The E-commerce Leader

[00:00:00] Devoid of basic financial culture, I guess you might say, um, and actually survive and thrive and, and, and because these platforms allow you for such lightning fast growth. You could envision a circumstance where someone creates a business, has no understanding of what a income statement is or a balance sheet, nor do they care, and has a seven figure business or whatever, and then is ready to exit.
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[00:01:27] ladies and gentlemen, we are this cramping in the studio today’s topic is going to be of interest. I think to those who are buying businesses, but also who own a business, they may wish to sell one day, which is nine vital financial metrics that I tend to look at when I’m evaluating a business, either because I’m going to consider buying it or on behalf of my clients.
[00:01:49] And I think some of these KPIs are things that as operators, we can easily take our eyes off, but when you’re buying They’re very much the first thing you look at. So hopefully it’ll be a helpful corrective and operators out there as well. So Jason, um, are you up for this topic? Yeah, yeah, yeah, yeah. This is a great one.
[00:02:05] I really like it. Uh, KPIs for those who don’t know key performance indicators. And, uh, yeah, this is going to be a fun conversation. I know it can mask and get daunting to people. And some of this stuff can feel too theoretical. So we’ll try to keep it real down to earth. Real practical and, um, hustle through this list of nine efficiently so that you get the real gist of the.
[00:02:27] Idea, which is how to evaluate a business using the mathematics that you’re presented with. Excellent. Well, talking of getting on with it, then let’s try and keep things as simple as possible. So the first thing I want to say is pretty simple financial metrics, Trump marketing ones, and that is, uh, Kind of should be obvious to any business owner, but when you’re very wrapped up in a particular platform or a particular business model, so especially if you, for example, sell on Amazon, you start worrying about a cost, which is a number that nobody outside the Amazon sphere knows what that even means is advertising cost of sales, and you suddenly get round up in a lot of marketing metrics, which are really important, and I’m not saying they’re irrelevant, but today we’re really focused on the finances.
[00:03:05] So I think it’s really important to, to boil everything marketing metric down. If you like that leading metrics, but they should have a trailing financial metric. If they don’t have a financial effect, then ultimately they’re a waste of time anyway. So that’s the first thing. Yeah. I wasn’t quite sure where you’re headed with that when you had that in the, the note to, uh, to describe.
[00:03:24] So let me unpack it a little bit. I, I would present it a little differently. What I would say is, um, your profit and loss statement and balance sheet, you know, the, the high level financials of the business, Trump, everything. And, um, a lot of the KPIs that you’ll dig out of the back end of, uh, seller central and Amazon or the Shopify analytics.
[00:03:46] Uh, information that’s supporting evidence, you could say to the top level financials and you should see harmony and resonance between the two, but to your point, yeah, you can’t just get, uh, you know, if you have a business, for example, that has, um, on Shopify, an average order value of 4, 500 and be like, wow, that’s the highest average order value I’ve ever heard of that doesn’t trump the fact that the P and L might be a complete blood path, right?
[00:04:13] So that’s, I guess the point you’re trying to get at. Is that right? Yes, exactly. No, I think you put it better than me. They should be in harmony, uh mm-hmm. , they certainly should support each other, but in the end it has to translate to numbers or financial numbers because otherwise, you know, you, you’re either not going to have somebody intelligent give you cash for it, or certainly the lenders involved and they normally are in big purchases.
[00:04:34] The lenders are obviously, you know, by their nature, financially, numbers driven. Mm-hmm. , and then they lend on lots of different types of businesses in some cases, and, and, The thing they have in common is balance sheets and profit loss and cashflow statements, as you say. Um, what they don’t have in common is that they’re online marketing businesses.
[00:04:49] The same lenders may rent things with no online presence at all. So the only universal constant for business is really the profit and loss and, and actually exactly as you say. Um, yeah. Which implies obviously you’ve got to have one. It sounds crazy, but I did know one business owner of an Amazon type business who did about seven figures a year in revenue and didn’t really have any books.
[00:05:11] I think he’s corrected that now. It’s not crazy. Okay. Here’s how it’s not crazy. I’ll make the, I’ll make the case that I’ll still man the argument for not ever having a profit and loss statement. Um, You can start an e commerce with absolutely no business background. And you basically have the understanding of a personal checking account, savings account, mindset, and you start in e commerce and the tools and systems make it possible for you to scale something so darn quickly that you can operate in an ecosystem like Amazon or Shopify.
