#21 - How To Value, Sell and Buy Online Businesses

First thing you got to do is get the numbers right. Sellers' discretionary earnings, net income, trailing 12 months, profit and loss statement, add-backs, net to accrual. Listing the business, getting under LOI, and then having it fall completely apart in due diligence because all the numbers are wrong. It's heartbreaking, it's debilitating, it's emotionally crushing, but it's reality. People listening, they know the value of their car, their house, their condo, their retirement account, but they probably have no real accurate idea what the value of their most their most valuable asset is, which is their business. So we're seeing larger, more mature businesses where the entrepreneurs are smarter, they're more educated, and the size of the businesses are much larger. You know, in 2013 when I closed 23 transactions myself, it was about $225,000 on average. In 2018, my average size was about $2 million.

Yeah, please.

And I've been hustling since I could walk, to be honest with you, but we'll jump to the adult version of when I was grown up and launched my first venture. Married back in 1997. And I was working for a company in Portland, Maine. I was the 34th employee and it was amazing. I loved going to work every day. I'd get there early. I'd stay late. I couldn't imagine being anywhere else until I couldn't stand it anymore, right? It got so big, so corporate, so people just trying to climb the ladder that there was a time when I couldn't imagine working anywhere else and then all of a sudden, within 2.5 years, I couldn't imagine working there anymore. So I jumped ship and launched a media buying business back in 1997. We used to buy radio airtime for direct response clients, which really are now all internet-based clients. And I said to myself, if I could just make $50,000 a year working from home, I'd be thrilled. That's just incredible. And I had one client. In 1998, my taxable income was just north of $500,000. So I 10 times my goal at that time. And it took off and grew from there. It wasn't long before somebody knocked on my door and said, "Hey, look, I've got a call center. I hear you're good at buying media. Do you want to partner on something?" And we did. And I launched my first product on radio, took it to radio and then did a television infomercial with it, let it run its course, did the next one, let it run its course, and then took that one 100% online in 2005. And that particular one we did 100% online from '05 to 2010 when I exited the business. So if you can imagine, we took it through the absolute best of the economy and the absolute worst of the economy. And it came out the other side of it emotionally toast, exhausted, not loving this amazing online recurring revenue e-commerce supplement business that I had that was providing a very healthy living for myself and my family for less than 20 hours a week. And I just absolutely had to get rid of it. It's— horrible story. People out there rolling their eyes going, what the hell's wrong with this guy? But if they're entrepreneurs, they know that you just get bored. It's time to move on. You've got to do something else. And so at the time, it just occurred to me, I never knew it before, that I had something I could actually sell. And so I started looking online and calling online business brokers, people that specialized in selling online businesses, which mine was. And I talked to 3 different brokerage companies. 2, I felt like all they were trying to do was to get their hooks through the telephone line into me for a commission. They just wanted me to sign an engagement letter. The third was Mark Doust at Quiet Light Brokerage, and he's now my business partner. And he looked at my profit and loss statement, gave me some good advice, and basically said, Joe, look, we're coming off the tail end of the economy. Your numbers are just coming back. If you wait 6 months, you're probably going to put another $100,000 in your pocket. And give some time to get organized and prepare. And I thought, who the hell is this guy? He's essentially telling me, go away. It's in your best interest, Joe, to hang on another 6 months and I'll be here when you're ready. There was no one else that I wanted to do business with at that time. And so I did. I waited. I implemented the things that he suggested and I tightened up my ship, so to speak, and made my business better for the next person that was going to run it and more valuable for me to sell it as well. He handed it off to Jason Yelowitz, who's still a broker at Quiet Light. Still a member of the team, leader of the team really. We listed the business end of October, had it under LOI and sold around Thanksgiving. It was a 30-day due diligence process, so somewhere around that period. We got nearly full asking price and then I had to figure out what I was going to do with my life. I had just bought a house that was built in 1989, Shawn. Some of these people listening weren't even born then. And the guy that built it put shrubs around the yard and there were 89 of them because I counted because they were like giant tree stumps. And for a couple of months, I grew up in in Maine, by the way. So I had a sharp axe and I live in North Carolina now, but I was a total redneck out there swinging an axe for about 30 days, getting rid of all those stumps. It was, you know, physical therapy for me after being just mentally challenged for so long. I just, I loved doing it because it allowed my mind to just wander in terms of what I wanted to do next. And I kind of came to the conclusion that I wanted to buy something and I wanted to do what Jason and Mark did here at Quiet Light Brokerage, which was help others grow and exit their businesses. So I did both. I actually, I bought a content site and had 42 amazing days, and then the floor fell out from beneath it. It was the Penguin update, so it got crushed. All the keywords that are on page one got crushed because the guy that built it cheated like crazy. And, uh, it was a very valuable lesson, lost about a quarter of a million dollars. But that lesson has helped me in what I do now as a partner here at Quiet Light. I joined Quiet Light in March, April 2012. Worked my tail off, closed 23 transactions in the first full calendar year, and then for several years thereafter, really closed more than 50% of total transactions for Quiet Light. Mark and I sat down, we agreed that we needed to partner, and we set a goal to do that and a path to do that about 3 years ago. And a big part of the goal was to minimize my role as the person closing so many transactions. So we've grown from a team of from 3 to a team of 10, and we brought on 2 brokers plus one more over the last 3, 3.5 years. And this calendar year of 2019 now will be the first year where I haven't closed nearly 50% of total transactions. We're doing so much this year, and some of the other team members that are incredible entrepreneurs— I'll probably be 10, 15% of total closed transactions. And the entrepreneurs that we have Man, they should be on your show because they've all made their first million and more. Brad rolled up 30 content sites and sold it to private equity. Jason's been a super affiliate. All sorts of incredible success stories with the entire group. Walker's got a best-selling book, Buy Then Build, that your audience should buy and read because it's all about buying online businesses and building a portfolio just like our friend Ramon is doing. But it's been a great journey. I think we've grown 5 times over since Mark and I decided to be partners. We've had a great success and we see great success in the future. Let me ask you.

