My CEO Life

A reader in India has sent me a question all around business valuation and more specifically he asked, how do you value a Web 2.0 business. 

At the REA Group we purchased 15 different businesses and during that time used a number of different valuation approaches.  These approaches included market values (ie comparative sales), discounted cash flow, revenue multiples, net earnings and EBITDA multiples, and value per customer. 

The objective in the valuation of a business is to work out the value in the hands of the current owners and then the value in the hands of the acquirer.  This give you the overall range and the negotiation objective is to agree a price as close as possible to the value in the sellers hands.  (Otherwise you are giving away too much value to the seller)

However, valuing a web 2.0 business is a different kettle of fish.

First of all when talking about a web 2.0 business, you are usually talking about one with little or no revenues, a focus on signing up subscribers and future promise of advertising or some other revenue potential. 

Now if the business has revenues and expenses and can demonstrate a good rate of revenue growth, then you may have a chance of building an acceptable discounted cash flow model and therefore a clean valuation. 

However, these businesses are usually not that developed therefore the focus needs to be on the number of signed up customers (subscribers), average session time and page impressions.  Using the growth in these numbers, you should be able to estimate the overall growth of the usage of the site over time.  The challenge is then applying an advertising model (or perhaps a paid for subscription model) to the business and then extrapolating some sort of value from that.  (Tough but doable)

Also – these types of businesses tend to have an exponential valuation rather than linear – meaning that the larger the busness is, the more it is relatively worth. 

Of course, the fundamental challenge for any web 2.0 business is will they ever earn real revenues.  The jury is still out on them.

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