The E-commerce Leader

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[00:00:00] And then this, the other shocking thought is if you want to expand and grow the business, a lot of people will, everyone will, I guess, generally buy a business in order to grow it. Right. If you want to grow it, if you want to double the. Revenue in, it depends what you can do with the profit margins, but let’s assume the profit margins are about the same.
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[00:02:21] Okay. With all of that preamble outline, now let’s talk about the nine vital financial metrics. Okay, good. So that was, that was quite a preamble. So the first one is, uh, first KPI, we’ve already mentioned it.
[00:02:35] Absolute, uh, size of earnings or SDE or profit, whichever metric you’re going to use. We’ll discuss that to the nth degree. Um that matters for the multiples. I’ve already mentioned this just to recap. If you’ve got a business that’s doing a hundred thousand dollars a year in pre tax profit or earnings Um, it’s going to be have a lower multiple applied to it than one doing five hundred thousand And it’s worth bearing in mind that if you hear numbers floating around about the multiples in your particular industry at a particular point They are universal for different business sizes.
[00:03:02] So that’s something The implication of that is, well, you may wish to grow your business yourself in terms of the, uh, the earnings before you try and sell it, because otherwise you’re going to get quite a small multiple. So that’s the first point. Yeah, I totally agree. I mean, it’s pretty self evident that that’s the most important thing for valuation.
[00:03:23] How do you actually get to that truth together with a seller is a whole different podcast. It is indeed. There’s a long negotiation, but, um, for me, my criteria would be anywhere between about 000 at the moment in terms of SDE. And if you’re buying businesses, the obvious implication of the flip side of what I just said is if you buy businesses that are quite small and put them together.
[00:03:44] you will automatically, on paper at least, adds to the value without doing anything else, because you’ve created a bigger earnings, therefore the multiple applied is bigger. This is part of what’s led the aggregators at the Garden Path, I would say, that with the um, with the, I don’t know if that’s a metaphor you use in America, but they’ve gone a bit wrong, because they, they kind of took that as their sort of gospel, and didn’t think about the practicalities of that.
[00:04:07] But that’s another podcast. It’s such a British metaphor. The garden path. Let me interpret that for Americans who haven’t been in a lot of British gardens. So what does that mean? Like you’re going, trying to go to the front door, but the garden path is so beautiful and wrong and goes out to the backwoods and I’ve never thought about it in that much detail in my life.
[00:04:25] I think it, what it means is you’re just going the wrong, wrong path. You’re going the wrong way, basically. Yeah. Yeah. Cause the garden path is beautiful. Cotton, go to Cotton Manor, man. Go to the, uh, big gardens that are beautiful and you’ll realize, oh, the front door is a minor footnote in the, in the castle.
[00:04:41] What everybody really wants to look at is the beautiful Victorian gardens in the back. Okay. Well, I’ve mentioned gardening to a person in the gardening business. Anyway, I think we get that one. Um, KPI number two is the profit percentage. of revenue that is, and then coming back to the idea of. Revenue growth being a good thing.
[00:05:03] I don’t think that’s true necessarily at all I’ve seen businesses recently where the revenue grew a lot and the profit grew a little And that actively made me not to want to buy that business And there’s another one that had a similar situation where I was advising a client of mine and I said that’s not good So I think the revenue in one case went up a hundred thousand dollars a year and the profit went up ten thousand That’s terrible.
[00:05:25] And so the profit percentage trend was really down there and that’s extremely worrying for any potential buyer. And I think it should be worrying for any business owner, but business owners tend to be focused on absolutes, not percentage. So just to state it clearly, the percentage of profit as a part of the top line revenue.
[00:05:45] Yeah. I mean, a million dollars and you’ve got. Sell a million dollars and you’ve got a hundred thousand dollars of profit. You’ve got a 10% Uh, exactly. Yeah, I mean and it’s often as as a percentage of of net revenue net of refunds But then it’s going down the rabbit hole the same basic idea applies I I would say personally again If i’m going to buy a business i’m looking at least 20 percent ste that is to say before any management costs are involved Um, I would say also that sadly a lot of my client businesses have been up at 20 or even 30 percent in the last couple of years in the pandemic times when e commerce life was good are now seeing 10 bottom line without accounting for their own management costs in some cases.