It's really more of our valuation process. The hardest part right now, I'll tell you, is calculating what's called seller's discretionary earnings. I don't want to get too technical, but that's the primary term. When people talk about, oh, I got a multiple of 2, I got a multiple of 3 or 4 or 5, it's a multiple of seller's discretionary earnings. And it should always be a multiple of the trailing 12 months seller's discretionary earnings. Now, what the hell is seller's discretionary earnings? It's net income. You run a profit and loss statement, the bottom line number is net income, bottom row, right? Net income. Well, you pay yourself a salary, you do some personal development, you travel but you write it off through the business. You might even write off a car, but you have an internet-based business, so you've got some personal benefits there. That's what we'd call them, is owner benefits. Those are called add-backs. So seller's discretionary earnings equals net income plus add-backs. So you figure out— the hardest part is figuring out what seller's discretionary earnings is, or SDE. And believe it or not, Sean, the hardest part is actually getting entrepreneurs to use good accounting software.

Yeah. And the more people I can reach to talk about that and get it through their heads that it's the most important thing they should be doing is making sure their financials are in good shape because someday they will wake up and go, "Man, I hate this," or something in life will change where they want to exit. And the best thing they can do is have good, clean financials and be prepared to exit. Because when you are not prepared— I just had a client come to me where he was looking at another brokerage firm and came to me and I felt kind of pressured, so I signed that engagement letter with him and then dug deep, deep, deep into the financials. He's doing $10 million a year in revenue. Turns out that all the top-line revenue numbers are not accurate. First thing we've got to do is fix that. Second thing we figure out is that it's all on a cash basis. If a business is growing— physical products business is growing like crazy and they're using cash accounting, the net income is going to be severely depressed. If you're taking all of the excess cash from the business and buying more inventory, and that inventory is in your profit and loss as an expense, you've got an extra $200,000 or $300,000 or $400,000 in inventory on hand. It's going to depress your net income by that $200,000 or $300,000 or $400,000. It has to be flipped to accrual. It should be done by a qualified e-commerce bookkeeper. They're out there. I'll be happy to refer anybody to any one of them. It's important. You should be doing it. This gentleman initially thought his business was doing $1.3 million in discretionary earnings. Well, after digging deep into it, the reality is, with all the proper adjustments the way it should be, he was doing about $800,000 in discretionary earnings. So he's gone from a value of in the $6 to $7 million range right down to $3.5 to $4 million. It's heartbreaking. It's debilitating. It's emotionally crushing. But it's reality. And I'd rather be brutally honest with somebody and get them on the path to achieving their goals and their financial success than delude them and overprice a business, take them through that emotional jungle they'll go through in listing the business, getting under LOI, and then having it fall completely apart in due diligence because all the numbers are wrong. First thing you got to do is get the numbers right.

