How to prepare your ecommerce business for sale: The financials
Key bookkeeping items every buyer will assess when reviewing your ecommerce financials. Are you prepared?
In part one of this series on ‘How to prepare your ecommerce business for sale: 5 steps you need to know’, we discussed our top tips to get your online or Shopify business ready for its close-up. You need to make sure you are doing everything you can to make your business as attractive as possible to make not only the buyer’s experience easier, but also yours.
In part two we will focus on exactly what buyers will look for when they carry out a deep dive into your ecommerce brand’s financials.
Here are the key items the buyer will assess when reviewing your financials:
A revenue analysis is exactly what it sounds like—potential investors look into and analyze your revenue to determine your growth trends and revenue streams. Make sure you have this data readily available:
- All sales data
- Pricing models
- Customer retention rates
- Revenue growth over time
Typically for ecommerce brands, buyers will carry out a risk evaluation focusing heavily on the composition and concentration of your revenue, by customer, product, and supplier.
For example, if more than 10% of your revenue is coming from a single wholesale customer, the buyer may want to delve deeper into the customer’s relationship history to fully assess any potential risk, so make sure you have all of the relevant background information readily available!
They’ll want to see your revenue fully reconciled to your sales channel like your Shopify or Amazon store, usually on a detailed basis so they can trust your numbers.
Other key customer KPIs they will want to see:
Low CAC (Customer Acquisition Cost)
Low CAC indicates your ability to acquire customers efficiently and effectively—a great sign to the buyer of higher profitability and a stronger competitive position in the market. While the average CAC for an ecommerce brand is around $45 to $50, many small businesses typically spend as low as $20, while electronics, beauty, and industrial brands can sometimes spend as much as $200!
High Customer LTV (Lifetime Value)
Customer LTV is how much revenue a customer will generate over the course of their relationship with your brand. If you have a high LTV, the buyer can see that you have developed strong customer loyalty which has led to you successfully retaining repeat customers. While the average LTV for ecommerce brands is around $160, a better benchmark to focus on is your LTV:CAC ratio, this shows how much you spend to actually get the customer compared to much you actually make from the customer. Aim for a ratio of at least 3:1.
High AOV (Average Order Value)
Knowing the AOV—the average your customers spend when they make a purchase, will give the buyer insights into your customers’ purchasing power, while also enabling them to evaluate opportunities for growth to boost revenue from existing customers. These benchmarks vary tremendously depending on the product you are actually selling.
2) Cost Analysis, Refunds and Chargebacks
Buyers will want to understand granular details of your expenses - how much are you spending on COGS, what’s your contribution margin, and what’s your ad spend? These are just some of the examples they look for.
Every business and industry is different, but here are some ballpark KPIs of what buyers will look for:
When it comes to assessing your expenses, an ecommerce-tailored P&L is crucial to give them the granular data they need with zero surprises to you.
COGS - They will look to verify COGS based on actual paid invoices from suppliers, global logistics, and 3PL warehouses.
Buyers will also look carefully at refunds and chargebacks, so they can point to greater insights or issues within the brand.
For example, we alerted one of our DTC customers when her refund rate reached about 5% while the average refund rate for most DTC brands is around 2-3%. After delving deeper and speaking to her customers, she discovered the quality issues and was able to reduce the refund rate to 3% before meeting with her potential buyers.
When buying your brand, buyers are also buying your inventory. Here is what they will want to know.
- How many months worth of inventory do you have on hand for each SKU?
- How much will it cost to order new inventory?
- Where are suppliers located and what is the shipping process? In case of supply chain issues is there a plan B?
- How is inventory fulfilled? Using a 3PL or FBA? Are there more efficient ways to do this?
Also, be prepared to answer any questions on product concentration, which will help the buyer understand both inventory and pricing risks within the business. For example, if there is a high concentration of a single item, it shows how much your revenue is dependent on the particular item as well as on the supplier of that item.
4) Calculate your SDE (Seller's Discretionary Earnings)
Potential buyers will often use SDE in the valuation of smaller businesses (less than $5 million in revenue) they are looking to buy, as it is extremely helpful in understanding the recurring cash flow.
Larger businesses primarily use EBITDA (Earnings Before Interest, Taxes, Depreciation, & Amortization) instead of SDE.
What's the difference?
EBITDA and SDE are similar concepts. The main difference is that to calculate SDE, you also need to add back the owner's compensation. In smaller businesses, owners may take money from the business in lots of different ways. While one owner may take a salary throughout the year, another may withdraw everything left in the company at year-end.
Valuing a smaller business based on a multiple of SDE allows buyers to normalize the earnings so they can compare apples-to-apples across the different businesses, no matter how you or other owners have been compensating yourselves in the past.
As a business owner, you’ll want your SDE to be as high as possible, since the value of your business will often be based on a multiple of SDE. For example, if your SDE is $300,000 and you receive an SDE multiple of 2.5x, then the business would have an implied value of $750,000 ($300,000 times 2.5x). For ecommerce, the average SDE multiple is between 2.0x - 4.0x.
On the other hand, the buyer will want to make sure that any adjustments you made to increase your SDE are accurate and won’t impact the future earnings of the business in the case of a sale.
Calculating the SDE includes adjusting the net profit for certain expenses, including discretionary expenses, in order to find the real recurring profit of the business.
What are discretionary items?
Discretionary items are expenses that the business paid but are really a personal benefit to the owner and not strictly necessary in the recurring operations of the business. Because of the ‘discretionary’ nature of these expenses, they are often the subject of debate between a buyer and seller. If any expenses fall in a gray area of discretionary or not-discretionary and you treat them as discretionary in order to increase the SDE, be prepared for the buyer to ask for extra documentation and further due diligence to support this.
When preparing for sale, we strongly recommend separating your personal (aka 'discretionary') expenses from your business expenses, to keep your books in better shape and to avoid any potential disputes with the buyer.
Read more about how SDEs work in our blog Seller's Discretionary Earnings Explained and also check out Finaloop's SDE calculator to get an idea of what your SDE would look like.
Finaloop can help you ensure that your financials are organized and 100% accurate, through AI accounting and AI bookkeeping. We’ve seen what it takes to close successful ecommerce sales with aggregators and with funds. If this is your long-term plan, get your financials set up today.
We are a technology company providing automated end-to-end accounting service to ecommerce businesses. Our system connects to your apps, syncs all your data and reconciles your books in real-time, replacing your bookkeeper, your accounting software, and your ecomm integrations. We offer reconciled books available 24/7, tax-saving insights, and a single place for all your financial data.
The information provided on this website does not, and is not intended to, constitute legal advice. All information, content, and materials available on this site are for general informational purposes only. Readers are advised to consult with their attorney or accountant with any questions or concerns.
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