[00:05:46] Devoid of basic financial culture, I guess you might say, um, and actually survive and thrive and, and, and because these platforms allow you for such lightning fast growth. You could envision a circumstance where someone creates a business, has no understanding of what a income statement is or a balance sheet, nor do they care, and has a seven figure business or whatever, and then is ready to exit.
[00:06:14] And the tools that we would commonly hear from in business school or in banking, work, that kind of thing, you know, the standard financial, uh, you know, tools, um, they would not be familiar with. And And fair enough, you know, they didn’t need it and they didn’t have to have it. I remember when we started our business, we did not have an income statement and we certainly didn’t have balance sheet nor did we care about balance sheet for so long, you know, but we didn’t have an income statement until my friend and mentor.
[00:06:43] Said to me, what do you, what’s your, you know, p and l look like? And we’re like, well, what does that mean, ? Right. And I had an M B A, but I was like, it didn’t make, it didn’t, it didn’t apply to what we were doing on eBay point taking until, until I needed it to apply. And other people would look at it and bankers or buyers or whatever would look at your business and then you’re like, oh, this is the financial universal instruments.
[00:07:07] This is what everybody. These are the rails that every, you know, kind of deal is structured on is these documents anyway. So that’s the, that’s why I wouldn’t be cavalier about saying, you know, everybody has to have a profit and loss statement. Fair enough. I mean, I guess in the end, there’s no point in doing work, including analytical work unless there’s a purpose for it.
[00:07:28] But I guess what we’re saying is, um, have some, there will be an actual documents before you attempt to sell your business. And here’s what I would say. It’s interesting that you raised that. Um, Here’s the flip of the mentality from e commerce operating to e commerce business selling. Um, when you sell a product, if you, you know, super primitive about it, you’d stick something up with one horrible picture.
[00:07:47] And back in the day, you know, you could get away with that. I did that sort of thing in 2014. Um. That’s not the case now. And, uh, so if you’re going to sell a product, you’d think about who’s going to buy it, what they’re buying criteria are, you’d put some attractive pictures up now, the equivalent that the mindset shift, I think for most business owner operators, that the equivalent to pretty pictures is pretty numbers.
[00:08:08] That’s what gets financially driven by as excited and that’s what they don’t understand that the profit and loss is essentially a marketing tool at some point in the process. So maybe one, that’s one thing. One JPEG of your income statement, that’s the image, that’s the picture you send. Kind of. Well, when it comes to getting the initial click, I mean, literally, if you list your business on something like Empire Flippers, where, you know, I’m not saying it’s the best place to buy a business, but you will get like five or six.
[00:08:35] Uh, numbers and you will literally get some pictures of, uh, some products and then you will get, um, you know, some, some texts trying to make the business as attractive as possible. So it’s kind of the part of the sales documents if you want. So that’s maybe a, a more palatable way of looking at it. You know, in the end, a profit loss is a sales document.
[00:08:53] Um, Which is, yeah, there’s a long way we can go with that, but that’s the simple one. So first of all, financial metrics, Trump marketing ones is the most important. But the second one, which again, is a big tendency amongst even seriously experienced owner operators. I got people in my mastermind have been in there for multiple generations of the family [00:09:10] business.
[00:09:10] And they still tend to focus on revenue for whatever reasons. And it’s understandable and it drives everything else. I get it, but profit not revenue is really, really critical to understand that you basically cannot sell. Most small businesses, except as a multiple of profits. And certainly I think that from everything I’ve seen, that’s true in the e commerce space.
[00:09:27] And it’s so important to obsess about profit and revenue is only a prelude to profit. I think when it comes to that side of things. Yeah, totally agree. So, I know you’re a very profit centric entrepreneur, although, you know, it takes time to adjust to that. Um, I just think 1, sorry, I was going to say 1 I would prefer.
[00:09:49] I think it’s a very helpful mindset shift to think about creating the value of your business, which means the profit times the multiple really. And, you know, to get an idea, maybe even sit down with an accountant once a year and say, what do you think is roughly the value of the business? That’s a more healthy way of looking at the asset.
