathematically it works as well. For example if business is growing stably at 20% per year, you can expect more future cash flow. If the business is declining 20% per year… well you can expect less cash flow. This highly reflected in a Discounted Cash Flows Valuation method.

Scalability and Growth Potential

The ability to scale operations and grow revenue without a proportional increase in costs is a significant factor in determining a higher valuation. Buyers are often willing to pay a premium for businesses with clear paths to growth, that do not require much capital expenditure.

An example would be marketing an ecommerce product to a Spanish speaking audience within the United States. This would utilize your current inventory and distribution methods and just require a relatively small expense to translate/modify your marketing content.

Operational Efficiency (or ease)

No body wants to buy a job that comes with a headache. Efficient operations that minimize owner involvement, have an established and require less human resources command a valuation premium.

These Factors Are Characteristic of ‘Type Of Business’

Businesses of the same type will have similar characteristics which gives a common range of valuation multiple to each type of business. Analyzing by business type will also give a more clear premium or discount to each valuation factor.

I’ll say it here “some businesses are a thoroughbred race horses and others are ponies”

Content websites are generally the ponies of the online business world as they are typically reliant on one channel for traffic (Google), and have few scalable growth levers (the exception is content sites establish a brand). These business typically go for 30-36x multiples… unless the establish a powerful brand that exists on multiple channels, then they can go for 60x (these are rare).

On the flip side is SaaS & App businesses. These businesses usually have recurring revenue which is very sticky along with some tech that is not easy to duplicate, and scale/growth potential.. On the low side they’ll go for 40x which will usually be a SaaS business that is a bit date. With current tech and stable profits 50x is starting point.

Physical Ecommerce businesses have possibly the widest variation of among multiples. It’s not uncommon to see a dropship ecommerce business with a 10% margin, which isn’t worth much, maybe 24x. Ecommerce businesses that can maintain 25% margins, and build a bit of a moat either through warehousing and distribution (3pl ideal), or branding/proprietary products go for 40-50x.

Recommend Reading: 5 Driving Factors Of Ecommerce Business Valuation Multiples

Digital Product Ecommerce Businesses have the perk of essentially having no cost of cogs, and very little overhead related to development (saas businesses can have high development and support costs).  They churn out high margins, and are appealing. They commonly trade around the 40x point with little variation that I see among them. Their opportunity is infinite scale through paid ads, and their achilles heal is competition and AI. Branding or accreditation can provide value premium. Example; a business listed for sale I included in the newsletter which did some type of pharmaceutical research training and was accredited by a recognized institute.

Virtual Service Businesses tend to skew lower on the valuation typically falling into the 30-40x range. The reasoning being that they are human resource (management) intensive and they could be replaced with ‘AI’. That said I do see some of them as having very sticky customer base particularly in the b2b service markets.

Marketplace not many of these come up for sale but when they do, valuations are often 40x+. Launching a marketplace is hard as you essentially need to attract 2 types of customer; buyers & sellers. But once established they are very sticky.