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Episode 11 – Investing in Digital Real Estate and Acquiring Online Businesses
Welcome to your December playbook… the last of 2021. There are ELEVEN total playbooks now.
You know here at CT (and me) we’re all about buying brick and mortar businesses. Boring, sweaty, recession-resistant necessary businesses that cashflow.
But there’s no denying that investing in online biz’s are another way to cashflow at a surprising array of prices, types, and styles.
If you want to know the basics, and a few models to follow of buying an online business, we broke it down for you this month in Cashflow.
A Review of the Opportunity
Cryptos, NFTs, the metaverse – investing in digital real estate is all the rage right now, but savvy investors are still watching the opportunities with a lot less risk and volatility.
Oftentimes online businesses can produce better than average returns. A good investment property will offer an average cash-on-cash annual return of 4-7%. The annualized average return of the S&P 500 during the last 20 years is 6%. Meanwhile, you could aim for a 30-40% annual return on your digital investments.
“It’s not passive, you have to put in energy and effort but as an asset class, the returns are quite strong and that’s why people are so excited about small online business acquisition right now,” said Blake Hutchison, CEO of Flippa, which sees 600,000 monthly searches for online business purchases.
The opportunities in e-commerce alone are massive. In 2020, more than two billion people purchased goods or services online, and during the same year, e-retail sales surpassed 4.2 trillion U.S. dollars worldwide.
And the online opportunities go beyond e-commerce, as there are Amazon FBA, content, or SaaS businesses too. While acquiring a brick-and-mortar business versus online can have their similarities, we broke down the how-to below.
Blake Hutchison is the CEO of Flippa, the leading marketplace to buy and sell online businesses. He eats, sleeps, and breathes within the world of investment and digital acquisition. We recently caught up with him where he shared his deep industry knowledge with the Cashflow community: 7 Figures with Digital RE And Online Acquisitions
Watch the insider interview.
Playbook
There are many options in the traditional offline business-for-sale market and an increasing number of investors are starting to realize that the benefits offered by online businesses could actually be a valuable portfolio-add. And hey…it might even be your preference!
Step 1 – Establish An Online Business Buying Criteria
The first thing you need to do is find the right deal. But before you get started on your search, you need to know your capital capacity as well as your goals for buying this business, and the deal parameters. Some questions to ask yourself:
Do you want to buy and roll up with the current biz’s you own?
Do you want to buy to improve and flip?
Do you simply want to buy a cashflowing business to get you to $x in monthly revenue?
Do you plan to buy and hold for a X period of time?
Do you want to dominate a category by buying vertical and holding long term?
Are you looking to turn this into a full-time thing or passive strategy?
How much time do you want to spend?
How much liquid capital do you have available to invest?
What’s your budget?
What are you good at? Can help choose what niche you look into.
Your strategy will dictate your search and deal parameters.
Once you know this there are a few places to begin your search.
Visit an online marketplace such as:
Filter your search by categories, such as asset type, website type, industry, monthly users, budget, and more to narrow down the opportunities and find the best fit for what you are looking for.
You can also directly contact a business owner – If you aren’t sure who a website belongs to, search Google or try a domain search on GoDaddy’s Whois tool. Then, make a phone call.
Step 2 – Choosing a Business Model
Advertising – This is one of the most straightforward and popular e-businesses. High-quality content sites with a strong traffic profile are typically very attractive to buyers as they offer a relatively secure income with low maintenance requirements. They can however also get turned off with one algorithm change so tread wisely.
Affiliate – This model is one where the business exclusively sells other suppliers’ products and services in exchange for a commission that is an agreed percentage of each sale. Major affiliate programs include ClickBank, Amazon, and Commission Junction.
ECommerce – eCommerce is the buying and selling of products and services over the internet. This option is especially attractive for a brick-and-mortar entity that is looking for a brand extension. Examples are a store like Amazon of Shopify, dropship, or brokerage.
Lead Generation – When a website uses relevant content to attract traffic and convert them into leads for a sellable service.
Software as a Service (SaaS) – Users pay a subscription to rent software hosted online instead of purchasing it outright and installing it on their computers. SaaS businesses are becoming increasingly popular for online acquisition as, like subscription businesses, they typically employ a monthly or quarterly recurring billing model and enjoy a strong amount of recurring income.
Remember, finding the best personal fit is imperative, and being confident that you will have the time, budget, and skills necessary to operate the business and move the P&L arrow up and to the right. Most importantly, does the business generate excitement and interest for you?
If you’re a first-time buyer, go with a content site. Ideally, one that is 2 years old or older. The age of a website is like the location for offline real estate.
