Bryan O’neill, co-founder of a web asset due diligence company, analyzes the key differences between the recommended due diligence process for acquiring traditional businesses, in comparison to that for internet businesses and websites.
There are many similarities to performing due diligence on brick & mortar businesses and internet businesses. In both cases, you need to make sure that the company’s finances add up, there are no legal issues, there are no hidden obligations (if you’re buying the business as a company, rather than an asset), and that all contracts are transferrable amongst other things.
But that’s where the similarities end and the additional checks, not applicable to traditional businesses, kick in.
Key Difference 1 – The Main Focus is on Traffic
In the brick and mortar world, buyer leads are most often generated through advertising, or in the case of retail,foot and/or car traffic. Whilst the same is often true with online businesses (in the case of advertising), many of them get the majority of their clients through search engines instead.
This comes with a whole enchilada of additional threats, as well as an additional due diligence burden. As a buyer you need to realize that by depending on traffic from search engines, the business is completely at the search engine’s mercy. Search engines such as Google often tend to push through ranking updates, most of which destroy hundreds of businesses overnight!
Because of this, it’s extremely important to include traffic source vetting in your primary due diligence checks, as you need to make sure that the website’s traffic is sustainable and that there are no red flags that could indicate otherwise.
Key Difference 2 – Technical Elements
There are various technical aspects that a traditional investor often won’t consider and lacks the know-how to check.
An example is checking a website’s link profile to make sure that the site has not previously used any unorthodox Search Engine Optimization tactics that could later backfire and decrease the site’s search rankings.
Another important technical aspect is making sure that the statistics engines that the website is using haven’t been tampered with, resulting in inflated traffic figures.
In addition, a good due diligence check also includes checking the website against known email spam databases, confirming the ownership of the domain names, making sure that the content published on the website isn’t plagiarized, that the software that the site is using is properly licensed and more.
Since most traditional investors, nor their legal teams, don’t have the sufficient knowledge to perform these checks, they are often outsourced either to private contractors or to online due diligence agencies.
Key Difference 3 – Maintenance Burden
Traditional businesses will usually come with employees who take care of the technicalities. Online businesses, on the other hand, typically don’t. Instead, most online businesses (even relatively large ones) have grown out from “hobby websites” or family businesses, and as such are very often owner-run.
Because of this it’s extremely important for investors to analyze the business owner’s daily, weekly, and monthly tasks to be able to properly account with the cost of outsourcing operations.
In addition, it’s important to evaluate and understand the difficulty of the tasks that the current owner is performing. Often the tasks are of a varied nature, meaning that it would require more than one employee or freelancer to successfully outsource everything.
Although continued competition by the seller is also an issue in the offline world, it’s much more common online. This is not only due to lower barriers of entry, but also because of the relative anonymity of the Internet.
The fact that many online acquisitions are based overseas also means that non-compete clauses in purchase agreements are difficult to impossible to enforce.
This increases the importance of running a proper background check on the seller to make sure that they’re not likely to start competing with the business that’s being sold. Luckily, a little bit of digging often yields a clear overview on any other businesses that the seller is involved in, as well as their history in buying and selling businesses.
Key Difference 5 – Lack of Audited Books
Traditional investors are used to having audited books and tax returns presented to them prior to committing to a purchase, making the verification of revenue figures easier. On-line, however, most businesses are owner-operated and as such, the presence of audited books is an exception, rather than a norm.
In these cases, the buyer largely depends on partial information when analyzing the accuracy of the provided historical revenue figures and it becomes increasingly important to perform secondary checks that would back up the provided financials.
These secondary checks can be as simple as dividing the number of unique visitors that the website receives by the monthly gross revenue figure (a metric that we call RPU or Revenue per Unique) and cross checking it against the industry averages, or as difficult as running sophisticated checks on the traffic sources of the website to make sure that all of the traffic is legitimate.
Which checks you run should depend on the extent of revenue verification that the seller can provide, however “the more the merrier” rule always applies as running too many checks is better than running too few and ending up with a business that generates a fraction of the claimed revenue.
Whilst there are many similarities in conducting due diligence on traditional businesses and on internet businesses, proper website due diligence should include some very specific checks and verifications.
With the increasing number of fraud attempts taking place in the industry, it’s highly recommended that everyone considering acquiring an online business either educate themselves in the specifics of the due diligence process or hire a professional.
Bryan O’Neil is an industry professional with years of experience in buying, selling and managing online businesses. After several years in the online brokerage industry, Bryan co-founded Centurica – a Web Asset Due Diligence and Maintenance company, which he now runs.