Valuation of an E-Commerce Business

This can be achieved using the standard practices for valuing businesses. However, not all valuation strategies would be applicable for an e-commerce business. Especially if you are a start-up in the e-commerce sector then valuing your business would be crucial. Reading this article would help you understand the factors considered while valuing an e-commerce business.

How to realise value for an e-commerce business?

There are different methods utilised for valuation in the world. However, not all methods would be applicable for a niche sector. For instance, the valuation technique used for a SaaS business would be different from the valuation technique used for a retail business. Therefore, it is important to understand the most appropriate method for valuation.

Methods of Valuation for an e-commerce business

The following methods are utilized for valuing an e-commerce business:

• Sellers Discretionary Earnings (SDE)

• Earnings Before Interest Taxation Depreciation and Amortisation (EBITDA)

• Revenue and Growth Variations

• Discounted Cash Flow Method

• Sellers Discretionary Earnings (SDE)- Under this method, the earnings of the business or the net revenue of the business in considered. Usually e-commerce businesses would utilize this method, if their net worth or revenue is less than US$ 5 million. This method is considered by small e-commerce businesses.

The following formulae is utilised under the SDE method for valuation: 

• SDE = Total Revenue – Cost of Goods Sold – Operating Expenses + Compensation Provided to the Owner

Under this method, the cost of goods sold and the operating expenses is subtracted from the total revenue of the business. The compensation provided to the owner is added to this. By adding the owners compensation, the true value or the earning potential of the business is understood.

• Earnings Before Interest Taxation Depreciation and Amortisation (EBITDA)- This method is utilised by a typical e-commerce business that has revenues of more than US$ 10 million. Through this method, the earnings of the e-commerce business is measured. 

The following formulae is utilised under the EBITDA method for valuation: 

• EBITDA = ( Total Revenue – Expenses) + Depreciation + Amortisation

The main difference between the SDE method and the EBITDA method is the way in which owner’s compensation is treated. The compensation provided to the owner is subtracted from the total revenue of the business. Hence the owner’s compensation is treated as an operating expense of the business. Usually this method is used for large players which have complex structures. 

• Revenue and Growth Variations- The revenue and growth variations method is utilised by players who have large investments in technology and capital infrastructure. Usually this method is not utilised by e-commerce firms which have revenue of US$ 10 million or lesser. Start-up e-commerce companies usually utilise the EBITDA method to calculate the value of their business.

• Discounted Cash Flow Model (DCF)- This method is not usually utilised for an e-commerce business, as the future earnings of the company is depicted through this method. DCF method of valuation is less suitable for e-commerce operators and is more utilised by a traditional business.

Calculating Earning Multiples

Once the earnings are determined using one of the above methods, then the e-commerce business has to calculate the earning multiples. Usually calculating the earnings multiples of a business is complicated. 

The following formulae is utilised for calculating the earning multiples of the business:

• Valuation of E-Commerce = Earnings x Earnings Multiples of E-Commerce

E-commerce businesses have earnings multiple of four to six times. Hence if the e-commerce business has revenue of 6 million and an earnings multiples of 5 times then the value of the e-commerce business is 30 million.

Factors that can Improve Valuation of an E-commerce business

There are particular factors which increase the value of e-commerce businesses. The following are the factors to consider:

• Financial History- The financial history of the business is one of the main factors which attract investors. Not only for an investment round, if an e-commerce company is acquired by another company, then financials are the key drivers to increase the value of the business. 

• Traffic- You are operating an e-commerce business, so major revenue is generated through online sources. To improve the traffic and rankings of your business, utilizing Google trends would assist in improving the inbound traffic and customers for the business. Big e-commerce businesses would invest in organic and paid traffic to improve their presence.

• Niche/Product- Valuation would depend on the products which are sold by your business. Investors would look into the products offered by your business and how these products operate in the market. Along with this, investors would look into factors such as scalability, transferability and sustainability of your business.

• Age of the Business- The age of the business is one of the main factors while valuing your e-commerce platform. Investors and customers would not look at an e-commerce platform or business which is less than one year old. E-commerce business that have operations of 4 to 5 years are usually trusted by customers.
  
  
• Return/ Refund- Having a proper return and refund policy is a major consideration what all e-commerce businesses have to think about. According to research on e-commerce companies the average return rate is 9 to 10%. More returns would deplete the revenue of an e-commerce start-up. E-commerce firms have to reduce the number of customer returns. Through this, the value of the business would increase.

• Logistics and Fulfilment- Logistics and fulfilment are one of the key drivers of an e-commerce business. Having seamless fulfilment services for customers would increase the reliability on the e-commerce provider. This would affect the revenue of the business, which is directly related to valuing the business.

Conclusion

To conclude with, valuing an e-commerce business is dependent on the amount of revenue of the business. The common methods used for valuing an e-commerce business are the Sellers’s Discretionary Earnings and EBITDA.