Step 3 – Analyzing & Evaluating
The first time you contact a seller broker or business owner about a business there’s a list of questions you may want to ask:
The goal is to assess a few key areas of the business to know if it’s a worthwhile deal, correctly valued, and where the opportunities lie.
- Reason for selling
- Business operations
- Growth opportunities
- Market trends
- Traffic
- Financial performance
- Continuing obligations
- Customer base
- Products/services
- Marketing
There’s no hard-set tool for valuation, it’s a lot based on experience. For the larger sites, some of the key metrics to look for are a net margin of 20-25% (although we like more cushion of 30-50%), to provide you with the capital to scale and acquire more customers.
The industry average is about 1.5-6x annual profit depending on a site’s age, traffic, and revenue.
Age – can let you know site domain authority, amount of organic search, and if there’s credible brand equity.
Revenue – how effectively is the current owner monetizing that traffic? There are tools to see the industry average of monetization per x visitors. A site that has multiple income sources should be valued more highly, with recurring revenue being the best situation.
Traffic – traffic trend is the primary factor for whether you’re prepared to pay more or less for a site. If traffic is trending up, your valuation will be more. If trending down, you have the opportunity to negotiate a lower multiple. Also if the site is depending on one of two sources for backlinks or traffic sources, it’s worth less than if the site has multiple sources driving traffic (a good traffic distribution).
Step 4 – Make an Offer, Letter of Intent (LOI)
First, you must remember that online sellers have options. You need to stand out and refine a pitch on why the seller should choose YOU as the buyer.
After you review the information about the business and are confident in the value of the asset, you’ll formalize your offer with a Letter of Intent (LOI).
An LOI is a standard-form, non-binding agreement between you and the seller to proceed forward with the offer on a good-faith basis. The document should include info on the offer structure & terms, financing, non-compete clause, any exclusivities if needed, timetable to conduct due diligence, training and support post-sale, and assets to transfer.
While some sites act more like a broker and require signing legal documents such as an APA/LOI/NDA, marketplaces like Flippa do not because you’re communicating directly with the seller where you can bid directly or negotiate your purchase price. When the deal is done, you’ll go to escrow to securely complete the transaction.
Step 5 – Due Diligence
Due diligence is the most important and most difficult step in this process and is the time to get your hands dirty with a detailed review of the business’ operations, financials, and traffic.
You can use a third-party firm to conduct the due diligence or do it yourself if you are confident in your abilities to uncover potential issues. Your broker should also help with gathering information.
Due diligence of an online business is slightly different from a brick-and-mortar company. The principle of fact-checking is still the same but without significant tangible assets and a very different customer acquisition process.
This is a quick breakdown of what to look for and the information to gather:
According to FEI International’s Guide to Buying an Online Business, there are six key areas to due diligence:
Traffic: Check which direction the traffic is trending, look for anomalies, and make sure the link profile looks natural. Ask for guest access to analyze the website’s traffic and backlink profile on Google Analytics and Google Site Console. We usually cross-match this info with various other SEO tools such as Ahrefs, SEMRUSH, and Moz. You can find a list of other site audit options here. If you’re not technical, grab some help.
- Concentration: A diverse set of traffic sources is the desirable situation so one change won’t crash your site. But not all websites have this and it is by no means a negative trait, depending on the fundamentals underpinning each traffic source.
- Nature: Traffic is somewhat subjective and its desirable qualities vary with the business model under review. For the specific business under examination, the key is to understand the traffic profile of the desirable visitor and look for this in the traffic data. Key measures of value are pages per session, average session duration, bounce rate, and of course the conversion rate, which can be found on Google Analytics. How much of the traffic is organic vs paid?
Financial: Verify the Profit & Loss statement against documented evidence. Confirm how much the website earns, its revenue sources and if they’re sustainable. Also, confirm operating costs and historical financial performance. Review 12-month trailing revenue and expenses. Look at ‘addbacks’ in the P&L. Addbacks are expenses added back into the profits of the biz (ex. EBITDA) and take into account owner benefits and one-time expenses not passed on to the buyer. This info can be used to inflate the asking price of the biz because it increases the valuation against the multiple.
Owner: Know who you are dealing with. Conduct a background check and make sure you’re doing business with someone reputable. Try looking up the seller on social media too.
Technical: Review the technology platform underlying the business operations and the support available. Who handles website changes, maintenance, programming? What plug-ins or extensions are used on an e-commerce or content site. For SaaS, get a sample of source code.
