Table of Contents
Selling Your Digital Business: Everything You Need to Know
Written By Khaled Azar
Summary
Types of Buyers
Valuation
Offer Terms
Introduction
If you’re considering selling your digital business, you’re probably facing a whirlwind of questions and decisions. Selling a business is a complex process, but with the right knowledge, you can navigate it successfully. In this blog post, we’ll cover the crucial things you need to know before selling your digital business. We’ll dive into understanding your company’s worth, the types of buyers you might encounter, the variables involved in valuations, and the terms buyers might offer. Let’s get started!
Types of Buyers
One of the first things to understand is the different types of buyers you might encounter. Buyers can be categorized based on their motivations and the value they can bring to your business. Here are the four main types:
Individual Financial Buyers
- Who They Are: These are individuals looking to buy a business primarily for its profitability. They typically seek a passive income source and have access to capital but might not offer the highest valuations.
- Example: An investor with a substantial amount of savings looking to diversify their portfolio by acquiring a stable, profit-generating business.
Company Financial Buyers
- Who They Are: These are larger entities such as private equity firms or family offices. They focus on the financial performance of the business and aim to enhance their investment portfolios.
- Example: A private equity firm seeking to add a profitable digital business to its portfolio to generate steady returns for its investors.
Value-Added Individual Buyers
- Who They Are: These buyers want to actively participate in and grow the business. They see potential in your company and believe they can add value through their expertise.
- Example: A cybersecurity expert who wants to enter the market by acquiring an existing cybersecurity company to leverage their skills and industry knowledge.
Strategic or Value-Added Company Buyers
- Who They Are: These buyers, often larger companies, aim to integrate your business into their existing operations to create synergies. They typically offer the highest valuations due to their ability to enhance revenue and reduce costs.
- Example: A major tech firm looking to acquire a smaller digital business to complement its product offerings and gain a competitive edge in the market.
Valuation
Understanding what your company is worth is a critical step in the selling process. Valuation depends on two main variables: your profit and your multiple.
Profit
Profit is straightforward—it’s the net income your business generates. To get an accurate profit figure, ensure your financial statements are clean and up-to-date. If you don’t have a clear picture of your profit, it’s crucial to work with an accountant to tidy up your books.
Multiple
The multiple is a factor that varies by industry and is influenced by the perceived risk and growth potential of your business. It is determined by several value drivers, including:
- Sales Team: A dedicated sales team can indicate strong revenue potential.
- Predictable Revenue: Consistent and recurring revenue streams are highly valued.
- Marketing: Effective marketing strategies that drive growth.
- Management Team: A competent management team that can run the business independently.
- Customer Diversification: A broad customer base reduces risk compared to reliance on a few large clients.
Example Valuation
Let’s say your digital business has an annual profit of $500,000. In your industry, the typical multiple might range from 3 to 5, depending on the value drivers. If your business has strong value drivers, you might achieve a multiple of 4.5. Your estimated valuation would be:
Valuation= [Profit] × {Multiple}
Valuation = [$500,000] × {4.5}
Valuation = $2,250,000
Offer Terms
Once you have an idea of your company’s valuation, the next step is to understand the terms buyers might offer. There are four primary types of terms to consider:
Cash at Closing
- Definition: The amount of money you receive upfront when the deal closes.
- Detail: Cash is king, and it’s the most desirable form of payment. It provides immediate liquidity and minimizes risks
Seller Financing
- Definition: The seller provides a loan to the buyer for a portion of the purchase price.
- Detail: This involves receiving payments over time, which can include interest. It helps the buyer manage their cash flow and can be attractive if you believe in the buyer’s ability to grow the business.
Earn-Outs
- Definition: Additional payments based on the business achieving specific future performance targets.
- Detail: Earn-outs align the interests of both parties but can be risky if the targets are not met. They often require the seller to remain involved in the business.
Roll-Over Equity
- Definition: Retaining a stake in the business or acquiring equity in the buying company.
- Detail: This can be beneficial if the buying company is expected to grow significantly. It allows you to participate in future upside but also carries risk.
Example Terms from Different Buyers
Example 1: Individual Financial Buyer
- Cash at Closing: $1,000,000
- Seller Financing: $500,000 over 3 years at 5% interest
- Total Offer: $1,500,000
Example 2: Strategic Company Buyer
- Cash at Closing: $1,500,000
- Earn-Out: $500,000 based on achieving $1,000,000 in new revenue within 2 years
- Roll-Over Equity: 10% equity in the buying company
- Total Offer: Potentially $2,000,000+ depending on earn-out performance and equity value
Conclusion
Valuing a business accurately is a complex but essential process for any business owner considering a sale. Understanding the various concepts that influence valuation, from market position and competitive advantage to the impact of digital transformation and the importance of recurring revenue, can provide a clearer picture of a business’s worth. Business owners should recognize that valuation is not an exact science but a range influenced by many factors, including personal circumstances and market conditions. By preparing thoroughly, leveraging multiple valuation methods, and staying informed about market trends, business owners can maximize their business’s value and make informed decisions when it comes time to sell.
Questions This Article Answers
- What is the value of my business?
- What is fair market value vs. strategic value?
- How do you value small and middle market businesses?
- Why is business valuation a range?
- How does recurring revenue impact business value?