Buying highly profitable online businesses requires a specific methodology or rating system to ensure consistently high returns while minimizing risks.
For anyone who has been shopping around for an internet business, it can be overwhelming to see the thousands of listings that exist at any given time.
If I do a search today for an e-Commerce business for sale, I will find over 50 listings from various brokers and sites and the valuation will range from less than 12X to well over 48X multiple on monthly earnings.
There are a lot of good online businesses that are overpriced and many terrible ones that seem attractive due to low multiples.
A rating system or methodology forces us to be less biased in our review of each opportunity and allows the data to help us invest in the right type of business. It also creates consistency in our investment approach and reduces the emotional factor.
When that rare perfect opportunity comes along, a sound rating system can allow you to act quickly and with confidence to strike a great deal.
Rating System
The rating system I use takes into account a number of important attributes in each deal and rates each attribute as a -1, 0 , or 1.
- The negative (-) 1 signifies a less desirable outcome for that attribute
- A zero signifies no impact to the buying decision for that attribute
- A positive 1 signifies that the deal scores well for that specific attribute
The sum of all scored attributes helps us determine if we should pursue the discussion further for that opportunity or if we should move on to the next one
Attributes and Scoring
Each rating system will be different for each person if properly done.
We each have different goals, motives and requirements. What might be critical for me, such as low time commitment for a deal, may not be important to someone that just lost their job. For them cashflow may be the most critical aspect of the rating system
So the list below is meant to support you in creating your own Rating system.
Here are the elements that should be considered.
– Asking Price
This is based on the budget you have to work with. Let’s say you want to purchase a site under $100K. You may start by create a scoring model as follows:
- Less than $75K = +1
- Between $75K – $100K = 0
- Over $100K = -1
The reason I would create a “over $100K” bucket even though your total budget is $100K, is because this is just the asking price. There may be sites that you can negotiate down to under $100K that are listed for $120 or more.
You want to be lenient with the rating in the early part of your review.
– Valuation Multiple
This is the multiple of Monthly Seller Discretionary Earnings that the site is selling for. Most internet businesses are around a 36 multiple (3X the yearly earning). Your rating may look something like this
- Less than 24X= +1
- Between 24X -36X = 0
- Over 36X= -1
Again, just because a site is listed above 36X doesn’t mean you wouldn’t entertain it. In many cases there could be some assets that make it well worth the extra multiple
– Years in Business
An older business is typically a more stable business and helps you understand seasonality and trending. A scale could look like this:
- 5 years old+ = +1
- Between 3 – 5 years = 0
- Less than 3 years = -1
– Hours Running the business
This one is completely subjective. It depends on how many hours you can afford to work on the business, you access to Virtual Assistance, who you can afford to hire, what you can outsource, etc.
My time is incredibly valuable to me so I rate this pretty aggressive:
- Less than 2 hours a week = +1
- Between 2 – 5 hours = 0
- More than 5 hours = -1
And for me this is real hours that I would need to work. This doesn’t include the hours that I would outsource.
– Selling Urgency (Motivated Seller)
Finding a motivated seller is a lot more valuable then finding a seller that simply wants to make a profit and is willing to wait for the right price. Rating of the seller’s motivated is a key attribute that should be a part of every scoring system.
In this case, you’re looking for a catalyst such as medical reasons, debt issues, divorce, failing partnership. I would rate those as a +1. If seller is bored or looking to retire, I would rate as a 0. If the seller wants a profit only, then rate as a -1.
– Growth Trajectory
Historical performance is usually the metric we rely on when making a valuation decision. So analyzing if the site’s is declining (over 6 months) , flatlined or on an upward trend is an important attribute.
Rate appropriately based on your goals and what you’re looking for
– Growth Opportunity
When we purchase a business, the goal is to find ways to grow it quickly (in the first 3 months). We do this to immediately increase the value of the business so incase we want/need to sell it, we have an profit or at least a cushion
The quantitative calculation for this attribute is bit subjective but you can use a rating such as this;
- Growth Opportunity with minimal investment = + 1
- Growth Opportunity with investment and 6 month or more out = 0
- Growth Opportunity with significant investment and timeline = -1
There is always a growth opportunity (new market, new product, purchasing a synergistic business, brick and mortar, new sales channel, etc) but there is always a cost of time, money or other resources. You have to determine a scale that makes sense based on your goals.
– Pride
This is the most subjective attribute but it’s important for most people. Essentially, am I proud to tell my family, friends and others that I own this asset. There are many niches that I wouldn’t want to be associated with. This might be simply a 1 or -1 scale
– Additional elements for consideration
There are a few other attributes that are worth rating such as the following:
- Growth Potential
- Chashflow
- Broker used vs For Sale by Owner
- Seller Financing
- Intellectual Property / Proprietary
- Marketing List
- Customer Base
At the end of you day, you need to determine what is right for you based on your goals.
Summarize opportunity Score
Simply sum up the score of all the attributes you using. This final score allows you to compare opportunity by opportunity and see which are worth your time and which you can park for now.
Sample Rating Spreadsheet
I can’t give you guidance on what scores should be taken to the next level as it will all depend on how many attributes you use. But typically consider that only 30% of the businesses out there are worth your time to review.
I would only working with the top 30% of the scored deals at any given time.
Iterative Process
The scoring of a deal should be iterative and recalculated at each point where more information is captured.
When I see a listing that I find interesting I will create the score entry in my system (I use Google Sheets). I take the highest scoring opportunities and request more information. Attributes that I don’t have any answers for, I rate as a 0 so as to not impact the score.
Then when I review the prospectus with more information, I take those details into account to update the scoring.
If the opportunity still scores well, I will then have a seller call and update the rating based on those seller conversations
Then I will determine based on where I land what offer to put together.
If at any stage the scoring comes back lower then the threshold I’ve created, I stop pursuing the deal.
Conclusion
The goal of introducing a rating system is to provide a general set of guidelines to help create a consistent approach to buying highly profitable online businesses
This will enable you to really see which opportunities are best across many listings. You can very quickly see the ones that are worth further inspection and time vs the ones that you can kill.
This rating system should be dynamic and the scoring should be update when more information comes:
- At the initial listing
- After reviewing the prospectus
- After each seller calls
Use the rating methodology as a constant validation that the opportunity has potential, is aligned with your investment goals and worth your time to pursue
I hope this helps you find your next highly profitable online businesses.