A few months ago, I came across a pretty interesting internet business that was for sale.
It fit perfectly with what I was looking for. It was fairly priced, there was plenty of opportunity to increase revenue, and I got along with the seller really well.
Although I was super excited about the business, after a few weeks of seller calls, due diligence, negotiations and submitting an offer, I ended up bailing.
Here’s the full detailed story of what went down…
The search
On a daily basis, I’m checking listings, my network, emails and contacts for internet businesses for sale. I spend quite a bit of time each day reviewing these opportunities to find those 1 in a 100…interesting, profitable, growing, revenue producing sites that are ideal investments for my portfolio.
A few months ago, I saw a listing that caught my eye. It was for an online education business that taught students software packages like Photohop and 3D Studio Max, programming languages like PHP and Python and Microsoft Office.
I was familiar with these sites as I had used them to learn some basic Python programming about 5 years ago.
I connected with the broker and received the prospectus with the company name on it. Incredibly enough, it was the same company that I had used 5 prior!
I felt I had a huge advantage as I already knew the way the platform worked and the quality of the training.
The analysis
I conducted a preliminary analysis based on the prospectus provided to get a sense of the how it would rate compared to the 8 key success attributes that I look for before investing in an online business. (here’s a blog that details the process).
From the prospectus I was able to gather the following critical information:
1. Reasonable Price:
Because of my NDA I need to keep the number vague but I’ll try to still make it clear. The site was getting a monthly recurring revenue of under $10K and netted under $100K of profit (Seller Discretionary Earnings) based on the previous 12 months.
The seller was asking well over $200K for the assets which was going for about a 30X of monthly SDE. Sites of this type were going for around 28X – 32X so it was fairly priced based on the claims.
2. Seller Financing
The initial prospectus claimed that seller financing was available but there was no detail provided as is often the case. This is always negotiated at the time of the offer. But I was happy to see that the seller was open to options and willing to be flexible to make the deal happy.
3. Trajectory
Revenue: They provided a very high level annual Profit and Loss statement at a yearly level which showed the 2017 revenues of about 10-20% lower than the prior year. I knew I would have to dive in here to understand what was happening.
Traffic: The prospectus didn’t speak to the traffic so I couldn’t tell if the page views and users was going up. It turns out the site had no organic traffic. They had a unique sales channel that they used for all their sales.
4. Age of Site
The site was started in 2013 by the seller, out of frustration that his university wouldn’t record the courses they were teaching and offering them online to their students.
So he built his own online directory of courses and the site was born. A site that was 5 years old was very appealing.
5. Work Effort & resource Required
The owner was claiming that they spend 1-2 hours a week on the business. This was exciting to me as I was limited on time
I knew I would need to invest a bit of time to grow the site (see opportunity for growth below) but I could do that at my leisure and could afford a few more hours a week.
It also stated that there was a technical resource that supported the site and platform to ensure that the students could log in and the courses were working as expected. This was already calculated in the costs. Since I don’t have a programming background and the individual was willing to stay on, this was a huge relief.
6. Broker
The broker was very response. I had an initial call with him based on his request (details further down). He was feeling me out and wanted to make sure I wasn’t going to waste his seller’s time.
The broker was from a smaller brokerage but had done a really good job with the prospectus and valuation so I figured he was good.
7. Seller Motivation
At this point, I couldn’t tell how motivated the seller was from the prospectus but after the seller call, that became clear. I’ll explain a bit further down.
8. Opportunity for Growth
The opportunities of growth seemed huge with this site.
- It was currently selling through only 2 sales channels in the US. I felt that there were 4-5 more similar sales channels out there that could be taken advantage of.
- I also thought the platform could at least be leveraged in the UK, Australia and Canada with no changes to the content/language. And I would even venture that it could go global.
- The seller was sitting on a database of 25,000 emails with customers and courses taken. I could do an email campaign to that base around job positions available for their specific skills, additional training courses or send them to other sites relevant to their knowledge.
- There was no SEO or content on the site to help it rank organically.
- There was no advertising on the site (could be an additional revenue stream)
- There was no spend on advertising to drive traffic through any of the big platforms like adwords, facebook, pinterest or Instagram
Needless to say, I was really excited about the potential.
The Calls
First Broker Call
This was just a vetting exercise by the broker. He has to weed out the unqualified tire kickers. He asked for my background, goals and how I would finance the purchase
I told him the details he was looking for but wanted to quickly get to the seller so I asked him some tough questions I figured he didn’t know.