Yeah, the most common way to buy an online business is through an SBA loan, Small Business Administration. There are little to no other resources out there in terms of lending institutions. That means that that two things have to happen. First and foremost, the seller, the business itself, has to be pre-qualified to meet the standards of the SBA, which means there need to be a couple of years of tax returns. It means that the financials can't be commingled among 5 other brands, but you're only selling one. The tax returns don't have to match up to the profit and loss statements. Banking institutions, lenders do add-back schedules just like we do. But in order to make your business more sellable to a broader audience, which brings more buyers, more offers, more competitive, closer to asking price if not over, and a better deal structure. Gets down to those financials and getting your tax returns filed properly and not commingling different brands under one LLC. SBA pre-qualified, number one. The buyers have to then also be SBA pre-qualified. Do you have the pedigree to run a business on your own? Uh, do you have enough money to bring to the table? The lenders, really, what do they want to They want to get their money back. They're protecting their investment, so they want to make sure the business is solid and they want to make sure that the buyer is solid. Even with that, it's a great opportunity for the buyers because with an SBA loan, you can borrow up to $5 million personally, and that's how we were able to sell Ramon's business. We had multiple offers on Ramon's business, and they were not all SBA, but we had 3 buyers bidding competitively. I don't know if he told you the full story, but it was pretty aggressive, and we went well over the original asking price and letter of intent that we had. I think one of them was SBA and two were not. One, uh, the other two were raising money from outside sources. So there are outside sources, but it's investor money is really what it is. You've got to have friends and family and contacts with people with money that are willing to invest in you. This particular person that does this, that didn't win the bid, is, he's a Harvard MBA. He's raised money before. He's very good at what he does. He understands treating investors well and giving them a good return on investment. So they trust him.

Yes. So these are rules of thumb, which means that, you know, they're in pencil and it changes depending upon who the lender is, who the buyer is, and what the business is all about. Anything sub-$1 million, you could probably buy with 10% down. So you're coming to the table with $100,000 and you're buying a million-dollar business. So they're loaning you 90% of the money, the SBA is. They're probably going to give you working capital money as well to buy the inventory and, and, and have some leeway in terms of waiting till the, the money's rolling. When you get above a million, depending upon the size, it's going to change and shift a little bit. That percentage that you need to put down is going to grow. And then on top of that, they're probably going to say, you know what, we want the seller of the business to have some skin in the game as well. So you, Mr. Buyer, this is a $2 million business, we want you to come to the table with 10%, and we want the seller to also take a 10% seller note, right? So you got to come up with $200,000 for a $2 million business, but in this case, we want the seller to have a note as well. So the lender is only risking 80% instead of 100%. And it will grow and change and shift like that as the business gets larger. And to be frank and honest with you, we're seeing that there's been a bit of a frenzy with SBA loans and lenders lending out, you know, 90% on transactions. It's going to change. Things are probably going to tighten up. And I think it's smart for both buyers and sellers if they want the SBA lending option to be there. It's going to grow to 15 or 20% down on a million-dollar deal because it's safer for for the lender. That means the lender is going to keep lending money over the long run, which is ultimately everybody's goal. It is.

Sometimes there's a 5-year balloon payment where they'll refinance the note or something like that and do what's left, but generally it's a 10-year note at 5 or 6%. So 90% at, uh, 5 or 6% over 10 years. And then they work to— okay, well, how much cash flow is the business generating? How much do you, Mr. Buyer, need to live off of? And how much cushion How much cash flow generation do we need to have there? So they're looking for a debt-to-income ratio. What the number is changes all the time, and I don't want to throw any numbers out there because it changes so much. But the bottom line is they need you, the buyer, to have enough cash flow to live off of. And we don't know everybody's car payment, mortgage payment, expenses. So it's all about your overhead and how much cash flow the business kicks off after servicing the note. Right. So service that note. Do you have enough to live off of through the ups and downs of the business? And they're doing Debt-to-income ratios there. Their favorite buyers, their favorite buyers of all time— I've sold lots and lots of these. The lenders will tell me, depending on lender, but they'll be like, man, I love this guy. His wife, she's making $400,000 a year and she can support the entire household. Those are the favorite. When you've got a second income in the family that is sticking around and keeps their day job and can support the family, the buyer, the husband, the wife, whatever it might be, is much more likely to get qualified for the SBA loan. But they're really looking for a mature professional that can operate the business successfully. They're placing a big bet on that individual and they want to make sure that they win with that bet.

You've got to have some life and some business experience. I had a deal a couple of years ago— probably 3 years years ago now. It was $2 million, beautiful business growing like crazy, and we were under LOI through an SBA loan. And the buyers were two Harvard MBA students, and the mom or dad of one lended them the money for the down payment. And they got turned down in underwriting because they didn't have any real business experience in the real world. They were Harvard MBA, someday they would— they're very good pedigree but no real life experience. So the banking institutions would rather bet on a high school dropout that has built and sold their own business, or built and runs their own business, than two kids that went to Harvard that have no real business experience, as would I.

