Why Does eCommerce Valuation Matter from the Start?
Let’s face it, eCommerce has changed our way of life.
Try to remember what shopping was like before you had the power to research, compare and browse (at speed) through what seems like an almost unlimited amount of products from anywhere you and your “screen” happen to be.
It’s pretty crazy, right?
Initially, “flexibility” was the noun most used to describe the power of the digital economy, not only did it give the customer more options than ever before, but it gave business owners more access to potential customers and greater ability to compete and grow in their marketplace. Who would say no to a shopfront that could be open 24/7, didn’t employ salespeople and the rent was almost free?
But while “flexibility” still remains a truism, for business owners, “complex” now has higher billing. As the marketplace has matured and populated, so has the technology, marketing, knowledge and talent needed to compete and grow at scale. This of course means the cost of doing business rises in line with growth, so much in fact that injections of outside performance capital at multiple stages is often mandatory for continual growth.
The importance of this cannot be understated. CB Insights analysed why 101 high profile startups failed and discovered that 38% ran out of cash or failed to raise new capital.
“Money and time are finite and need to be allocated judiciously.CB Insights : https://www.cbinsights.com/research/startup-failure-reasons-top/
For the startups on our list, running out of cash — tied with the
inability to secure financing/investor interest — was the top reason
startups cited for their failure.”
Now, remember – these were high profile startups – the attrition rate of early-stage eCommerce businesses not being able to acquire capital is thought to be much higher.
As Alex Mccauley of StatUpsAUS states:
“The data suggests that early-stage funding is harder to come by for Australian companies than at any time in the last five years.”https://crossroads.startupaus.org/overview
But surely the odds are easy to beat right?
Hmmmm. The Small Business Association in the U.S reports that
“21.5% of startups fail in the first year, 30% in the second year, 50% in the fifth year”
And for eCommerce businesses it’s even more dire, Forbes reports that:
“90% of e-commerce start-up businesses end in failure within the first 120 days.”
We share this information to highlight the importance of putting your company in a position to get a high valuation and becoming investable. In our experience, almost every Founder we’ve met didn’t truly understand the complexity of the task to get to profitability and then scale.
The pressures and resources needed for tech, data, strategy, and content on your bottom line, is very significant.
Forbes reports that:
“Founders need 2 to 3x longer than they expect to validate a business model.”
Perhaps you are currently asking yourself…
“Do I have enough cash flow to last three times longer than I thought to validate my business model?”
The Clock’s Ticking…
If you take one thing away from this article the TLDR is this…
There is a finite window to impact your eCommerce valuation to raise enough capital to scale (enter into new markets), this cash is needed to survive any early failures and support success. To impact this valuation, you must not only significantly impact revenue (sales orders online) but also build out those metrics that are most likely to increase your valuation and therefore investability. We estimate that this window per brand/company is generally about 12-24 months per new market (country).
Being able to optimise the valuation of the company also plays another vital role, as the higher the valuation, the less dilution of shares – during the early stages, this amount could translate to a difference of 15% to 30% of overall equity – which at later stages in the company’s life cycle (think exit) this could be huge!
Alex Mccauley of StatUpsAUS again:
“Many accelerator operators and later-stage investors note that they regularly see startups with seed stage terms so onerous that they are unable to attract any further funding down the line, crippling the business from the outset.”
Understanding and keeping focus on eCommerce valuation metrics is crucial to be able to grow with proper funding at the right time. This article is going to unpack what that means and why it matters for DTC eCommerce brands, especially for those in the early to mid stage of their growth.
Investability – The key to Success
Whilst at its heart eCommerce businesses still have the core values of traditional Commerce businesses, the way success is defined and therefore the investability of an online business can be very different. eCommerce businesses are highly focused on future valuation and continuous growth as opposed to immediate profit. Direct to consumer companies can continue to report high losses but still increase in valuation as long as they are growing at a fast pace.
Often, Founders believe the only hurdle to getting outside investment is convincing an Investor that their company is worth investing in. However, getting someone to invest in your business at the right time and at the right value could be the difference between success and failure, or the difference between a small exit and the kind that makes the headlines at the Financial Review.