Specifically:
- What other channels did the seller try to sell through in the past and why did he stop using those channels?
- What was the marketing persona of a buyer of the service?
- How many content providers were there?
- Why was SEO never a focus, were there challenges that the site encountered?
This showed I had done my research and they were open ended making it more difficult for him to answer completely
As expected, he preferred letting the seller address these and said “Let me set up a call the seller, he would happy to speak with you.”
First Seller Call
The first call was just to build rapport with the seller. You want to let them see that you are passionate about their site (you’ll take care of their baby), and that you know what you’re doing (you won’t destroy their years of work).
This is a critical step. If the seller likes you and wants to work with you, he may offer you:
- a better price,
- advantageous financing terms,
- more ongoing support
- or he may even sell to you over a better offer just because he likes you.
Remember your relationship the seller isn’t done once the contract is signed. He still needs to work with you around training, transition and earn-out and ensure the site continues to grow.
The first call was excellent. We built great rapport. I told him about me, my background, my goals, my family. I told him I was a customer (which he loved).
Turns out we went to the same university and both studied engineering. He opened up and admitted that the other buyers he spoke to just wanted to make money and didn’t have passion for the site.
And he said they couldn’t understand his engineering methodology (I’m still not sure what he meant by that but he said I understood him…good enough for me).
He concluded by saying at the end of the first call that he would love to “work with me” as a fellow engineer and saw this as a great opportunity for both of us
I was very complimentary to the success of the site so far and what he had built. And although I stroke his ego a bit, it was all genuine. The guy had done a great job.
I was able to get the following information in the first call:
- why the valuation
- Where he felt there was opportunity for growth
- Challenges he had
- His loss of passion after working this for 5 years
- He wanted $60k to buy a boat and enjoy his retirement
Due Diligence
This is where things started to unravel…
I did a number of due diligence steps, as I always do when buying a site. One of those steps I asking for was to get a detailed P&L, with screen shots to prove the revenue and expense claims.
Now, I can’t show you the exact revenue numbers as I signed an NDA but I can provide you directional information. This was the revenue trajectory for the past 2 years (yikes):
Degradation of revenue over 2 years
As I dove into this a bit further, the revenue was only coming from 2 sales channels in the last 12 months, where the year before there were 4. And in the last 3 months, there was barely any revenue coming from what was the largest sales channel a few months prior.
I also checked the site in detail and looked at the quality of the content. I noticed that many of the courses were dated. There were courses on versions of Microsoft office that had a number of new release since.
This was troubling to me. I was beginning to realize that growing this site wasn’t just about getting additional sales channels but it would require me to find new and fresher content to post. This would be a LOT of work
Second Seller call
I wanted to now probe and start getting some answers. I still wanted to keep it friendly and continue to build trust with the seller. But it was important that I got the information I needed to address my 3 major concerns:
- Content quality
- Drastic drop in revenue
- Competition, many universities now offer free course
Content Quality
The seller admitted that he had lost the passion for the business and had started working on a few other projects. He said he worked with a couple of content creators and he himself had created some of better selling content in the past.
He reviewed with me which courses were newer and which were aged. Although there was a lot of aged content he said it helped him market a large number of courses and he had a strategy for selling those that he shared with me. Again because of NDA I can’t get into that
He was willing to introduce me to the content developers to help me get them to create more content.
Overall, I felt I could manage the content quality issue but I had a concern around how much time that would take.
Revenue Drop
The largest issue by far was the revenue trajectory. I had a really hard time understanding the drastic drop in sales.
The seller claimed it was because he was no longer passionate about the business and wasn’t keeping an eye on the sales channels and their performance. He said he wasn’t putting effort in ensuring the courses were being pushed at regular intervals.
This worried me. Passion or not, if you have a site producing the numbers this did for 1-2 hours of work a week, you find a way to carve out 1-2 hours a week.
And if the activity is to check in regularly with the sales channels on performance, you can’t let that slip. A businesses value is all about it’s SDE. When that drops, your valuation drops.
It was just impossible to tell what caused the revenue drop. The potential causes that were going through my head:
- the site got bad publicity from somewhere
- the sales channels no longer wanted to carry the courses because of quality/age issues
- the platform was glitchy or didn’t provide a good user experience
- that there were a large number of users asking for their money back.
- that the price point of the courses wasn’t right
- that new competitors had shown up and taken their clients
Without clarity, I felt the risk was really high.