[00:06:26] So quite a lot of businesses that the owners of which think they have a profitable business once they start accounting for their time properly. Realize they’re basically running at breakeven, which is a very sad realization, but it’s certainly something you’re going to have to discuss a lot with a potential buyer.
[00:06:41] A lot of people just walk away if it’s not got any real profit in it. So reality check, unfortunately. Yeah, I guess it depends on the way you look at it. So here’s the case for buying a not profitable business. Let’s say there’s a 3 million, 5 million business that’s not profitable that somebody wants to sell you.
[00:07:03] It’s infinitely easier to steer a moving ship or turn an airplane that’s falling gently to the ground than it is to get the airplane off the ground. Now, you know, I mean, if you, if you’ve got a business that’s doing. You know, let’s just say it’s doing a million dollars in, in top line revenue. It’s not profitable at all.
[00:07:27] You get that thing, 5% profitability, that’s 50, 000 a year. I mean, big doors swing on little hinges. So the fact that somebody needs to sell that kind of business, they know it’s not going to be worth hardly anything. And then you’ve got an opportunity to manage your way into a super fast and efficient path for.
[00:07:51] Um, for, for success, uh, I, if you ask me, which would you rather start a business that you make profitable from day one and get it to, uh, seven figures in top line revenue or buy a business that’s got seven figures of top line revenue that has no profit. I would take the second one every day, you know, I mean, there’s other factors involved, but you get the point.
[00:08:13] It’s like, it’s good. You got a spaceship. You’re already up in space. You know, so that’s, that’s the case for it. Um, now, if you’re, you know, if it depends on, it depends on obviously many other factors, like, do you have a thesis? That you could apply that would make it profitable. Can you see a path towards profitability?
[00:08:33] Can you see the clear error in the operator’s ways? Maybe there’s clear reasons why they’re not profitable that are obvious to them and you. Uh, and on and on. So that’s an extremely good point. I mean, quite a lot of people do. There are people that specialize in that. Place called the Harbour Club, which I’ve not joined because it doesn’t attract me as a business model, but they specialize in buying distressed businesses, which is to say that you might, if a business has got debt as well as as revenue, but no profits or no cash flow with which to pay the debt off.
[00:09:05] Um, and that sounds like a lot of public utilities are like that in the States. And certainly in Britain, I mean, Thames water, for [00:09:10] example, has been that they unfortunately supply our water and they basically are kind of broke after I paid their shareholders and they paid for their debt. But, um, if you’re going to do that, I would say that’s probably worth a pound or a dollar if you’re buying the debt as well.
[00:09:24] I’m not sure that’s a very valuable business. Well, to your, to your prior metaphor, imagine if you were a landlord seeking a property. And the person wanted to sell you the property and they didn’t have a tenant, they had no income. It was just, just the building you’re going to, you know, you’re going to pay one thing for it.
[00:09:44] But if you’re buying it and it had a big tenant in it, let’s say it was a commercial building. Yeah. And it had a big, huge tenant in it. Well, which would you rather, well, if you’re a bargain shopper, you’d rather buy the one that didn’t have the tenant at a bargain price, get yourself a tenant. And then you’ve got a, you know, much more, a valuable asset.
[00:10:03] Absolutely. Absolutely. So that’s the way to look at a business that doesn’t have profit. I think I’d agree with that. It’s interesting that if you want to bring other people into the equation, particularly if you’ve got equity investors, they would need to be people who are quite risk on and up for that kind of journey.
[00:10:20] And they’d have to trust that you have the insight and the operating chops, if you like to, and or team to turn it around. If you’re looking at lenders, they will tend to be based there. They’re more conservative about that. It’s to be really hard to get a loan against something which hasn’t got positive cashflow.
[00:10:37] Doesn’t mean that it’s impossible, I guess. Yeah. Interesting. I mean, quite a daring way of looking at it. Let me embellish it one step further. And that’s the idea that, um, there’s two reasons to buy a company. One is for cashflow and the other was for a strategic purpose. So, you know, let’s say you’ve got a business that has good cashflow.
