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Website / business valuation 101If you appreciate from the previous page that most sites are just mini-businesses, the conclusion that they are valued like businesses will come as no surprise. And, like businesses, they're valued based largely on the income they generate. Let's examine a typical business VS a typical website and see how their assets compare:
So a business is the sum total of its assets (minus its liabilities - i.e. net assets - but we'll come to that later). And the value of that combination of assets is measured in profits. You may have heard of P/E (Price to Earnings) ratios. The PE ratio measures the price of a company relative to the profit (earnings) it generates. Note: All the value of the company is contained within that calculation. There is no further value added for individual assets as the collective value of all the assets is reflected in the earnings. In the case of a website, similarly, the earnings reflect the total value of the underlying assets. Very occasionally, a website may have an asset that hasn't been fully exploited. For example, a seller may have a lot of valuable content that he never bothered to monetise, or a database of email addresses that has never been mailed. In such cases, the asset rarely realises a value at sale unless it offers the online equivalent of an asset stripping opportunity: If it can be sold individually, its value in the deal is generally limited to what it would command if sold in isolation.
What about business liabilities? Every registered business in the western world is required to produce a Balance Sheet periodically (usually annually). This is simply a statement of all the assets on one side and the liabilities on the other. A simplified example:
Where the liabilities are more than the assets the business is bankrupt. The usual case is that assets are more and the difference is the share capital invested by the owners. (This goes in the liabilities column as this is the money the business owes to its owners - but don't worry if that sounds odd :-)). This share capital is a measure of how much the business is worth on paper. It's the value of each individual share multiplied by the number of shares. This book value can differ from sale value i.e. what a buyer would pay to acquire the business. Where the capital (book value) of a business is $100K, the business is earning $30K a year, and similar businesses are selling for 4x annual earnings, this business is likely to sell for $120K and with a book value of $100K represents a buying opportunity for canny investors.
So, who decides the multiple? We've established that the earnings represent all the underlying assets of a business, but what multiple of those earnings is a fair price? There is no single answer to this. The multiple each buyer uses to reach his own perception of worth is influenced by several factors. 1. The future earnings (cash flow) and how confident the buyer is that these will proceed at the level he anticipates 2. Interest rates: Given a sufficiently high interest rate bank deposits would be a safer way of making the same level of profits. A really low interest rate may tempt buyers to borrow money to invest. 3. Competition among buyers influences the multiple 4. Various other factors
So what's all the DCF stuff then? To round this article off, let's examine the main formal valuation term. DCF stands for Discounted Cash Flow. Anticipated future earnings (cash flow) from a business are discounted to a current value i.e. how much you'd need to pay now at a given interest rate to ensure those cash flows at those specific periods in the future. I've examined this, Internal Rate of Return etc., in my more detailed article on Sitepoint. In the meanwhile please feel free to use these spreadsheets for all your Balance Sheet/ Profit / Cash Flow/ DCF, IRR and other financial calculations.
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