A local business growing organically with decent profit is mostly not investable. The business grows as the Founders learn and adapt to the various business challenges, but because the Founders are concentrating on the now and the near future, they are unable to plan for what the business needs down the track – as they say, you only know what you know. The pace of growth, the narrowness of it’s strategies, and the lack of a clear future roadmap will deter any savvy investor. As such the end result for such a company is to be either eventually squeezed out of the marketplace by increased competition and operating costs, or sold at a much lower valuation than if they had continued to grow and open up other marketplaces. An investor is only interested in a business if their investment is likely to multiply in a relatively finite time span. Short term losses do not bother investors as long as the business is on the right track to future growth.
The Australian government announced a $100 million budget to invest in early stage eCommerce businesses but was only able to distribute 20% of the budget due to a lack of investable companies. One of the main contributing factors was the poor track record of local VC companies having successes with these Australian eCommerce brands due to not being able to mitigate the risk of rapid eCommerce sales and valuation success.
As such, business strategies designed with a practical and demonstrable focus on exit are always highly investable. Factors such as website traffic, strong business fundamentals, diverse marketing channels, large owned audience, robust financial structure and latest data and technology platforms are some of the factors that directly affect the valuation and thus investability score of any business.
Why the Timing of Getting Capital Matters.
What stage your business is at WHEN you need Capital is also closely related to WHY you need the capital. Here are two examples in explanation::
Scenario One. The most common pitfall that early stage businesses make is running a strategy solely based on profitability.
Because this often leads to focusing solely on metrics such as Return on Ad Spend (ROAS) and tactics that are short term focussed. Given the complexity of eCommerce marketing and available resources, this also often translates to only relying on a few marketing channels to drive growth, effectively having all their eggs in a few baskets. Any profits are put back into resupplying inventory and scaling the media campaigns, and if they are lucky, also developing and adding further skews to their offering.
In the beginning, if they have success in these channels – this seems like a winning strategy – especially short term until those audiences and marketing channels start to dry up or stagnate. This often results in relying on flash sales and discounts to drive purchases. This (also) short term thinking results in further lowering profit margins and reducing the perceived market value of their products – the eggs in the proverbial baskets start to look meagre indeed.
If the Founder tries to get capital before growth has slowed down, any capital requirements in this cycle normally result in a low valuation due to the eggs/basket problem and the lack of other healthy investability factors such as long term metrics like Cost Per Acquisition/CPA size of customer database, owned audience, verified reviews, percentage of repeat visitors, customer lifetime value and healthy average order value – and much more besides.
(This is just one set of investability metrics for more check out our article here).
If the Founder has timed the need for more capital because the audience has stagnated or dried up, then the company valuation and therefore the amount of equity they have to give away (if they can get funding) becomes much worse.
Scenario Two. On the other hand, Founders that are able to plan for becoming highly attractive to investors, still seek to continually increase sales of products (this is still critical), but not at the cost of short term success only. These strategies see them building foundations that also pay off in the mid to long term. Decisions are made based on getting the business to a point of becoming investable, instead of maximising sales only.
For example; By concentrating on the CPA and maximising user experience and adding value to the customer journey, they are able to raise the average order value (AOV), percentage of repeat visitors, owned audience, customer database and in turn lifetime value of the customer (LTV). All of these metrics not only stabilise and increase profit long term but increase the valuation of the company.
This is just one set of valuation metrics that more knowledgeable Founders plan to have in place for WHEN they seek capital.
These Founders seek to get capital before their growth slows down, normally when they have proven marketing message/s that connect to the customer journey metrics mentioned above. They have built a robust tech stack, with a clear and powerful reporting framework, they have a clear strategy to increase the marketing channels and extend their audience, and a comprehensive researched product development roadmap.
In other words, they seek capital WHEN they know they are highly investable.
WHY do they seek capital?
To continue their growth by using their market learnings so far and repeating a similar set of processes in a new, similar geographic marketplace, all the while quarantining the current local marketplace to shore up success there and ensure steady market value.
The result – investors see current steady growth in the current marketplace, robust metrics that prove that the company is investable and a solid plan to repeat the success rapidly in a new market, given the Capitalisation.
Cost to Scale
But why do businesses need outside capital in the first place? Surely a successful eCommerce business needs only to invest the profits back into the business to keep growing at scale?
In order to keep growing, eCommerce businesses need to seek bigger audiences and customer bases with similar if not better economies of scale. This almost always means global expansion, but this comes at a high cost. Expansion in an existing or new market requires the front-loading of capital and is an ongoing process. From our direct experience, we estimate the cost of launching in a new market requires a minimum funding of $700,000 to $1,000,000 AUD before it becomes self-sustainable. Remembering of course that it’s imperative for the business to make sure that any success in markets they are already in are protected, to avoid stagnation or loss of market share.