[00:10:58] Well, you know, you don’t need to buy another business that has good cashflow. But if you bought a business that had no profit, but they had a string of amazing products that you would take control of that are bolted on strategically to your existing business, then, um, you know, that’s, that’s, that’s what people call a strategic, uh, you know, add on.
[00:11:19] Um, and, and so buying a business for that purpose for the strategic add on of the value of the assets, the products, the brand, uh, on and on and on. Um, you know, that’s another reason to not necessarily, um, eliminate businesses from your list that don’t have profit. If you’re in that situation, you know, if you’re in the mood to bolt something onto what you’ve already got, so there’s, so there’s quite a bit of nuance here.
[00:11:42] Number two, this is why the whole business of buying selling business is so fascinating because there’s so many nuances. I’ve got to have a logic to them, but there are many different ways of slicing this. Well, look, we, we, we said we, we get through succinctly, but I think it’s good to discuss in detail.
[00:11:59] But let’s get to the next one. So the next one is a profit trend year on year. And it’s. The last few months. Now, if you’ve got a business that quite a few I’ve looked at recently, um, the profit and loss is only two years old or three years old. So you can’t see much of a trend to be honest, year on year.
[00:12:13] But if the last few months are going down again, you know, this could be a great opportunity, or it could be a reason to run for the hills, depending on how equipped you are to turn businesses around and what you think drives it. The only thing I would say about turning around a business based on specifically on the Amazon platform.
[00:12:29] Is this and this doesn’t apply more university necessarily, and you’re all your points are extremely valid. I take them all. Um, often the lack of profitability on Amazon is symptomatic. If you’re going into marketplace that you cannot dominate because it’s already got somebody else in it. Now, that’s the sort of profit and loss.
[00:12:46] This is where the profit and loss and marketing metrics need to be. Create a picture as a whole, because you can’t just work on the financial statements. I would want to look at the market and the keywords that people are after, how big the markets are, and what sort of market share that a particular company that I’m considering buying would have.
[00:13:02] Um, but often I would say that if there’s just a downward trend in profits, it could be several unsavory things, all of which would be out of my control as a new business center, which would be, um. Pressure on consumer discretionary, um, spending, which is really terrible in the UK right now, because we’ve had big interest rate rises rises on top of big inflation, which is they’re struggling to control particularly here.
[00:13:21] UK is worse than mainland Europe, which is worse than us, although. everywhere. So that’s a pretty nasty trend. Um, again, it doesn’t mean you shouldn’t buy the business, but you’ve got to make sure you buy it for the right amount. If you’re buying it at the bottom of, uh, if you think getting towards the bottom of a trend.
[00:13:34] And then there’s of course, whether your product has been swamped by the competition, which is super hard to reverse. Again, it can be, but I see a lot of optimism around that from product creators and not much reality of. Turning things around there and less you are on the, on the cusp of turning it around anyway.
[00:13:52] So that’s all I would say to that. I mean, I take that one quite seriously, the trend thing. Yeah. There’s so much in here that immediately goes into a whole different bucket of, uh, you know, conversation, which is non financial. Absolutely. And so we have a different podcast from when it do that are all about the non financial elements of evaluating a business because what you just mentioned triggered three or four things.
[00:14:15] That are, you know, the age of the business and the competition space and how well, you know, the category and on and on, you know, those, those are worth thinking through, you know, separate from the financial related year over year, uh, profit or not. Absolutely. Yeah. But I would say again, like if you own a business, if you buy businesses, you’re going to have some kind of, uh, way of fairly simply.
[00:14:37] In quickly eliminating things from your inquiries, because there are hundreds of thousands of potential businesses, and equally, if you’re selling a business, you’ve got to be aware that you’re going to be, it’s a bit like a CV or resume being, um, sifted by an HR department somewhere, you know, in theory, they should interview everyone and take everyone equally seriously.
[00:14:53] But in practice, if you don’t have certain things on your resume, you may just be eliminated up front. And if your business has a downwards trend in profit, generally speaking, you’ll find it listed on broker sites for a much lower multiple. Um. And will be harder to sell, which doesn’t mean it can’t, but it’s just something you’ve got to be aware of that people will simplify what, as you say, is actually a very nuanced thing.