[00:10:03] I think that we’ve grown the revenue, therefore we’ve grown the business. Yeah. Yeah. Yeah. That’s an interesting way to approach it. Um, and yeah, I mean, I totally, I totally agree with the emphasis on profit. Obviously the. Revenue for your businesses to some degree of vanity and metric people want to say they have a seven figure business Um, because that’s a vanity statement And um, so if you’re compelled by such things then, you know, that’s what you focus But you know, that’s a little bit like, you know, don’t be fooled by your own rhetoric, you know Yeah, absolutely.
[00:10:35] Yeah had one uh client of mine. He said he had this great phrase, don’t be chuffing on your own exhaust, which is a strange idea. So in other words, don’t believe your own marketing. And by the way, the revenue is a positioning metric for buyers. I mean, and generally for people in the space to take you seriously for lenders as well.
[00:10:52] So it is important to have it, but you’ve got to recognize that for. From a business to business point of view, that’s basically a marketing number. That’s not really something you should take seriously yourself. You should make sure other people take you seriously because of it. If, if you’re like, again, it’s marketing, you know, that’s an interesting, uh, attention point there.
[00:11:09] So I guess to say what you’re saying is profit is the emphasis when you’re in the sales process. But the truth of it to your point there is that there are many, many buyers who aren’t interested in a business that doesn’t have a turnover of, you know, Million two, 2 million, 3 million. I mean, it’s, it’s just too small of a venture for them to want to acquire.
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[00:12:18] and so in that regard, it does matter, um, in terms of what you get for that business. Profit matters. Yeah. So I guess this is great. This is good. Good nuance discussion here. So I guess you could say profit drives value, not revenue. Having said that though, I want to put a third nuance on the next point, which is this, that the actual, um, we’ll talk about that later, but the earnings in absolute terms does drive the value in relative terms.
[00:12:42] So what I mean by that is this, if you’ve got a business doing a hundred thousand dollars a year in earnings, and we’ll get into what that is in a second. What does that mean? Pre tax profit, whatever you want, we can define in a second. Um, The multiple that’s going to be applied to that because it’s smaller, more vulnerable, more likely to crash and burn.
[00:12:57] There are many, many businesses like that. So it’s less rare. The multiple that’s applied to that. So the relative value of that business is lower than a business doing, say 10 million a year in pre tax profit, because it’s more stable. There are fewer of them, so they’re more valuable. Um, so there is something about the absolute size of profit, which does drive value and the revenue is a very quick proxy for that, because otherwise you’d have to sit down and do great maths with spreadsheets before you even talk to somebody.
[00:13:24] So, yeah. Yeah. The other thing, sorry, we’re our preamble is taking on a whole show of itself. Uh, but the other, the other bit of that, that’s, I think important is if you have a business that has that level of profit, let’s say 100, 000 a profit, what the implication is for prospective buyers, that you’re not done investing in that business, that you’re going to have to either be a staffer yourself or add more capital to beef up the team, because if it’s too small, it implies that it’s not a fully cooked Business.
[00:14:01] Whereas if you say, well, we have 5 million or 10 million in top line. You were like, well, you probably have a. human resources person and a marketing person and a finance person, you probably got a fully cooked business there. And so buying a business that has that level of top line, uh, you know, revenue, it, it does send a message that’s also important to prospective buyers.
[00:14:22] Which is, I’m buying a business, I’m not buying a job. Good, now that brings me to the next criterion. I’m glad you’ve mentioned that because really these, this comes down to then dealing with profit in a slightly more sophisticated way. And this is working a damn rabbit hole, but I want us to use what you just said as a sort of sanity check.
[00:14:38] So. You got to define what earnings metrics you’re going to use. So there’s operating profit EBITDA SDE, and I’m sorry to get into technical detail, but I think this matters a lot. And this is the sort of thing where a business owner operator who, until now, as you said, there’s grown maybe even a seven figure business, but now fussing about this may want to talk to their accountant to get some mental clarity.
[00:14:58] So I would say. This is my take on it. You may have a different take on it. So let’s discuss. So operating profit, I would say relatively straightforward income minus direct costs minus overheads. So we’re not dealing with tax, not dealing with interest. So we’re assuming that there’s no interest or any loans in the business at this point, EBITDA.