Either way, he was valuing the business at a 30X multiple on the last 12 months and I wasn’t going to pay that.
Competition
The seller admitted that there was definitely more competition. It was especially true for programming languages courses as many universities were giving these away for free. For the Microsoft office and businesses courses, there were a number of companies offering these for sale as well.
But the seller felt the sales channel he was selling these courses through was an advantage and he was positioned as the low price but high-volume player in the space.
Although I was ok with that since the business really didn’t have a lot of overhead, it is difficult to compete with the free courses that exist.
The Offer
I was ready to make an offer
Although there were many concerns and challenges, find me business that doesn’t. I was willing to put in an offer as I did feel there was quite a bit of potential and the seller and I really got along.
However, I was going to make an offer that I was comfortable with and that would force the seller to be engaged for the long term.
- I valued the company at 30% – 50% of what the seller wanted. I decided to go to the top end of where I was comfortable because I was going to ask for aggressive terms. I can’t provide the exact number of the valuation.
- I then structured terms to try to motivate him and reduce my risk and upfront capital
- 5% deposit (due immediately)
- 30% down at closing (after full due diligence)
- 50% monthly earn out
- Final balloon payment after 18 months
- $40K bonus structure after 18 months if certain growth numbers were hit
Considering the revenue drop, this was quite a fair offer.
The 50% per month earn-out would keep the seller engaged early on and motivated to try to grow the revenue ASAP.
Also I didn’t want to offer enough where he could immediately by that boat and sail away. I needed him on land, close to internet access ?
And finally, I had a $40K bonus structure at the end to try to get him engaged for the long term. If he would have helped me hit those the numbers he required to get the $40K bonus, I would have made a boat load of money and would have been more than happy to give him that money.
The Negotiations
When I submitted the offer, the broker called me right away and said that this valuation would never fly. I walked him through my analysis and told him my concerns. I was very detailed in showing the due diligence and valuation I was using. He couldn’t refute any of it and spoke to the seller.
Seller came back. The broker called me and said the seller really wanted to work with me. He said he loved my energy, ideas and the way we bonded. He said he was willing to align to the valuation but wanted 75% upfront.
Why I Bailed
First off, I wasn’t surprised by the counter offer. The 75% upfront was magically the cost of the boat plus the commission fees he would have to pay the broker.
I could have countered but I was never going to over 50% down-payment with this level of risk
As I continued to look at the site and do research, I saw a few comments on the internet about people unhappy with the quality of the courses. That’s not the end of the world, you can’t please everyone, but added to the risk of the low revenue, it just didn’t feel right.
I felt I was starting to get close to gambling versus making a sound investment.
So I let the offer expire and told the broker I was not going to accept the counter offer and not going to counter back.
Part of me is disappointed. I really liked the seller and the broker, I really liked the business and the opportunity but I’m about making sounds investment decisions with low risk
Learnings
From a buyer’s view:
- I preach the importance of building a good relationships with sellers early on as it really provides a lot of leverage during negotiations and after the deal is closed. But it works both ways.
I had to remind myself to look at the business independently of the relationship I had built with the seller. He was a great guy. I would have enjoyed working with him. But I had to remember to focus on the numbers.
2. Second, know the reason for the numbers. If someone gives a reason that a site is not performing and it doesn’t sound right, you have to get to the bottom of it or walk away.
When the seller’s only reasoning for the lower revenue was that he took his eye of the ball and that the selling channels just no longer pushed his product. That didn’t sound right like the complete picture so I just couldn’t proceed with the deal
From a Seller’s view:
- The relationship is critical for the seller too. I was willing to go to the top end of my valuation range because I felt I would have had a partner in this deal.
- Being open to earn-outs can put more money in your pocket. Buyer’s walk into very risky situation when buying a site as they don’t know the blind spots they are facing. Earn-outs are the only way to protect their investments. A savvy sellers that is confident in his web asset should be open to structures that keep them in the game for the long haul as they can command a higher price.
- Know your numbers and what is causing the rise and drop in profitability. If a seller shows lack of knowledge on a part of their business, buyers will either try to take advantage or be too concerned to make the purchase
I hope this was interesting and provided a few lessons along the way.
I’d love to hear from you and understand what you would have done differently. Would you have structured the deal differently? Or would you have taken the risk and done the deal ?
I’d love to hear from you..reply to this post or send me an email.