[00:15:12] Most people will simplify it. Um, including me. I mean, I prefer to see a steady or small growth year on year. I I’m not so keen on declining ones. If that Amazon focused in other spaces, I might see that a bit differently, I guess. Yeah. Um, the next one is, is where everyone will argue for the next 10 years or let’s literally months anyway, which is the profit multiple or the initial expectations.
[00:15:32] Something’s listed for, if I see a business that I’ve seen, for example, um, it’s doing about a hundred thousand dollars a year in revenue. Um, The price points average, and this is another one, but with the low average price points and other various things that are pretty mediocre, and they’re trying to sell it for five or five and a half times annual profit, then I just think they’re not serious and walk away.
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[00:16:43] other people might be more patient and willing to knock you down, but. That starts to feel like that sort of silly bargaining situation. You can get them with the South Asians. I’ve been in before where they say it’s 15 and you end up with it being three. It starts to feel like, how seriously can I take this person?
[00:16:57] So what’s the clearest way to express this? So great question. The profit multiple is something to consider when you’re buying the business and the profit multiple in your mind, that’s. You would consider to be appropriate for, let’s say a seven figure Amazon business, seven figure Amazon business, uh, that has, let’s say a hundred, 100, 000 of profit.
[00:17:21] Yeah. What’s an appropriate multiple for on that 100, 000 of profit. That is a great question. I actually have some, a spreadsheet that I created for a client about this. But, um, it’s, I wouldn’t say it’s absolutely perfect. I would say a really perfect business, um, that is doing under, you know, about a million dollars or something.
[00:17:40] I’ve seen a business that a client had, it had 30% pre tax profit, um, which is SDE, but nevertheless, there wasn’t much management time needed. It had 20 products. So that was a nice spread. There wasn’t too much concentration risk. Um, it’s, uh, sourced in UK, sold in UK. So the working capital requirement was lower, which is one of the other criteria.
[00:17:58] I should have put this one later because the multiple is one number, but it implies so many different metrics. So just to be clear though, there was top line sales of a million and 300, 000 of SDE. Yeah, it was actually two different businesses, but they sold them to the same people. So yeah, and that sold for five points.
[00:18:14] I think one was sold for 4. 5 times and one for 5. 5 times, so about five times profit. [00:18:20] So, and that was at the peak in January last year. So, if we take that as the absolute peak for a business of that kind of size, if you’ve got a business doing 10 percent, and which demands a lot of working capital because you’re sourcing from China, selling Europe or US, which is standard for a lot of.
[00:18:33] Physical product businesses, um, and the price point is not that great. And, you know, then you put a few things against it, then you’ve got to see that it’s not worth five times. I mean, how much is it worth? That’s the argument you’re gonna have forever in a day, and that’s hard to be objective about that isn’t objective.
[00:18:47] In the end, there is unlike property, and I’d say this is an important one to bear in mind with a small business. There is not really a liquid market for small businesses. In many cases, there is no market and most businesses that are listed with brokers in most small businesses. I don’t know the stats specifically for e commerce or Amazon businesses, but most of them just don’t sell.
[00:19:07] I think it’s about one in 20 for the last few years. Now that may be off by several, by, you know, by quite a lot, but that gives you a flavor. Um. Whereas if you got an apartment or a condo or a house, generally, at some point, you can put a value on it by comparing it to the multiple very, very similar properties in the same area.
[00:19:25] You can’t really do that neatly with, uh, most small businesses. And so there is not really much objectivity about the multiple, which is why everyone argues about it forever. And the truth is. A business is worth what somebody will pay for it. Exactly. So, and never more so than with a really small business.
[00:19:40] I mean, once you get up above 10 million STE, then, you know, you’ve got private equity companies and trade buyers fighting other businesses. You have multiple people trying to buy a business that gives you a bit more of a liquid market. There is a little bit more of an objective value to it, although. It still gets crazy.
[00:19:55] I mean, even for example, Skype was acquired by Microsoft for, I believe a thousand times a month, um, annual earnings, which is insane, but it’s because as you said, they believe they could crop, cross sell and upsell down sell all day long. So even there, there’s no really objective criterion. So you’ve got to get your head around that as a business owner or a buyer.
