How To Evaluate a Internet Property Part 1 – Payroll

FinancialsRecently when I had free time on airplanes I started writing about how to properly evaluate an internet property. The writings got so long thought that I thought I would put it into a book. But now experiencing all the pains of writing/publishing a book I am just going to release it in a series on my blog.

I get a lot of email asking for site evaluations or if they should sell their site or how much… etc.. Through the years I have purchased and sold probably 500 different Internet properties. These properties can be anything from just simple parked domains to full blow advertising networks and price ranges from $10 to Millions of Dollars.

I have also consulted for Accounting and Law firms in the Omaha and Lincoln Nebraska area in valuating an Internet properties worth. Basically when I valuate these companies/properties they just give me all the financial and history I need for my valuation but never tell me why they need the valuation. So while I give them an accurate valuation of what I would pay for the company its not necessarily what they should sell for.

So here is my guide to website valuation.

Financials are of course a huge part of a website valuation. A company can be grossing millions a year but only profiting a few hundred thousand or even only a few thousand. Many factors come into these costs.

When most are thinking of a website just see the end numbers. What is the gross and what is the expense that gives you the profit. There is a ton more to think about.

Payroll: Most of these companies might be a 2nd source of income in which the owners are not paying themselves a salary or at least a not very realistic salary. This is one of the biggest mistakes people over valuation in companies. If it’s a smaller business/website the current owners are probably doing all of the accounting, legal work, labor, hardware/server administration, computer programming, product fulfillment, customer service and various other day-to-day tasks. Closely examining these items should play a very large role in your valuation of this company. Are you able to do all of these tasks? Most likely you are not. Let me give you a real world example of a valuation I recently did for a company that was selling Remote Control Cars on eBay. (it actually was not remote control cars but I will use that to protect what he does 😉 )

A former attendee of my Elite Retreat conference called me out of the blue one day and asked if I would give his business a proper valuation. The whole business was selling Remote Control Cars on eBay and it was a 100% drop shipping business. She was a stay at home mom and it began as a hobby. The whole thing started because a local independent department store went out of business and had a ton of these RC Cars. She had done a lot of research on eBay finding out what these were selling for then decided to purchase the lot from the department store. She raked in quite a return on her initial investment and used that money to start purchasing these RC Cars from local stores and around the Internet to then resell on eBay. Over the next couple years she started to learn everything there was about RC Cars. They wanted to build the business bigger so they took on the drop ship model. They would buy at wholesale prices and drop ship directly from the manufacture. Now they had a scalable solution and even though the profit margin had narrowed they could do a much larger volume of sales being that these products were always in stock and not just when they found them at a closeout or special prices. They were doing hundreds of sales a month and because of there grass roots experience they could offer customer and technical support to their clients. They also had a huge advantage in that they could up sell various add ons because they were so familiar with their products. This also led to them having a huge returning customer base that would buy from them just because they had piece of mind in knowing that they could call for help if they needed to and also they could easily purchase add-ons that would work for their RC Cars.

Ok now that you know all of that lets look at some of their financials. Over they last 3 years they are averaging gross revenues of 2 million dollars per year. They have 1.85 million dollars of expenses total, which leaves 115 thousand dollars a year in net profit. Not to shabby right? Now a idiot would valuate this company based on that profit number x 5ish and give this company a 500,000 valuation and call it a day. But that is not a very accurate valuation.

In order to give it a good evaluation I needed to dive deeper into what was going on. I asked Jamie how much time it takes to accurately run the business. How much time for customer support? How much time for accounting? How much time for shipping? How much time for posting eBay ads? How much time for posting feedback and other misc tasks? All these things are EXTREMELY important for a proper valuation (as I will show in a minute).

The answers I got back are really important for the valuation. She told me she spends an average of 20 hours per week answering customer support emails or questions via the eBay site. These emails and/or questions come in all days of the week and at any time. She also explained to me that sometimes not answering these emails could cost them a lot of money on an eBay auction or eBay store sale. She said she has them all go to her blackberry so she can answer quickly no matter where she is. She also told me she spends a minimum of 10 hours per week on shipping/fulfillment. While most of it can be handled electronically if there were issues it sometimes took as long as 24 hours to hear back from the supplier. As far as posting the eBay ads she said that took less then 1 hour per day. She posts ads on eBay every day but can schedule them ahead of time. The same was true for her eBay storefront. It took sometime to setup but after setup it was good to go. Jamie told me she contracts a 3rd party to do her graphic design that is a friend and does not charge her. In exchange she uses her account and her incredible feedback and reputation to sell his products for him. The thing that took up most of her time though was the accounting. She spent a average of 25 hours per week dedicated to keeping the books straight. Then I asked if there was anything else. She said she spends a lot of her free time on competitive research and looking for new products to add to their inventory. She also spends a lot of time trying to get better deals on existing products in order to increase their margins. She also went on to say she spends countless hours researching the Internet reading forums on what other eBay sellers are talking about in regards to saving money on fees and writing ads that convert into better sales. I asked her if she could somehow put a average per week on this misc stuff and she told me probably at least 15 hours per week.

So now lets look at this.

25 hours a week for accounting.
20 hours a week for customer service.
10 hours a week on order fulfillments.
7 hours a week for placing orders.
15 hours a week on misc stuff.

Total = 77 hours per week.

So now lets take 77 hours X weeks in a year (52), which gives us 4004. That is the total number of work hours per year this business takes. Then if you divide the profit (115,000) by that number (4004) it tells you the hourly values of this labor before it becomes non profitable. In this case that number is 28.72.

That is a very important metric. Being Jamie was not taking any salary what so ever for doing this 77 hours per week of work we have to put some sort of valuation on it. The 28.72 number is VERY important because that is the amount of money that could be spent per hour on labor to do these tasks before there is no profit…

Now depending who you are or what you do this metric is good or bad. If you are a person already very busy and not in the eBay/RC Car business this means you are going to have to hire someone with at least some eBay experience and hopefully with drop shipping. And you are most likely going to have to pay that person… lets say 20$ per hour. Now your profit just fell drastically. A company that was profiting 115,000 per year under your adapted business model is now only profiting roughly 35,000 per year.

I will show my math:

$20 per hour x 77 hours(hours per week) x 52 (weeks in a year) = $80,080. Now take the total profit per year of $115,000 minus the new payroll expenses of $80,080.

This is pretty much based on paying 2 people to do the 77 hours worth of work per week. If you only paid 1 person that person would be severely overworked and also you would have to pay them overtime (usually time+half) which would mean your profit margin just fell quite a bit more.

I am not going to get into the experience and knowledge and valuation of those quite yet. They will come later in this guide. This is strictly payroll.

Now lets look at the reverse of this. Lets say you already were running a drop shipping business on eBay. You already have the staff and experience in doing exactly what she is doing. Therefore the payroll expense is very minimal if any at all.

Now you see perhaps what roll payroll plays in a valuation. Its VERY important to do research in this area to give a proper valuation.

Also its important to know that if you are selling the business be as accurate with these facts as possible. While it might make the business look better to fudge numbers or to conveniently not include numbers that might not make the business appear as profitable to get that big payday, the new owners will soon discover what you did not tell them and most likely file suit for you misrepresenting the company. And that will suck for you. Not only will you have an enormous new legal expense but could possibly back to square one with a lot of lost revenue and time. So just be honest.

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