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What You Should Know Before Investing in Online Businesses
By Quiet Light
For many entrepreneurs, buying an online business can be a rewarding investment, both personally as well as financially. If you are considering going this route, however, it’s important to identify what you should know before investing in online businesses. This enables you to do proper research and establish a clear roadmap to success.
In this article, we address:
- How investing in online businesses works
- What to look for in an online business acquisition
- Types of online businesses you could invest in
- Tax benefits of buying an online business
How Investing in Online Businesses Works
Before investing in an online business, it’s helpful to have a sense of how the process works from beginning to end. By following a logical framework, adequately preparing for your investment, and executing your plan faithfully, you can increase your chances of finding and making a good investment.
In general, there are several phases when it comes to investing in online businesses. These include:
- Establishing investment criteria
- Identifying a business that meets your criteria
- Completing the offer and purchase process
Establish investment criteria
Regardless of whether you represent a venture capital firm or are an individual looking to make a purchase on your own, it is crucial to first establish your investment criteria.
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By establishing your investment criteria, you can get a better idea of the specific type of business you are looking for. This will help you make an informed and analytical purchasing decision.
There are several things to consider when establishing your investment criteria, including:
- Establishing your budget
- Considering your skill set
- Assessing your risk tolerance
- Considering your interests
Establishing your budget
First and foremost, it is important to establish your budget. Of course, this will depend on your own personal financial situation and the financing options available to you. Determine how much capital you have available for investing in a business. Also, figure out how much you want to keep in alternative investments. For example, the stock market, real estate, Roth IRA accounts, a mutual fund, or your savings account.
In addition, you may want to look into business loan options. Small Business Administration (SBA) loans are a popular option when it comes to financing the purchase of a business.
Considering your skill set
Once you have established your budget, take a realistic look at your skill set. Consider what you are good at when it comes to running a business and what areas you may lack experience in. By identifying your strengths now, you will be in a better position to find a business that allows you to play to them and create value.
Assessing your risk tolerance
All business ventures entail some risk of failure; risk is unavoidable. However, some businesses carry more risk than others for a variety of reasons. In general, high-growth companies entail higher risk, while low-growth companies entail low risk.
Some individuals thrive on risk or are in a position to be able to take greater risks. Others may prefer to play it safer. There is truly no wrong or right answer here, but it is important to be honest with yourself about your own level of risk tolerance. Once you know how much risk you are willing to take on, keep it in mind when making a purchasing decision.
Considering your interests
Lastly, it is important to consider your interests when determining the right business to purchase. Running a business often requires considerable work and time commitment from the owner, at least initially. By purchasing a business that lies within your field of interest, it may be easier to find the motivation necessary to sustain your efforts for the long term.
“By establishing your investment criteria, you can get a better idea of the specific type of business you are looking for.”
What you should know before investing in online businesses: How to identify a business that meets your criteria
Once you have taken the time to establish your investment criteria, it is time to find a business that meets your specific needs.
Business listing sites like flippa.com have a range of online businesses for sale. Whether you are looking for SaaS businesses or content sites, you will find many different businesses of all sizes and types listed on Flippa or other similar platforms.
In addition to looking on listing sites, an experienced business Advisor can help you find the right business. By understanding your needs and utilizing their extensive networks, your Advisor can help you find opportunities that may not be available otherwise. In addition, they can guide you on finding a business that meets your criteria.
Complete the offer and purchase process
Once you have identified a business that appears to meet your criteria, it is time to move through the offer and purchase process.
Initially, you can reach out to the business owner and introduce yourself as an interested buyer. This is also an opportunity to seek further information about the business. Before revealing more information about their company, the seller will likely require you to sign a nondisclosure agreement (NDA). This agreement prohibits you from revealing certain details about the business.
If you like what you see when you examine the business, you can schedule calls with the seller to discuss details, ask questions, and get to know each other. If you decide that the business is a fit, you can then make an offer.
During the offer stage, you and the seller negotiate the price and terms of the deal until you reach an agreement. The right business Advisor will also help you navigate the negotiation process in order to reach a more favorable agreement.
Asset Purchase Agreement
Once a deal has been reached, you and the seller sign an asset purchase agreement laying out the legal terms of the deal. Next, you enter due diligence.
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During due diligence, you and your team have the opportunity to investigate the business thoroughly. This will allow you to ensure all claims regarding its performance are accurate and true. Of course, this includes cash flow and business expenses. This is an extremely important process because it allows you to verify the business is actually performing as the seller claims it is.
Once you are satisfied with the results of the due-diligence process, you and the seller close the deal. During closing, you transfer the agreed-upon funds into an escrow account. Then the seller releases the business assets to you, and the escrow agent releases the funds to you.
Four Elements to Look For in an Online Business
Let’s consider some of the important factors to look for when choosing a business to invest in. These include:
Taken together, these four factors are sometimes called the Four Pillars of Value.
Business growth after purchase is essential for you to achieve a healthy return on your investment. As such, it is very important to look at the past, current, and likely future growth of a business you are considering investing in. If a business shows consistent past growth, it is a good indication it is likely to continue growing into the future.
In addition to analyzing the company’s past growth trends, it is important to consider whether or not there appears to be any room for future growth. If so, can you identify specific ways you could drive future growth once you take over?
For example, let’s say you are considering investing in a content site. You examine a prospective company and identify several content gaps in its current marketing strategy. Based on this information, you may feel confident you could address these current shortcomings once you take over in order to drive future growth.
