Business valuations are complex, so it’s impossible to provide a rule of thumb based on a single number like revenue or profit. Ultimately, fair value for a business is what a buyer is willing to pay in an arms-length, non-distressed transaction.
It’s possible that someone would have strategic motivations for acquiring a business that would allow them to pay more than a typical buyer, but for the purpose of this article I’m going to focus on a typical scenario. I’m also going to assume that the business you are looking to buy/sell generates less than $1 million in annual revenue, with more than half of the revenue coming from Amazon sales.
As a general matter, businesses are valued based on cash flow (with a potential adjustment for included assets or liabilities). However, two businesses that generate the same amount of cash may be valued very differently depending on the expectation for FUTURE profits. In other words, even if Business A and Business B each earned $100,000 in profit last year, wouldn’t you (as a buyer) be willing to pay more for Business A if you expected it to earn more money next year?
Similarly, even if you expected both businesses to earn $100,000 again next year, wouldn’t you be willing to pay more for the business that had less risk? Let’s assume Business A has a diverse base of 100 products and 10 years of operating history, while Business B has only 2 product and has been operation for only 1 year. Business B would be considered a much riskier purchase from a buyer’s perspective, and would therefore be valued less than Business A.
While this is a very simplistic example, I’m trying to illustrate the concept of how business risk and business growth can impact the value of a business.
A common valuation approach is to use a multiple of annual cash flow. So, if a business generates $100,000 in profit each year, a 2x multiple would result in a value of 200,000.
I’ve seen some people suggest that an Amazon business should be sold for 3x - 5x annual earnings (or more) because that’s what they’ve seen “other businesses” sell for. However, businesses that generate most of their revenue through Amazon are inherently risky because there is so much that is out of your control.
For this reason, I would say a typical Amazon private label business should sell for 1x - 2.5x annual cash flow. There are cases where the multiple may be higher or lower, but I think that’s a good starting point. To figure out where a business fits within this range, let’s refer back to the concept of business risk and business growth.
A business is likely to receive a valuation at the higher end of the spectrum if it has the below characteristics and would receive a lower valuation if it doesn’t.
- High profit margins
- History of strong growth
- Diversified pool of products
- Diversified revenue sources (i.e., being less reliant on Amazon only)
- Good product reviews
- Non-fad products
- Competitive barriers to entry
- Room for brand growth / new products
- Brand recognition
- Large subscriber list / social media following
- Daily activities are largely outsourced
- Requires very little overhead
This is not an exhaustive list of what will impact value, but it should hopefully provide a good place to start. If I haven’t pounded home the point enough, where a business falls within the valuation multiple spectrum depends on how much buyer risk has been mitigated.
Ultimately, it comes down to a negotiation between the buyer and seller, but a business that has very few of the positive characteristics outlined above may only sell for 1x it’s annual earnings (possibly less if it’s very weak). Whereas a strong business with stable cash flow, a diversified income stream and other positive characteristics will command a price closer to 2.5x.
The next step would be to then adjust the value for any included assets. So, if you were to value a business at $500,000 based on the cash flow it generates, but the seller is also including $100,000 of inventory (at wholesale cost), the business would be valued at $600,000.
Similarly, if any liabilities were included in the sale, they would lead to an adjustment as well.
I should also note that proper record keeping can also make a difference. The truth doesn’t matter if it can’t be confirmed by a buyer. So, if you generated $100,000 in profit but can’t (or don’t want to) produce financial reports or other relevant documentation to support your claims during due diligence, a buyer is likely to discount the value accordingly.
This post is part of the Ultimate Wiki Project