Many potential buyers ask themselves this question when they are considering the seemingly high cost of an online business purchase. The average monthly net profit multiple is affected by many different factors, but as a general guide the purchase price is usually around a 30x multiple. As a simple illustration, an established online business generating a dependable monthly net profit of $10,000 will typically sell for around $300,000.
This multiple equating to, in some cases, as much as three years of the foreshadowed profit naturally causes buyers to pause for thought. Why not invest a much smaller amount building a business in the same general niche from the ground up?
It’s a lot to do with time
Yes, the short answer is time, in two different senses. Firstly, there is the significant period involved in building the business from scratch given the basic requirements for clarification of the niche and precise product or service focus, establishment of the site, the creation of content, the development of relationships and formal agreements with suppliers and content creators, the building up of a critical mass of customers or subscribers and the attainment of a recognised brand presence with a reputation of trust. During this lengthy establishment period there will still be significant outgoing investment, although obviously lower than the alternative of a straight-out purchase price, and with initially little or no cash flow in return. Secondly, the establishment phase will also require an enormous input of the developer’s time on which it is essential to place a dollar value. This valuation will depend, of course, on the individual circumstances of the business owner. For investors whose time is scarce or of high value if deployed elsewhere, then starting a business from scratch makes no sense at all – unless the vision for the business is highly original with virtually no existing equivalents.
Advantages of buying an existing business
By contrast, there are numerous advantages to buying an established business. Provided the business can demonstrate reliably audited income, expenses and net profit figures, along with levels and sources of traffic, then there is proof of concept from the outset of the acquisition. This certainly doesn’t apply to any totally new business, regardless of the level of confidence the developer may be feeling. An existing business when acquired should come with the primary domain, all files and codes including product or service codes, transfer of agreements with product or service suppliers including content producers, verified email accounts of customers or subscribers, and marketing methods including social media accounts.
The expertise of the seller as support during the transition period should also be part of the purchase agreement. If an earn-out provision is negotiated this will provide additional confidence in the viability of the underlying business performance and in the continuation of the seller’s active support for the agreed period, as well as somewhat reducing the payment required outright at the transfer date.
Barriers to success if building from scratch
Unless your online business concept is genuinely very highly differentiated from existing businesses in the space and you believe on reasonable grounds that it will meet a significant unmet need or want, then it makes little sense to invest some of your money and more importantly enormous amounts of your time to build the business from scratch. There may also be significant barriers to successful entry into existing niches. ‘Copycat’ barriers are largely informal but nevertheless effective through searches favouring established businesses and those with existing agreements or affiliations with the larger service suppliers. Industry registration standards and other regulations or terms of service agreements can effectively put a moat around well-established online businesses against which you would be attempting to compete, so that it becomes more difficult to simply enter the field and replicate their offerings.
The only good basis for building an online business from scratch is that both of these two following conditions apply. Firstly, the concept is unique and not simply an emulation of an existing successful business. Secondly, you are confident that you have the expertise and most importantly the time to build it. The actual cost of this time, which could be spent on alternative pursuits, needs to be realistically valued. If your primary reason for building a business from scratch is that you simply cannot afford a purchase, then it’s important to ask yourself whether you can afford the long hours, the delayed cash flow at the same time as the necessary establishment costs are invested, and the perhaps exciting but nevertheless highly stressful processes of establishing your website and systems, sourcing product or service inventory, developing a customer or subscriber base, creating business relationships, developing fulfilment systems and building a brand and its social media presence. Sure, it’s initially a lower financial outlay but a massively greater time and effort investment, with little or no cashflow for a prolonged period and no guarantee of success.
The case for buying
On most counts it’s clearly better to buy than to build from scratch. And of course this doesn’t exclude building further on the existing business performance so that the asset continues to grow in its eventual resale value. If feeling a little daunted by the seemingly high purchase price of an established business, never overlook what is taken for granted by traditional investors: it’s the potential capital gain value on eventual resale which is as important as the regular profit returns. Additionally, while a greater outlay is required for buying than for building from scratch, a financial loan if required is generally much easier to source for an established and proven business than for a new and unproven online business proposal.
As always when buying any business, whether traditional or online, doing the due diligence is essential. It’s not just a matter of checking on the revenue, expenses and profit figures. It’s equally important to thoroughly evaluate the agreements and systems already in place. It may be difficult or even impossible to change unfair agreements or inefficient systems which are in place once you have taken control of the business. So, ensuring that the level of control over change which you will have is sufficient for your plans for the future is a vitally important detail, although one which is often overlooked in the intense excitement of an online business purchase. Just a little extra time invested here will allow you to sit back and enjoy your income stream and future capital profit with confidence and, if you wish, little ongoing time demand after settlement and transfer is completed.