How To Maximize Your Ecommerce Exit — Frank Kosarek | How To Value Your Brand, How Buyers Judge Real Business Value, Why Most Founders Lose Exit Value, What Documents Buyers Expect, What Buyers Fear Most, Why Brand Equity Drives Value (#458)

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00:00:02:22 - 00:00:21:04
Unknown
Hello, Welcome to another episode of the E-commerce Coffee Break podcast. If you have decided to sell your business tomorrow, would you walk away with a fortune or leave six figures on the table? Today we are discussing the best exit strategy for selling your business. It's the one thing most founders ignore until it's too late. To help us navigate this, I'm joined by Frank Kosarek

00:00:21:07 - 00:00:42:20
Unknown
He is the former head of M&A at Open Store and he just didn't study exits. He oversaw 50 of them. Now, as the co-founder of this part, he helps owners avoid the mistakes that kill deal value. So let's welcome him with the show. Hi, Frank. Welcome. Thank you for having me. Excited to be here. Frank, when you look at a founder who trying to sell a business but isn't ready, what's the first red flag you see?

00:00:42:22 - 00:01:06:23
Unknown
I would say the biggest red flag across the board is a lack of documentation of what a potential buyer would need to underwrite that deal. So you could be doing $50 million at a 80% EBITA margin on Shopify. But if your financials don't reflect that, you don't have an operating playbook to understand how you turn the flywheel and get that sort of cash flow.

00:01:06:24 - 00:01:34:15
Unknown
Predictably, you know, frankly, no buyer is going to believe you and that business has no value to an outside acquirer. So getting your ducks in a row as it relates to your finances, your operational playbook and even legal structures is the best first step to consider when maybe an exit is on the horizon. Mm hmm. I want to dive into all of this, but right now I want to ask you is like, is it true that most founders wait too long to think about selling?

00:01:34:17 - 00:02:01:08
Unknown
I would say the best time to sell is at the crosshair of two circumstances. The first is you're at a local high as it relates to sales figures, marketing performance, gross margin, contribution margin that crosshair alongside a playbook for expansion that maybe you're not excited about. Right. So you're an equal. So you're an e-commerce wizard. You love optimizing your conversion rates and your marketing.

00:02:01:10 - 00:02:19:18
Unknown
And to take your brand from 10 million to 50 million, it involves going into retail and opening opening up Amazon. And those strategies don't get you excited. So you're at a local high from what you've been able to do and then you crosshair that with the next phase is not exciting to you. That's probably a good time to consider selling.

00:02:19:21 - 00:02:37:21
Unknown
Mm hmm. So it's really looking into yourself to see where do you see yourself not only as a business owner, but as a person, as like, is that the road that I really want to go? Exactly. Now, when it comes to and you mentioned it before, it's very important to have your ducks in a row when it comes to your financial story reports and so on and so forth.

00:02:37:21 - 00:02:52:15
Unknown
And I can imagine you have seen a lot of mess there. Talk me through it. What's in a perfect world scenario or how do the financials need to look like and what kind of reporting do I need to bring? Yeah, this is a great question because I get this one a lot from founders who have never heard this acronym before.

00:02:52:17 - 00:03:17:14
Unknown
So I will share this for the benefit of the audience. There's a critical metric in eCommerce, M&A, and also all small business M&A called sellers discretionary earnings that's related. And what that means is the adjusted cash flow that a new owner would expect from your business without any election on how much salary you're taking for yourself, what sort of benefits you're giving to yourself.

00:03:17:14 - 00:03:53:00
Unknown
Right. So functionally, the equation for SD is your business is net income and then to that you add back your salary as the founder, your health care expense, let's say, and then any non-recurring one time expenses. So let's answer your question specifically. The perfect financial track record to present to a potential buyer is one where, you know, by month we're looking over the past, the trailing 24 months, let's say, from revenue, gross margin marketing expense down to contribution.

00:03:53:03 - 00:04:18:16
Unknown
We're also documenting out and itemizing the operating expenses. And then from those aspects, we are adding back every single month in a clearly documented sort of searchable format. The personal and nonrecurring expenses that will compose monthly and then eventually annually SD. So if we had that in a PNL statement with SD calculated out by by month, you are well ahead of the game.

00:04:18:18 - 00:04:45:11
Unknown
Mm hmm. And I reckon that's something you helped found, though, was to get this right when they work with you. Is that right? That's right. So we are a marketplace for small and medium sized businesses in eCommerce, as well as staffing and recruiting. But one of the things that we help with is preparing a data room, preparing a confidential info memorandum and preparing up to date financials so that when the business goes to market, it's represented accurately from an underwriting perspective.

