Website Valuation

A guide to valuing your web site.

Introduction

Valuing an internet business is somewhat different than a traditional business but there are still guidelines that can be followed. Like all businesses, sales and profits are key numbers to consider but you still need to be able to break down the business and look at it's components. The prices paid for different websites vary tremendously based on the type of site and the type of activity at the site and other factors because not all traffic has an equal value.

Valuation Models - Fiancial-based

Multiple of earnings - This is where you take your annual earnings and multiply it by a certain number. Large publicly-traded internet companies Expedia, Google, marketwatch.com, and thestreet.com trade at market multiples of anywhere from 8 to 30. Lower multiples apply to smaller websites.
Discounted Cash Flow - With this model you take all the projected cash flow from future years and discount them to the present. Since you can't always project cash flow far into the future you may want to project only for a certain number of years into the future.

Valuation Models - Traffic-based

Multiple of unique monthly visitors - Some people value a site based on putting a value on each unique monthly visitor because they take the view that the individual visitors are the ones who give the web site value. This method is flawed when it comes to measuring sites accross different categories because it assumes that visitors in different categories are worth the same amount of money.
Multiple of page views - This view is based on the fact that each page view is considered 1 impression of a banner ad and since you know what your ad rate is (the amount of money you charge per page view) you can you can value the site by multiplying your ad rate times the number of page views you get. This is a very commonly used metric and a good one if the site is running ads and not selling products or doing affiliate marketing. It should be used to value content sites (like About.com) because they make money from ads. An e-commerce site though should be mesured using a multiple of earnigns or a discounted cash flow method.

Small Website Valuation and Market Inefficiencies

Small and medium website purchases are one of the biggest investment opportunities available right now because the market for small websites is an inefficient market where many of the sites are selling for a discount to their true value. The reason for the inefficiencies, in my opinion, is based on supply and demand. The low cost of entry associated with starting a website these days has led to an environment where there is a big supply of websites that are completed but not popular.

When these webmasters decide to no longer own the sites they attempt to sell them. The market for used web-site sales acts a the "secondary market" for web sites where the professional designers who create web sites for a fee would be the primary market. The secondary market has become saturated with websites that make no money so this is why there are so many cheap sites available.

But there are good sites being thrown in with the bad ones. Many small webmasters seem to be under the impression that 1 time annual earnings (or 12 times monthly earnings) is the correct valuation for a business. This is way too low. Now admittedly, there are unique risks in this area - mainly "informational" risks - but this is way too low. If you look on many of the sites and forums where small webmasters are selling their sites you will see many examples where websites that generate $10,000 per year in earnings are selling for $10,000. This means an investor with $100,000 can buy 10 different sites and make back his purchase price in 1 year while having a 6-figure income every year going forward. And with 10 different sites he is pretty well diversified. The same goes for medium-sized web sites - there are tons of sute that make $200,000 selling for 2 times earnings.

	Lack of diversification - Most small sites have a very concentrated source of revenue depending on one product, customer, or advertising channel..
	Lack of negotiating power for the seller - There are many small websites out there but not as many buyers so the buyers have a lot of leverage when making the deal.
	Illiquid market - Right now there is no central exchange for the buying and selling of sites. This makes the market more fragmented and makes it harder for website sellers to find a buyer which can push the price down if they need to sell quickly.
	Short track record - Most small sites have only 1 to 3 years of profits to show which increases the earnings visibility risk.
	Fraud risk - Because of the low selling prices of most sites, many buyers decide to skip the due diligence when buying a site. They accept the risk that the numbers may not be what they appear. But this risk is incorporated into a smaller transaction price for the buyer. This risk is augmented by the fact that most small webmasters don't keep official and reliable documentation like audited financial statements.

Business Analysis

Besides coming up with a rule-of-thumb to get a good starting point for valuation you still need to analyze the business to see how the individual characteristics of a site affect it's value.

Revenue. This is the amount of money coming in before expenses. It is important because it shows how much money customers are willing to pay for your product or service (if it is an e-commerce site) or how much advertising revenue you can get (for a content site).
Profits. This is probably the most important number because it is the reason why a business exists. This is how much money you have after expenses.
Profit margins. This is important because if you have low profits margins then your proifts could dissapear if you have any pricing pressure with the prducts you sell or an increase in one of your key costs.
Revenue concentration. This is an often overlooked characteristic of a company. If you derive too much money from one particular source then there is a huge risk to your profits.
Legal environment. This is important in certain sectors of the internet. For example, there were new laws in 2005 that stated that posting porn pictures on a web site was illegal if you didn't have a piece of physical proof of the age of the actors. This decimated some porn sites overnite. Another area with potentially big legal changes is online gambling. If it is made illegal then many gambling sites, portals, and content sites will lose much of their value. These potential legal risks lower the value of your site.
Brand Strength. This is one of the most important but hard to measure. Branding is something beyond the numbers - it is a combination of customer loyalty, the emotional connection with the user, and other things.
SEO strength. This is important because SEO gives you very targeted, low cost traffic.
Traffic. Traffic is one of the starting points and basic factors in valuing a site. Unique visitors and page views are the two most important numbers here.
Site design. This is one of the least important issues but it still counts for something. If the site has a very recognizable or artistic design then it can add value.
Backend. A very intricate and highly functional backend can be very expensive to build. This can be a good competitive advantage over another site because the competition probably won't have the techncial expertise to build it or the money to hire expert coders to make it for them.
Amount of content. Content takes a lot of time to write. If you have a site with a lot of content then a prospective buyer will most likely want to buy your site instead if trying to write it from scratch.
Customer databases. This is valuable not just from the obvious practical reasons (because you can more easily cross-sell them other products and services) but it also provides proof of your customer count so it is more easy to sell your site when a prospective buyer can verify this.
Assets. This only counts if you have any particular assets which are valuable like inventory or cash which a buyer would acquire along with the site. This includes any intangible assets like patents.
Domain Name. A profitable business with a good domain name is worth more than an equally-proftable business without one. Good domains get a lot of type in traffic so you get free visitors and a good domain name will have a higher resale value.
Market Share. A web site with a high market share will command a larger multiple than a site with a lower market share.
Growth Rate. A site with a high growth rate should be valued on some kind of discounted cash flow number because using a valuation based on its current numbers doesn't take into consideration that they will have much more business in the future than now.
Premium Services. Even if you have a site that lets users see content or use services for free, you should have premium services for people who want to pay a little to get a lot more. A 1 percent subscription rate on premium services is considered good.
Customer Acquisition cost. Sites that have a hgh customer acquisition cost are much riskier and sites that have a low customer acquisition cost. A low customer acquisition cost sometimes signifies a stronger brand where customers are being signed up through word-of-mouth where the site gets free marketing and loyal users.
Pending competition changes. When a new competitor annouces that it is going to enter a market this may push the value of a website in that market. For example, when Amazon annonced it may get into the DVD rental market this pushed down the value of Netflix. A prospective buyer not only needs to know what the competition is, but also what it will be in the future.

Recommended Model

If you run a small website then I recommend you sell it using a 3 year discounted cash flow valuation. I chose 3 years because the web business environment doesn't have much visibility because it is still new and changing from year-to-year. In 3 years many things could change: SEO could completely change, PPC could get way more expensive, AdSense rates could go down, web merchants may move away from affiliate programs, and, just plain old competition. I would recommend you don't sell your page for 1 times earnings because that valuation is just too low - you would get the amount of the selling price by just holding on to it for 1 year. And then you still have all the future profits.