[00:20:12] I think that that’s incredibly negotiable. Yeah. Yeah. Okay, great. What’s number five? Number five, working capital requirements. And this is really, really important. And this is awkward to calculate and awkward to, you know, to figure out. And you can argue, but it’s really, really critical. If you’re importing from China or India and you have to have effectively about six months worth of stock and you have 10 different skews, that implies a certain amount of money that has to be tied up and the business owner cannot use for other purposes.
[00:20:41] Um, so that’s really important. People don’t think about that enough, in my opinion, either as operators or let alone when they’re buying businesses. And, but if you, if you ignore that, you can have a very, very rude wake up call. Um, as one of the things I was pointing out to a, a business buyer, he’s a savvy guy, sold his own business for, you know, good money, several.
[00:20:59] Uh high six figures and but he wasn’t in the e commerce space before and he wasn’t really aware of the huge working capital requirements You have to account for so for me, that’s absolutely critical uh number to look at because You could buy the business and think hey, I I funded the transaction or i’m making payments to the Prior owner or whatever, but then it’s like, Oh, I need 87, 000 for a container of stuff next to at least.
[00:21:27] And then this, the other shocking thought is if you want to expand and grow the business, a lot of people will, everyone will, I guess, generally buy a business in order to grow it. Right. If you want to grow it, if you want to double the. Revenue in, it depends what you can do with the profit margins, but let’s assume the profit margins are about the same.
[00:21:43] Then you’re going to double your catalog most likely. And that means you’re going to have to double the working capital requirements. So you might be looking at a half million dollars in, in additional capital requirements in the first year or two, depending on how ambitious you are for a so called small business.
[00:21:57] um, and these are not casual things. And in the buying and selling transactional process demand. Or requirement is almost like a ghost in the machine. Like if the seller didn’t say anything about it and the buyer didn’t ask anything about it and the buyer is like, I got a business. And then they don’t think forward three months or six months or nine months and ask themselves the question, how much cash do I have to have?
[00:22:26] The seller is like, see you later. Goodbye. You know, that’s, that’s your problem. Absolutely, caveat emptor, right? Buyer beware, and particularly true for buying entire business. If you don’t do, if you don’t get financially literate if you’re on the buying side of it, you’re really asking for trouble with the e commerce.
[00:22:44] I mean, certainly if you’re importing hard physical goods, I know that e commerce includes digital goods like you guys have, which is completely different and a lot less scary. And you can buy and sell in the UK and that’s a lot less scary as well. But yeah, the numbers get big quickly. And what you need to do is a cashflow projection of some description.
[00:23:00] and I don’t expect most people to be equipped to do that. You need to have an accountant do that. But if you don’t do that, you are effectively buying. It’s almost like, I don’t quite like buying other things. I’m here’s my metaphor. It’s like, you’re buying a train or you’re maybe you’re buying a bus or a coach or some big vehicle that’s already in motion and you’re stepping onto it whilst it’s emotion at 60, 70 miles an hour.
[00:23:24] If you don’t have headlights on and you don’t have a map of the territory, you could go careening off a cliff. There you go. It’s my totally overstretched metaphor for the day. Or better metaphor. If you don’t have. Enough money to buy gas for that bus. That’s the next time it needs to stop at the gas station.
[00:23:42] You’re not going to stay at the bus station. That’s a much less dramatic metaphor. I got a good bus, but I can’t leave. I can’t make it move. Yes. You’ve gone on the bus whilst it was moving. The owner sort of got off the bus and like, you know, speed style, like Keanu Reeves onto, you know, somehow. And then, um.
[00:23:58] Yeah, yeah, exactly. You wanna have gas and that is joking apart. That is a very, very real risk. I, I see that with existing businesses all the time. They grow and then they hit the wall. I’m like, yeah, just ’cause you need another half million dollars of capital injected if you’re gonna grow based on your current profit margin.
[00:24:13] Now of course, if you can change that, you change everything. But as we discussed, that’s not easy to change, particularly if you’re in a brutally competitive price comparison environment like an Amazon marketplace. Other. Other situations may vary, you know.
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