00:04:45:13 - 00:05:13:05
Unknown
Mm hmm. I want to go away from the seller a little bit more on the side of how the buyer thinks and acts, what parts an e-commerce business specifically scares buyers the most. So for context, I used to be the buyer exclusively, so an open store, I was in charge of our new brand acquisition pipeline, which meant deal origination, light underwriting, some diligence and then integration of our new Shopify brands.

00:05:13:07 - 00:05:29:24
Unknown
So this was my bread and butter every single day. I was just looking at the buy side and I would say, you know, the deal price you need to be comfortable with from a multiples perspective, the deal structure needs to have some some hold back, meaning I am not giving you cost the 100% of the deal price upfront.

00:05:29:25 - 00:05:55:18
Unknown
I am crunching out some of it to make sure that the business is integrated successfully. But overarching all of that. The number one risk I came across was what we call key person risk. And that means, you know, let's say I'm selling swimsuits online and it just turns out that I'm a swimsuit model and my Instagram presence is half a million followers and I can make an organic post and sell $100,000 of inventory.

00:05:55:21 - 00:06:22:20
Unknown
That's fantastic for me. But if I sell that brand to you guys and you're not an Instagram, you know, swimsuit model, well, where does that leave performance? The business, right? So I think from a buyer's perspective, there are lots of creative deal structures hold back structures and also, you know, just keeping the founder involved post close that can mitigate that sort of risk so that you don't have a massive dip in performance after you close.

00:06:22:23 - 00:06:42:15
Unknown
Mm hmm. I'm definitely not a swimsuit model. And I can tell you right now, when it comes to the deal itself, and I think that might be something that our listeners are interested in. Is that a one off payment? Is this a recurrent payment? What kind of deal structures are usually out there? I would say it depends on your buyer profile.

00:06:42:22 - 00:07:11:18
Unknown
The usual deal structure, I would say, is some combination of cash paid upfront upon closing alongside what's known as seller financing. And seller financing is basically think of it as an implicit loan that you as a seller are making me as a buyer. Right? So let's say I want to buy your brand for $1,000,000. I'm going to put $500,000 down and I'm going to say class, I'm going to pay you the other $500,000 with interest rate.

00:07:11:18 - 00:07:32:26
Unknown
That's, you know, something around the prime rate over the course of 36 months. Right. So 500 K upfront and then every month I'm going to pay you in installments. That's amortized with that interest rate baked in. Right. It's not quite 5050. I would say there's some percentage that's cash down. Some percentage that is a seller hold back or seller financing.

00:07:32:29 - 00:07:59:00
Unknown
And then on top of that, you may also have what's called an earnout, which is a performance variable kicker on top of the purchase price that is dependent on how the brand does. After I sell it, you sell it to me or I sell it to you. And sometimes that earnout structure can last for three five years into the future and provide meaningfully more compensation and consideration on top of the base case.

00:07:59:03 - 00:08:24:11
Unknown
So I would say some combination of those three kind of pieces of infrastructure are what gets deals done. Mm hmm. How do you value a e-commerce business? A lot of e-commerce business are cash flow driven. So there is literally it's skews in and out of products, in and out, and then cash flow in and out. And I think a lot of business owners there sort of just look at revenue and overvalue their own business.

00:08:24:11 - 00:08:50:22
Unknown
How do you come to the real value? Right. It's a question of first off scale. So I think at a certain revenue attainment level, I like to say I would say 50 million plus there is a change in how you think about multiples as a buyer, and that's also a function of who your your buyer profile is. Let's say you're doing $50 million for a consumer acne brand.

00:08:50:24 - 00:09:18:20
Unknown
It's very possible that a consumer fund would be interested in acquiring your brand and might do so on what's called a revenue multiple. So it's up some multiple of that $50 million of topline is where the business would reasonably trade. I would say at a lower scale. And at this point we're dealing with 1 to $5 million of revenue and probably, you know, 1000000 to 10, 15 million of enterprise value.

00:09:18:22 - 00:09:48:16
Unknown
The valuation methodology is going back to that metric. Sellers, discretionary earnings, the number it is a multiple of that figure and the exact multiple depends on the growth rate, the gross margin, the particular type of industry that you're you're working with. But I would say a general range is two and a half times that discretionary earnings number up to maybe five or six times for a really mature, let's say, high subscription revenue type brand.