[00:15:15] So it earns before interest tax depreciation amortization is all of the above minus appreciation amortization. So in other words, you’re stripping out the non cash costs. Now, the important thing is everyone talks about EBITDA. When they’re talking about businesses doing maybe a million dollars in revenue and maybe whatever, a hundred thousand, two hundred thousand dollars in profit.
[00:15:34] Now, I think that’s just an inappropriate metric because of exactly what you just said, because a bigger business, you can apply a bit dirty because they have got their staff there and you’re not buying a job. You’re buying a business. Whereas SDE, seller discretionary earnings is basically the income minus direct cost minus overhead, whatever, but then it includes the actual cost of running a business because often the owner operator isn’t really paying themselves properly.
[00:15:59] And this is, you know, not at a market rate for managing a business full time. And this is where, you know, whatever number, whatever. Num, name, sorry, is the word I’m trying to say. Whatever name you use for it, S T E E B H R, whatever this smorgasbord of terrible acronyms and abbreviations. Really what I would say is earnings after you’ve paid for management is really important if you want to buy a business.
[00:16:24] Equally, there’s a lot of people out there who are happy to buy a job. So that’s where the market really splits in two. And I think it’s really, really important to be clear minded about this and, and think this all through, it’s quite complex. Yeah, yeah, no, I mean, it makes a ton of sense when you just think about what’s leaving when you buy the business.
[00:16:42] Yeah, absolutely. Yeah. What’s leaving is the prior owner and what roles did they play? And you know, if they were the CFO and CMO and CTO. And they’re leaving, you’ve got three, you know, three roles to fill. Well, so there’s implication there for expense, you know? Uh, and so you, that’s kind of a way to look at it is, uh, what, what’s leaving when you, when you sell the business and is there replacement dollars in the budget to rehire those people?
[00:17:14] Yeah.
[00:17:17] And is, you know, what, what’s this a fair value of the business, if in fact, the. You know, prior owner is doing four jobs. Well, are they paying themselves for doing those four jobs and you know, like, yeah, that’s, that’s the tricky part of it is, you know, how do you establish valuation when, uh, they, they may be, they may be paying themselves, um, fairly, but they may not be.
[00:17:39] But nonetheless, there’s a pile of money there that they would consider to be profit that they’re withdrawing. And the question is, can you run that business going forward, uh, you know, in the same way. Uh, you know, you know, after buying it fairly, and those are the, that’s the hard part of evaluating a business is kind of got, uh, staffing co mingled in with, uh, the, the income and the expense.
[00:18:02] Well, let me put it this way. The owner staffing, you know, the owner staffing. Got it. So a couple of points on this. And this is a really, really critical point. By the way, we’re getting into the complicated stuff up front somehow, but that’s fine. I mean, this is really the stuff you’ve got to sit down and, and really think through and educate yourself, talk to brokers, talk to your accountant, talk to other people who [00:18:20] sell businesses and really get a handle on because here’s, here’s my thinking.
[00:18:23] So most people are more familiar with property or real estate as you call it in the States, ironically, because we have royalty and you don’t, but you know, property, whatever houses, condos, flats, um, Broadly, there are often more than one set of buyers for any entity or asset. That’s true for businesses, due for real estate.
[00:18:39] So let’s take real estate as a simple example. I’ve got a property that I own that I let out of real estate. It’s a house and there are two distinct pools of buyers for this, which is quite a good. Simple metaphor for business setting. Uh, one is people who want to buy it and live in it. And that’s a bit like people who want to buy a business and operate it.
[00:18:58] Um, the other one is landlords. In other words, people who want to buy a business and and have it operated for them. They will pay different money. In fact, the money for this i’ve been had it valued by an estate agent. The money that a person who wants to buy this property for was 200, 000, about 240, 000.
[00:19:13] The money that a landlord would buy it. If I have a certain type of license, which I can’t get at the moment would be about 245, 000. So there are two different markets. So that pushes the average kind of market value of that house up if I can sell it to landlords so that to put it, to boil it back down.
[00:19:30] Um, for business owners, if your business can be operated without the new owner being present, that gives it a much broadest field of people who will be interested in buying it and therefore pushes the valuation up. In my opinion, that doesn’t mean you can’t sell it as a business that demands an owner operator to sit in it the whole day and work it.
[00:19:49] But that, in my opinion, reduces the size of the field of buyers and thus pushes the value down. That’s my take.
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