When considering growth expectations for a company, it is also crucial to think about the growth trends of the industry as a whole. Is the market expected to grow into the future, or is it in decline? By taking into account the growth expectations of the market and the individual company, you can get a better idea of whether or not a business represents a worthwhile investment.
As with any investment, it is important to consider the relative risk involved. As discussed previously, all businesses entail some risk. Some are riskier than others, however. You must weigh the relative risk against the potential upside of a business. Once you do, you can see how the tradeoff fits into your unique personal and financial situation.
Of course, it is ideal to find a business that has low risk and high growth potential. As you might expect, however, these types of businesses are often priced much higher as a result of these characteristics.
To capitalize on your investment, the business must successfully transfer. This must happen without negatively impacting performance.
Issues with transferability can arise if the business is difficult for a new owner to manage. This can happen if there are no clear standard operating procedures in place, or if the owner runs a disorganized operation. On the flip side, if an owner creates clear operating procedures or has a team in place to manage the business, it will be much easier for a new owner to take over.
A business tied to the owner’s personality or likeness presents obvious challenges to a new owner. For example, let’s say there is a travel content site focused solely on the owner’s personal story. In this case, you will find it hard to step in without seeing a decline in performance.
As such, it is important to look for businesses that can easily and successfully transfer to a new owner without negatively impacting sales and growth. Fortunately, there are many popular business models that allow easy transfer of ownership.
A profitable online business that can provide clear documentation of its operations and performance is more attractive than one that can’t. For starters, clear accounting records make it much easier for you to verify the performance of the company during the due-diligence process.
Clear documentation makes it a lot easier to take over ownership of the business. It also helps instill confidence that the business is run competently. This, in turn, should lead to fewer surprises during both the transaction process as well as once you take over operations.
Types of Online Businesses You Could Invest in
There are many different types of online businesses you could invest in, catering to a range of interests and requiring a variety of skills. Common online business models include:
- Amazon FBA businesses
- SaaS businesses
- Content sites
- Ecommerce businesses
Amazon FBA businesses
Fulfillment by Amazon (FBA) businesses are one of the most popular online passive-income ideas available. With the growth in popularity of the Amazon platform, entrepreneurs from all walks of life have created successful Amazon FBA companies in every product niche imaginable.
Amazon FBA companies often source their products from suppliers and manufacturers around the world. They then package their products with their own company branding and ship the products to an Amazon warehouse. The products are listed on the Amazon platform, allowing the seller to access Amazon’s immense customer base.
When a customer purchases a product from an Amazon FBA company, Amazon boxes and ships the product out to the customer. Amazon handles all fulfillment responsibilities in exchange for a percentage of the company’s revenue.
Given the tools, market access, and fulfillment services Amazon provides, once an Amazon business is established it does not necessarily require much time or input from the owner. If a team is in place to run the business, even less is required of the owner.
In addition, Amazon companies can grow to be quite successful. Combined with their potential to be relatively hands-off, it is easy to see why they are such a sought-after investment.
Software as a service (SaaS) companies are another popular online business model. SaaS businesses function by offering a software solution to customers on a subscription basis. That is, customers pay monthly, quarterly, or annually in order to maintain access to the software service.
SaaS companies can offer software solutions to consumers as well as businesses. Due to their subscription model, SaaS companies benefit from recurring revenue. This makes them quite attractive as an investment opportunity. For someone with the right skill set, buying and scaling SaaS businesses is a solid option when it comes to investing in online businesses.
However, SaaS companies require ongoing customer service and development teams in order to help maintain customer retention levels.
“While they do require a lot of up-front energy, time, and effort to get off the ground, content sites can become passive-income-generating machines if successful.”
Content sites are websites that specialize in content creation and content hosting in order to attract visitors. The nature of the content could be informative or entertaining and could include written posts, videos, or photos.
Content sites can be monetized by hosting ads, affiliate marketing, or as a tool to help a company launch its own online store, online course, or other digital product categories. Many sites combine several monetization methods to maximize revenue.
One of the major advantages of a content site is that once it is up and running, it can be relatively passive. However, they can require a lot of up-front energy, time, and effort to get off the ground.
As the name implies, an ecommerce business simply sells its products online and then ships the products to its customers. An Amazon FBA company is an example of an ecommerce business, although FBA is not the only ecommerce business model available.
Many companies opt to stay away from Amazon and sell their products on their own website. In addition to avoiding the fees associated with running an FBA business, running a business on your own site allows you greater control over your brand, direct access to your customer information, and more flexibility in your direction.
Some downsides are it can take more time to get started, build a customer base, and get your brand out there. In addition, you will need to handle your order fulfillment. This can happen by shipping your products yourself or hiring a third-party fulfillment service.
“It is important to work with an expert accountant to ensure you maximize your deductions while staying within the law.”
Tax Benefits of Buying an Online Business
Some wonder if there are any tax benefits associated with buying an online business. Regardless of whether you pay cash or go through the SBA lending process to acquire a loan, there can be certain tax benefits when you own and run a company.
While you will be required to pay sales tax in most situations, owning a business allows you to take certain business-related deductions that you would not be able to otherwise. This can help you minimize, or even eliminate, your tax bill.
However, it is crucial to always do so in a legal manner. It is important to work with an expert accountant to ensure you maximize your deductions while staying within the law.
In addition, the way you structure the legal entity of your business and pay yourself as the owner has implications for your personal tax rate. Again, speak with your accountant and lawyer in order to choose the legal structure that is right for your business.
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