Pre-qualification letter that you'd get from a lender takes 24 hours depending upon how busy they are. So you're gonna say, hey, I want to buy a business, I want to do it with an SBA loan, what do you need? They're gonna send you a form, you fill— they send it back. He said, "Yeah, OK. Let's have a conversation. You're qualified. I think you're qualified to buy a business based upon your experience and your assets and your cash. You can buy something for up to $1.5 million. That's where we're comfortable lending you that money in terms of the value of the business." Now you've got some direction. You know, OK, I'm going to focus on buying a business and I can buy something up to $1.5 million. So why bother looking at something for $6 million? It's just a waste of your time, assuming that you're going to be be an entrepreneur where you're going to just do an SBA loan purchase. Once you find the business though and you go under letter of intent, right? So a listing comes up, you look at it, you look at in details you talked about, and you have a conversation with the buyer and you feel comfortable making an offer. And the offer is what you should be closing at ultimately once you get through due diligence successfully. Letter of intent— letter of intent is that non-binding, that letter that says I'm buying the business at this much and we're going to close on this date, right? And the terms are built into it. Then you go through due diligence. And then you close. With an SBA loan, it's going to take 60 to 75 days to close. And by close, I mean money changes hands and the assets of the business change hands from the letter of intent to closing. 60 to 75 days, right? We've done it in as little as 30, but it's the exception, not the rule, right? But cash— cash deal, 30 to 45 days, SBA.

10x bigger. But at the same time, there's plenty of small stuff too. Small stuff being sub-$500,000 or so. The other thing that we're seeing is the multiples, honestly, they've grown. There was a time that— back to the multiples, a multiple of discretionary earnings— there was a time that I would list things at 2.74, so it would round down online, because buyers just wouldn't accept anything above that. Now, we're seeing businesses of the same caliber and size that are easily pushing up into the 3 to 3.5x range. Range. But there's definitely stages. Smaller businesses will be in a certain multiple range depending upon age and history and defensibility. But there's more bigger businesses that are getting larger, and therefore the multiple is higher as well because they're less risk. There might be multiple channels of revenue, which means it's less risk. Less risk means a higher multiple. So we're seeing buyers be educated on that. 100% or 90%+ Amazon FBA businesses, buyers are becoming much more comfortable with. I wrote 10 Steps to Selling an Amazon Business in 2015. And it was like, I was pioneering something. Everybody's like, no, it says right there in the terms of the seller account that you cannot transfer control of an Amazon business. It said generally in brackets, and I had done it. And I had gotten permission from Amazon legal to do it in certain circumstances, in most circumstances, and from Seller Central and the rest. So you could do it. Buyers are getting much more comfortable with that to the point where people are buying up Amazon businesses and building a portfolio of them. Back to the size and how size matters. If you've got something that's doing $1 million in revenue, it's worth an awful lot less than something that's doing $100 million in revenue. And not just in terms of discretionary earnings, but the multiple. The multiple changes dramatically when you've got a much bigger business and less risk. And that's what private equity guys are doing and family fund people and search funders and people that are just smart in building portfolios. They're buying up low-value, sub-$1 million, $2 million, 100% Amazon businesses. When I say 100%, it's probably 90%. There's always some trickle-over to their website. And then they're putting a portfolio of these together. And they're buying them at 2 to 4 times discretionary earnings. But when you pool them all together, you don't have a business doing $200,000 in discretionary earnings anymore. You've got a bigger business doing $2 million in discretionary earnings. And that 3x multiple might immediately jump to 6x multiple, or depending upon how defensible it really is, maybe even more. So they're buying them up low, and just by pulling them together, they're becoming much, much more valuable. I have yet, though, to hear of one or be connected with one that has gone that approach and been successful in selling it to a much larger private equity firm. That's the goal. That's the plan. That's the theory. And I think it's 100% legitimate. It's just that I don't think any of them have matured to the point where they've bought enough where they'll sell them off to a larger private equity firm, right?