Customer Service: An e-commerce site lives and dies with its customers, so having competent and sufficient customer service is imperative. Does the biz have in-house or outsourced customer service? Is it domestic or overseas? Is there a less expensive option?
Operational: Verify the time commitment and tasks required to run the business. How much of it is done by the owner versus outsourcing or someone in-house? Look at the team closely (if they have employees) and make sure all are in good standing.
Legal: Seek independent legal advice on the legality of the business’ operations.
Make sure you’ve addressed:
- hosting costs
- is the domain transferable
- is the business using any licensed software
- can you secure the same terms from credit card processors
For an e-commerce asset, understand what percentage of revenue comes back via a refund, find out the revenue lines and cost to buy a product, and send/package to the buyer. Ask for 12-month trailing revenue and expense data. Don’t buy a business that is about to have a stock-out problem and make sure supplier relationships are strong. Also, talk to all vendors and manufacturers and make sure the business is in good standing.
We’ve sourced a full eComm financial model so you can determine valuation and cashflow with all costs involved.
You can also outsource the full DD process if you’re a first-timer or just unsure about online tech. But make sure you’re LEARNING what’s being done. Flippa has a service for DD.
Step 6 – Financing
There are many financing methods available and the opportunity for creative financing exists but there is also a lot of competition as the market to buy an online business is hot.
- Cash: Cash is still king here as the preferred method of payment with offers requiring financing paying a premium to beat out an all-cash offer. Methods of raising cash include cashing out or borrowing against a retirement account, an SBA or third-party loan, finding an investor or taking a loan against your securities.
- Seller financing: SF is a big part of this industry, primarily for an asset worth more than $100,000. With this option, the seller becomes the bank. The buyer makes a down payment, then pays off the balance to the owner monthly, usually with an interest rate ranging from 7.5 – 12%. Learn why seller financing may make sense for you.
- Debt: Loans can be obtained through the Small Business Administration (SBA) or many third-party lenders such as Lending Tree. Many banks don’t understand online financing, so find a lender who understands digital real estate and online businesses. Visit the SBA website to get matched with a lender, or contact Guidant Financial or Clearco. Yardline Capital is a source for e-commerce financing. Other options include borrowing against the working capital, a microloan, merchant cash advance or credit lines. Here’s what you need for an SBA loan.
- Holdbacks: Stability payments can be included in bigger deals where a percentage of the purchase price is held back for a certain time frame to ensure the asset performs within a specified percentage of the prior year’s performance or other milestones and financial verifications. A holdback agreement is sometimes used in larger deals where a business may be reliant on certain arrangements staying in place, such as long-term service agreements or employees of the business continuing to work for the firm.
- Crowdfunding: is the practice of gathering a group of individuals, including families or friends, to donate comparatively small quantities of money to bigger projects, such as starting a new company or selling a new product.
- Earnout: An earn-out is when the buyer agrees to pay the seller a percentage of either the revenue or the profit of the business for a set period of time. This is used in situations where the business may be young, have erratic cash flows, or an uncertain future, so the buyer wants to leverage the seller’s knowledge and resources in an attempt to run/grow the business in the period immediately post-sale.
- Equity: An uncommon option as most sellers wish to move on to something else post-sale and in this scenario, equity is often offered in exchange for services as opposed to an outright purchase. In this case, the buyer could offer a defined payment plus 20-30% equity in the business to the seller. It would be an ongoing partnership, with both parties sharing in the long-term success of the business.
Step 7 – Signing the Asset Purchase Agreement (APA)
The APA is a legal document with binding terms which both you and the seller must adhere to. Get a clear understanding of your pre- and post-sale obligations/liabilities (and those of the seller) from your broker and your third-party legal counsel. Keep in mind you’re acquiring both the assets AND the liabilities of the company so double down on the due diligence.
The success of an acquisition is largely dependent on the transfer of assets and training, so make sure to put a particular focus on this in any agreement. You should also be very clear on the process once you have signed the APA, how escrow works, and the costs and timings involved. Having a good dialogue with the broker and seller pre-sale will help facilitate a smooth and timely handover.
Side note, we believe it’s worth the extra expense to have a legal entity working on your behalf the entire way. Flippa also has a service for this.
Step 8 – Escrow Transfer Process
Once the APA is signed, it’s time to transfer the funds and assets for the transaction. A reputable broker will typically direct the buyer and seller to a third party such as Escrow.com, like Flippa does, to protect both parties during the transfer – similar to a title company during a real estate transaction.