Capital is paramount to success and maintaining a high valuation makes it easier for businesses to get such an investment.
Illustrative cost distribution to launch and scale
|Global Scale||Local Scale|
|Inventory and Packaging||$200,000||$200,000|
|Social, content, Talent, etc.||$150,000||$100,000|
|Team, Tech, data, etc.||$250,000||$150,000|
|Localisation & Optimisation||$100,000||$50,000|
Note: the distribution of cost could vary depending on strategy and market opportunity.
Catch 22: The Cost of Making an eCommerce Company Valuable.
The sad truth is that few early-stage eCommerce companies successfully scale into global markets and if they do, fewer still manage to do it without giving away too much equity.
Unless you are an outlier that goes viral, captures the imagination and dominates the marketplace, there are usually two hurdles that stop early-stage eCommerce companies from becoming highly investable and following the path of Scenario Two above.
- As previously mentioned, most Founders are still learning as they go and are largely unaware of the need to plan from the outset on when, why and whom they will receive further investment. They are unaware of the complexity of the solution and the number of resources it takes to continue to grow and validate the business model.
- It’s an expensive exercise to become valuable.
We get it. The number one job of the CEO/Founder is to make sure the business is capitalised, and therefore the number one fear of any Founder, is running out of cash when they are doing well. So it seems highly counterintuitive to spread out the costs over multiple cost centres (see the examples below). As a Founder, why the hell would you want to spend on stuff that might pay off next year when you are trying your best to increase revenue today and tomorrow?
We touched upon a few examples in scenario two above. Now let’s look at a few other non-negotiable foundations that make your company investable.
Data, Marketing Performance and Technology
|Every decision in today’s world is expected to be data-driven. Maintaining the data infrastructure is not only important for decision making, it is also one of the key factors driving the valuation of the company. Crucial decisions such as right timing to launch in a new market or identifying the right marketing channels have to be based on data and algorithms. A sizable customer database could double the valuation of the company.|
|Websites are the backbone of an eCommerce business. Just like store location and interior of traditional business, the success of eCommerce business is highly dependent on the technology platforms. These systems need to be customised and well maintained as per the requirement of the markets. Being ahead of the game is the key to success.||Full stack end-to-end Tech capability and project management allow for:|
|Marketing Performance – Digital marketing is the sole sales driver. Customised marketing channels need to be set up based on market popularity and customer engagement. These marketing channels need to be continuously optimised by a highly trained team to find the best ROAS/CPA and tuned for LTV.|
Other than the external cost to launch and grow a business in new markets, the three teams above are some of the most in-demand and expensive talent pools in today’s world, in other words, finding the right people is both difficult and costly. Developing the people, platform and processes, hiring, training and maintaining or alternatively taking the risk of outsourcing or hiring an agency – requires a significant amount of capital.
(For more on this see our article Failure to thrive – How To Beat The Odds And Succeed In eCommerce).
Unfortunately, most Founders don’t have the cash flow or access to capital and the prior knowledge to be able to build these foundations in parallel with selling products and growing the business in their local eCommerce marketplace.
It’s a catch 22 situation:
|The Investible Catch 22|
|Can’t get capital without sacrificing too much equity. (Not investable enough)||Can’t become investable without having the capital.|
The DigiVest Solution
Our business model was designed from scratch to solve this very conundrum. We created an alternative, fair and balanced way for early-stage companies to grow, with mitigation of risk (including capital) being one of our key drivers. Unlike traditional venture capitalists and investors who offer capital for equity, we are in the trenches early, helping eCommerce businesses become investible – for example; amongst other services, we provide all of the data, marketing performance and technology services described above.
Unlike agencies, which charge a fee for execution, we are mainly rewarded for results. Through our unique Skin In The Game (SITG) Model and Investability First approach, we share a large part of the risk upfront with our Founders. We not only provide a true partnership approach to achieving your revenue and valuation dreams, but we also ensure you have a clear path to access capital when you need it, to further grow and scale your business without sacrificing too much equity too early.
A Partnership with DigiVest means access to a system of processes and best practices proven to get companies to scale, run by a team who is invested in your success (literally) at an upfront cost less than any other alternative. We are selective about who we partner with as our resources are also finite, but if you think this solution suits you. Click below to begin the process.