We’ve all been there: sitting in math class and silently wondering when the heck we’d ever find an application for all those formulas, proportions, and percentages.
Ladies and germs, that day has finally come. Reach back in time, deep into the recesses of your teenage brain. Today we’re going to use all of those things to determine the value of your Shopify store.
We know, we know. We’d love to make it quick and easy but, unfortunately, the makers of Magic School Bus didn’t make an episode for this. (Boo hiss.)
Have no fear, the Tako team is here! We don’t have a catchy song or teleporting school bus (yet), but that doesn’t mean we can’t channel our inner Ms. Frizzle and make this business valuation lesson a little more fun for everyone.
(And it is supposed to be somewhat fun. Business valuation is a gnarly subject with a zillion moving pieces, lots of “proprietary formulas”, and very few one-size-fits-all rules. This post is intended to be a high-level primer of the subject only – if you’re serious about selling, you’ll need to do a lot more research!)
First, a Quick Glossary
Here are a few basic terms you’ll hear when we talk about business valuation, starting with, well…business valuation.
Business valuation is exactly what it sounds like: the process of determining the economic value of your business. You might want to do this for a variety of reasons, but the most common is to determine its sale value. Cha-ching!
Business metrics are measurable values used to track business performance and are essential in determining the value of your Shopify store. There are hundreds of metrics you might consider such as revenue, customer acquisition costs (CAC), churn rate, ROMI, customer lifetime value (CLV, also called LTV), profit margins, and – ah, yes, we see your eyes beginning to glaze. To get a better idea of which metrics are generally considered to be most critical, check out this article from Oracle NetSuite.
Fair value is a cumulative measure of your store’s intrinsic worth, all assets and liabilities considered.
Market value is the price assigned to a business actually being sold in the marketplace.
Fair value and market value are not the same thing. Fair value is what it’s worth, intrinsically and objectively – market value is what someone will actually pay for it.
eCommerce Business Valuation Factors
There are several key factors that go into valuing an eCommerce business:
As a general rule, the higher the traffic to your Shopify store, the higher your business will be valued – so long as that traffic is high quality. You might have hundreds of would-be customers entering your store on a given day, but if all – or even a high percentage – of them walk out without buying anything, no value is created. Traffic quality (which is ultimately more important to valuation than volume) is typically measured by looking at conversion and bounce rates.
Being that 68% of online purchases begin with a search engine, it stands to reason that Search Engine Optimization and traffic go hand in hand. The stronger your SEO strategy – and consequent web presence – the easier it will be for customers to find you.
SEO is tricky and boring for most of us. Lucky for you, we gritted our teeth, drank our six shots of espresso, and wrote this comprehensive guide to SEO for Shopify stores. (You’re welcome.)
Building long-lasting relationships with your customers is critical if you want to see lotsss of dollar signs when valuation time rolls around. Being able to consistently turn web searchers into visitors, visitors into buyers, and buyers into repeat customers who will tell all their friends (and strangers) how great you are validates your product, your strategies, and your shop.
When determining your store’s fair value, you’ll typically look at your net earnings for at least the previous 12 months, so it’s literally impossible to separate that consistency from value. To evaluate customer loyalty, take a close look at your customer lifetime value and churn rate.
Savvily increasing the number of revenue streams feeding into your shop enhances growth potential and can boost your overall value over time. Having multiple streams of revenue is very similar to financial investing’s diversification, where you distribute your investments across various industries and financial instruments.
No one with half a brain will argue against diversification. Whether in eCommerce or personal investment, it not only increases the likelihood of an attractive payoff, but also protects you from the risks that come with putting all your eggs in one basket.
(Psst – subscriptions are a great way to diversify those streams!)
I mean…duh. Your Shopify store is part of a capitalist ecosystem. (Sounds evil; isn’t.) At the end of the day, valuation metrics equal dollar signs. If all that traffic, customer loyalty, SEO, marketing, and more don’t actually result in a healthy, balanced financial statement, your value will be low. Whomp whomp.
Editor’s Note: I don’t know how relevant this gif actually is, but it’s all I could hear in my head when working on this section, so…there you go.
Age of Business
Companies who’ve been around for 3+ years will value higher than those that are younger, because there’s more trend data, more proof of concept, and more history.
Shamelessly making this about us for a second:
The Mack Truck Theory guides everything we do operationally at Tako, meaning that if any one of our team members is hit by a Mack truck, the agency could still carry on, with very little disturbance to our clients or bottom line. (Though we hope they’d be disturbed by the fact that someone on our team had just…died.)
Having strong, smoothly functioning, well-documented operational procedures heightens the value of your shop because it means your business will continue to hum along no matter who’s at the helm, so long as they can follow directions. This not only signals exceptionally streamlined daily operations, but also high transferability if you decide to sell!
Business Valuation: the Math Part
Warning: math ahead. 😵💫
Although there are dozens of metrics available, valuation calculations often begin with determining your business’s earnings. Business earnings are a key metric, and there are two main ways to determine your earnings.
First is the Seller’s Discretionary Earnings (SDE) approach. Typically used by companies with an estimated value of $10 million or less, the formula is as follows:
SDE = Revenue – Cost of Goods Sold – Operating Expenses + Owner Compensation
The second method to determine earnings is the EBITDA method, which stands for “earnings before interest, taxes, depreciation, and amortization.” By contrast to SDE, this formula is typically used by companies with an estimated value over $10 million. The formula is:
EBITDA = (Revenue – Expenses) + Depreciation + Amortization
There are other earnings models you could use, such as the revenue and growth model, but that’s more volatile since it’s based on expected growth and not, y’know, actual numbers backed by historic data. That’s how we get companies “worth” 50 jillion dollars that have never actually turned a profit a day in their lives. (What’s up, Airbnb.)
Once you have your earnings, the next step is to discover your earnings multiplier. The earnings multiplier is a single number (that’s actually made up of a ton of other numbers; more on that in a second) that you use to determine your overall valuation:
Valuation = Earnings x Earnings Multiplier
If you don’t want to do any real math, you can stop here! Most eCommerce businesses have an earnings multiplier of 2x to 4x if they’re using SDE. Where your business will actually fall within that range depends on some of the factors we defined above, along with dozens of other considerations such as return rates, customer service, logistics, physical property, intellectual property, and more.
If you’re curious, and want to see more closely where your business would fall in that range of 2 to 4, you can bust out your calculator. Let’s use liquidity as an example, with a multiple called a current ratio.
“Current” literally refers to the current state of your business and the ratio tells you whether or not you can afford to pay your bills. In business, it looks like this:
Current Assets / Current Liabilities
If the value of your assets is $70,350 and the value of your liabilities is $35,000, you’ve got a multiple of 2.15. That’s over a 2:1 ratio of assets to liabilities, which is the generally accepted minimum to be considered “in the clear”, although it would put you towards the lower end of our earnings multiple range.
Now let’s assume your assets are worth $150,000 and your liabilities are still $35,000. The multiple jumps to 4.38, putting you toward the higher end of the range
Liquidity is just one of dozens of factors to take into consideration when considering valuation. You’ll also want to compare your numbers to that of competitors or peers in your space, to see how you stack up. (It gets hairy from here, tbh, and we are not a business valuation firm 😬.)
OK, there was no song, dance, or school bus, but we still hope you found this lesson informative and digestible! We won’t give you homework, but if you have any questions on how you can improve your business valuation factors (and maybe get a higher valuation in the process!) you know where to find us.