There are six steps to this process:
- Escrow transaction terms agreed by buyer and seller
- Buyer transfers funds into escrow (secured but not released yet)
- Seller transfers assets to buyer
- Buyer acknowledges receipts of assets and initiates inspection period
- Inspection period to confirm correct representation of assets
- Buyer confirms satisfaction with assets and releases funds to seller
Step 9 – Post-Acquisition
Utilize the training from the previous owner during this transition period that we mentioned you should include in the APA, which typically lasts four weeks. Use that time to learn about the day-to-day operations, procedures, and processes and document them.
What to do after acquisition falls into two stages: Improvement and Optimization.
Improvement – Audit your site with a resource like ahrefs to address broken links, 403 errors indexing issues and speed problems, etc and fix what’s not working.
Find out who handles tasks such as SEO, web design, content marketing, web development, etc., and confirm if you have the talent in place or if you will do it yourself or hire out.
Optimization – There are quite a few things that can be done to your business depending on the business model. Easy things to look to improve are:
If you need help operating or growing your new piece of digital real estate, the Flippa Partner Market has experts with the skills to grow your business.
Tips & Tricks
M&A With Brick and Mortar
You might own a brick-and-mortar business and not want to be involved in the online space. However, adding an e-comm arm to your business is another way to add a cashflowing income stream.
For example, if you own a pet store or chain of pet stores (our friend Ramon bought this store for $300k and now it does mid-eight figures in revenue) you could buy an established e-commerce business that can complement that revenue stream. Now you can aggregate the online businesses for more efficient operation costs while building a multichannel and diverse business model.
You could also buy a blog that does well with SEO for keywords that could tie into your offline business.
We’ve broken down a financial projection spreadsheet if you’re looking to acquire a business in the content space. If you’re buying a blog to boost your website SEO traffic, collect emails and monetize through a newsletter as well (something we know a bit about!).
We’re also seeing an increase of scaling by online businesses through M&A by combining a purchased online biz with one they already run. Efficiencies and economy of scale make these additions more profitable as more websites are purchased.
Flippa CEO Blake Hutichson had advice for newcomers to the online business buying game: “If I was a first-time buyer, and limited by budget, I would try to find a pathway to a minimum $5,000 acquisition; chase a content asset doing between $250-500 monthly net profit. That’s usually a blog with Adsense installed, which is placing ads on the blog. You aren’t making a lot of money but through the first 12 months, you’ll either prove you can either run it at the same level or hopefully grow it. Then, buy a similar business only 10x larger and do it again.”
Advance Deal Negotiation Strategies
Here’s a cool article from Empire Flippers on ways to negotiate the online biz buying deal structure.
Not Looking to Acquire?
I always tell people that if they’re new to an asset class, get exposure to it first by investing in a fund before you do the actual deals.
We chatted in Unconventional Acquisitions to Andrew Youderian, who runs eCommerce Fuel Capital’s accredited investor fund.
Sell Your Site
Are you a seller? Ready to flip a website? Know when to sell by grabbing an exclusive free copy of Joe Valley’s book The EXITprenuers Playbook.
AMA
Due to the delayed nature of the playbook, we’re not doing a full-length Q&A with Blake! But we have a treasure trove of humans who we can bring on in the future to ask questions, or you can reach out to on your own:
James Camp
Bill DAllisandrio
Or you can reach Blake directly at blake@flippa.com!
However, we will be talking with a member from your very own cashflow crew, who has executed multiple online acquisitions from Flippa.
He’ll be joining us on the January Cashflowian Spotlight on Tuesday, January 18th at 3 pm CST.
Remember we also have our weekly call TONIGHT, Tuesday January 11th at 3pm CST. You can join both meetings using the same link below.
Stack cash and buy digital,
Codie and the CT Crew
Disclaimer – This is the “Be an adult” section. Everything mentioned above isn’t advice, just a recount of what I did. That said: This article is presented for informational purposes only. The opinions stated here are not intended to recommend any investment or provide tax advice. Neither are they an offer to sell or the solicitation of an offer to purchase an interest in any current or future investment vehicle managed or sponsored by Codie Ventures, LLC or its affiliates. All material presented in this newsletter is not to be regarded as investment advice, but for general informational purposes only. Day trading and investing do involve risk, so caution must always be utilized. We cannot guarantee profits or freedom from loss. You assume the entire cost and risk. You are solely responsible for making your own investment decisions. We recommend consulting with a registered investment advisor, broker-dealer, and/or financial advisor. If you choose to invest with or without seeking advice from such an advisor or entity, then any consequences resulting from your investments are your sole responsibility. By reading/sharing this newsletter or consuming our content on our other channels, you are indicating your consent and agreement to our disclaimer.