00:09:48:18 - 00:10:13:06
Unknown
Mm hmm. Now, if somebody listened to this episode trying to think when they will sell, what kind of homework or what kind of task can they start now to make sure that they have the right documents, rights, systems in place to make the business attractive for someone? Right. I would say the first is bring on a very competent bookkeeper who has a a mind for a minute.

00:10:13:08 - 00:10:32:21
Unknown
Someone someone who understands what I described earlier about carving up the last 24 months and clearly delineating, you know, the businesses, net income and then also personal artifacts that would compose the SD number. I think the other piece is, you know, think about documenting every odd and end of the business, right? How do you develop new products from end to end?

00:10:32:28 - 00:10:51:07
Unknown
Is there an operating manual for that? What are the marketing channels that are required to keep this business humming at a certain revenue attainment? Are those transferable to a new buyer? If not, how do we mitigate that? Right. And then the other piece I would say is, is also how do you think about the legal structure of the business?

00:10:51:08 - 00:11:11:20
Unknown
Right. So there are there are tax implications. I'm not a tax advisor. I won't pretend to be. But there are legal and tax implications to the type of legal entity that holds your business. If you're an LLC, there's one typical transaction structure, and if you are a C Corp, you have multiple options and and each can have its own set of tax implications.

00:11:11:20 - 00:11:33:17
Unknown
So that's not a there's not a big action item there, but it's something to consider with a tax professional. Well, before you take the business to market. Mm hmm. Now, a lot of businesses, specifically in the DTC market, it started as a side project, as a side hustle, and then they get traction, grow very, very fast. And obviously all of that you mentioned is sort of on the sideline in the mind of a founder.

00:11:33:19 - 00:11:59:29
Unknown
So really, do recommendations start early to make sure that you have the right structure in place when it comes to the sale? Now, you have bought and sold a lot of businesses. Can you give some examples of businesses and what kind of results and the timeline, how long it took to sell them? Yeah, So I would say typical timeline for a mature cash lying e-commerce business is anywhere from 3 to 6 months to find a buyer.

00:12:00:01 - 00:12:17:05
Unknown
And that's not to say that, you know, that's too slow or too fast. We think about a low volume, highly curated type marketplace that that we want to run here, which means we're not going to rush the business to market. We're going to find the right buyer at the right valuation with the right capital source to get the deal closed.

00:12:17:11 - 00:12:36:18
Unknown
And if that takes six months, so be it. We're happy to take the time. You know, I think it's interesting. A lot of brands don't even realize the full potential of what their exit could look like. We have calls all the time with founders who say, oh, you know, I'm doing X, Y, Z dollars in cash flow and my business is worth, you know, this amount of dollars.

00:12:36:18 - 00:12:52:13
Unknown
Right? And I'm like, well, you know what? You're probably selling yourself a little bit short there. So it is useful even if you're not interested in selling tomorrow, to have a back of the envelope in your head of what the business could be worth and an update that once a quarter. Right. Do you have a big quarter that is going to impact your valuation?

00:12:52:13 - 00:13:16:27
Unknown
Absolutely. And if you make a mistake on inventory or hiring, that also has an adverse impact. So getting expert eyes on that sooner rather than later will limit surprises, I think, when you go to market. Mm hmm. I think it's a good point that you mentioned there, too, to know what your business is worth or not, words that might motivate you to either work harder or it might surprise you on what?

00:13:16:27 - 00:13:44:09
Unknown
It's already worse. Now, who's your perfect customer at this point? I would say from my perspective, so we service two verticals right now. One is staffing and recruiting agencies in the 1 to $5 million range. And then my specialty is, of course, the eCommerce vertical, describing my perfect candidate as something like a brand doing maybe $5 million of revenue across Amazon and Shopify with strong consistent cash flow.

00:13:44:09 - 00:14:04:21
Unknown
I would say, you know, at least two years of operating history and a brand that's shown evidence of real equity, brand equity. And what I mean by that is I just came across a brand where on Google that they have been crushing it on Google ads. And when you look at why, it's because one of their branded keywords.

00:14:04:22 - 00:14:26:20
Unknown
So like, you know, when you search X brand in this category, the return on ad spend for that keyword is 20 times, right? 20 times. So that means people want that brand. And when they search it, that ad converts at a very high rate. And to me, that's the clearest evidence of brand equity. And I think that's a very easy case to make to an acquirer, even on that number alone.