It's going to be crystal clear that you said this year. Yeah. So therefore, Ramon is out. We sold his business last year. He said last year. I have to say Ramon. So I had a listing this year. It was a beautiful brand, well-branded, majority Amazon, 90% plus growing, I think, you know, which they should rapidly at that age. But, you know, 200% year over year. But again, at that young, they should be growing. The owner of the business, I want to call him a former CPA, not a retired CPA, because he was about 30 years old and left the corporate world as a CPA to become an entrepreneur and run a business online and built it from scratch while his wife, who was a schoolteacher, stayed employed. And not only that, he was the stay-at-home dad to his 2-year-old running this business. But the beautiful thing— and this goes back to financials and instilling confidence— he's a CPA, but he outsourced his bookkeeping to an e-commerce bookkeeping firm. Love that guy, right? And I knew buyers would love him too. He had a beautiful brand, beautiful videos on all of it. I just loved it. And I remember I said to him, look, this has everything. It checks absolutely all the boxes— SBA eligible, growing like crazy, beautiful brand, easy transfer— all of the 4 pillars that we talk about. I'm like, look, I think we need to go out at least a 3.5 multiple. It was a smaller business too. It was doing, I don't know, $400,000, $350,000 in discretionary earnings. So it wasn't really big, Yet. So the multiple's a little bit lower. I'm like, we need to go out at 3.5. And again, that's 3.5 times discretionary earnings for the trailing 12 months. Inventory is treated separately at this size. So inventory is just purchased separately. So it'd be 3.5, whatever the multiple is, plus inventory at closing. And he's like, oh, I don't know. I don't know, Joe. I'm a little stressed out. Would it be OK if we went out at 3.3 instead? Which is absolute— again, just the opposite of what most entrepreneurs are going to be. They'd be like, oh, I don't know. Can you get me 3.6? Right. So I'm like, look, I know we're pushing the multiple a little bit based upon histories, but you check every box. But okay, we'll go to 3.3 because you have certain motives. And that's important for everybody to understand that listening— everybody sells for a different reason. It's not always about getting maximum value for the business. You want to get as much as you can in a good deal structure to a great buyer so that you can just transition and move on if that's your goal. We've got one close— it's under LOI now— that the goal is to stick around. It's a $20 million valuation, thank you, $5 million. The guy wants to stick around and help grow it to $100 million, and he's found the right private equity firm. Different goal altogether. But this particular seller, his goal was to sell it, find a great buyer, and move on. And that's what we did. So we went out at $3.3. The response was exactly what I thought it was going to be, and I had to shut down his calendar and take it over to schedule 3 calls a day for 5 days in a row. I didn't want to do any more than 3 because these calls can take at at least an hour, sometimes longer. And that's part of our process. Again, trust and instilling confidence. Build a great package, have them look at it. Numbers are there, all that client interviews there, and then the videos there as well. But we, we want the buyer and seller to be on a call too, so that you can ask the same questions and look at each other. Hopefully, if we do a video conference call in the whites of each other's eyes, because again, you're going to be all over the world. Who knows where the buyer and seller are going to be? So we wound up with about 15 calls. I just had to shut it down. We had 10 offers. The highest one was at about 3.65 times, and so we just had to shut it down. 10 offers on the business. Paul, the seller of the business, did not pick the one that was the highest value. He picked the one that he liked the most, which is really important. Another lesson for buyers— simplest thing: if you want to be a good buyer, don't be an asshole. If you want to get the deal done over an SBA buyer, it's not necessarily about making the best offer in terms of dollars. It's asking great questions and making the seller of the business feel like they did an amazing job. And, you know, I'm going to take over your baby and I'm going to do an amazing job with it. You're going to be proud of what we can do with it. And if you have staff, perfect, I'd love to keep those people in place. Is that okay? And it's exactly what Paul wanted. It's exactly what he heard from multiple buyers. But he chose one that ended up at about a 3.5 multiple, all cash, transitioned the business in 30 days. And the buyer's very, very happy with the business. It's one of the best investments he's made. I think he's bought 3 or 4 from us now. Hmm.

I like it. So I love this episode because I feel like it's very tactical. And as somebody who tried to build things from scratch, definitely doable, definitely very hard. It is intriguing to me the prospects of piggybacking off of somebody who's taken it as far as they can go, and either they're too tired or they've sort of reached the limit of where they think they can grow it to. With their skillset, or they're just ready for the next adventure, taking something that has some momentum, that has some revenue, that has existing customers, that has existing either manufacturers or content supply, whatever it is. I love this idea. I'm surprised more entrepreneurs don't do this. I think there's definitely a, at least where I am at in Silicon Valley, there's a bias towards DIY. You know, you gotta, you gotta start from scratch, do the whole hero's journey from day zero. And I think there's a whole set of people that are out there that are business people and they can take a business, see it for what it is, analyze it, make an offer and grow that business. And, and I hope that, you know, more people do this. And if you've done that, send me your story. I want to hear it. You know, if you're, if it's a great story, I'll put it on the podcast, but I love meeting people who are in this space doing this thing. It is to me, it's like the modern day real estate. And so Joe, I appreciate you coming on. Where should people get more of this? You said you have your podcast, shout that out, shout out, you know, the website, your Twitter handle, however else people should get more info.