00:14:26:21 - 00:14:50:05
Unknown
Right. And then I think that the final pieces, bearing in mind a strong margin profile, you know, if it's a product that you're manufacturing as the as the end producer, I would say 40% plus gross margin, ideally 50% plus is attractive with a contribution margin hovering around 20% makes that a very investable asset. Yeah, that sounds like a solid business.

00:14:50:07 - 00:15:08:22
Unknown
Walk me through a typical onboarding process for a new client. What steps are involved and how long does it take to get everything right from their site? It's as simple as creating an account actually, on the on the busy port website. So we'll ask you some basic from our graphic info, your website, your name, a little description of your business.

00:15:08:24 - 00:15:36:27
Unknown
We'll also ask you to connect your QuickBooks account if that's what you use or if not, we have other forms of bookkeeping we'll accept and then any supporting documentation that you would like to include in your data room. We will will and take that will take that listing into our queue where our team will review, you know, the asking price, you're considering, the documentation you've submitted, and then we will personally get on the phone with each of you and say, you know what, this valuation makes sense.

00:15:36:27 - 00:15:55:04
Unknown
Or how about we think about structuring a deal in this way or asking this amount? And once we have a meeting of the minds there, the business goes live on the this port site and then we begin pitching it out to our network of buyers. That is absolutely part of our scope. Mm hmm. Very helpful. And I think you mentioned before having a good accountant.

00:15:55:05 - 00:16:18:24
Unknown
A good tax consultant definitely helps in the process. Now, how do you earn money? What's what's your pricing structure? So our pricing structure is on the sell side, and this is a key differentiator for us. The average business broker, many of whom are high performing folks who do a great service, some of them will charge 10 to 15% of the deal price as their commission, which is, I think you know, industry standard.

00:16:18:27 - 00:16:49:09
Unknown
Our sell side fee is 6%, so significantly lower than industry standard. We can do that because we have a lot of the onboarding process that SIM creation financials recast. That's actually done via air. So we don't need large teams to, you know, we don't need to pay those folks to the same extent. So that's one piece. And then in some cases we we offer some buyer referral programs where someone can ask us to do a routine search and go out and look for a very specific profile of business.

00:16:49:12 - 00:17:08:27
Unknown
But the main source of fees is that 6% seller fee. Okay. I don't make sense. If you sell your business to somebody who pays a good price for it, then the 6% is basically in the sales price. We don't lose out there. Frank, before our coffee break comes to an end today, is there anything you want to share with our listeners that we haven't covered yet?

00:17:09:00 - 00:17:27:27
Unknown
Yes, I actually I get this question a lot. It's funny. I'll get on a call with a founder and they'll say, Do people really buy ecommerce businesses still? I'm like, Of course. Of course people do. I of course, I worked for an aggregator. You know, Thrasher was another big one. Moonshot Brands. Many of these have changed their strategies.

00:17:27:27 - 00:17:50:15
Unknown
So it can seem like, oh, you know, who's buying these text brands anymore? But I can tell you there is strong investor interest, both from private individual buyers and institutional buyers in strong cash flowing businesses. If you have a strong cash flowing business, I can assure you that there is a buyer out there. So don't despair. Like that's absolutely something that we want to instill on this audience.

00:17:50:17 - 00:18:13:22
Unknown
If you want to exit that is 100% in your possibility set and we wanna help you get there. Mm hmm. Now, I'm surprised to hear that people think there is no market out there. There's definitely a market. I just spoke to a couple of folks the other day who are basically actively selling their business. There's always buyers, there's always sellers in the market, and e-commerce is highly dynamic, so that will not go away.

00:18:13:24 - 00:18:31:24
Unknown
Frank, thanks so much for giving us a very deep insight in how to sell e-commerce business if you're running an e-commerce business out there. To our listeners, keep this in mind if you have an exit strategy early enough, you will make more money at the end of the day. Frank, One question I have. Where can people go and find out more about you?

00:18:32:02 - 00:18:49:09
Unknown
Yep. So our site is Biz Dashboard ABC.com. You're also welcome to email me directly. I'm frank at is dash port. Com. You can also find me on LinkedIn. I'm happy to throw my LinkedIn URL in the show notes here. Cool. I will put all the links in the show notes and you're just one click away. Frank, thanks again for your time.

00:18:49:10 - 00:18:54:18
Unknown
I hope a lot of people will reach out to you and you will help them in selling their business. Thanks so much. Thanks for having me.