for E-Commerce Brand Owners

Unboxing the SDE, Seller’s Discretionary Earnings—and other considerations for a successful exit

When an owner-occupied business—such as an e-commerce brand—is sold, its value is typically measured as a multiple of the Seller’s Discretionary Earnings (SDE).

Nov 18, 2021
Rainforest Life

Rainforest is a consumer brand platform with a strategic focus on acquiring micro brands and building them into exceptional brands of tomorrow.

Unboxing the SDE, Seller’s Discretionary Earnings—and other considerations for a successful exit

When an owner-occupied business—such as an e-commerce brand—is sold, its value is typically measured as a multiple of the Seller’s Discretionary Earnings (SDE).

Unlike EBITDA (earnings before interest, taxes, depreciation and amortisation), which is used for larger companies, SDE allows small businesses to “add back” certain expenses, such as1) the owner's salary, car, travel expenses, or medical insurance, as well as2) one-time investments or expenses, like costs for licenses, restructuring, or emergency repairs. The SDE is said to provide a more complete picture of the profits that the owner-operated business is able to generate on an annual basis.

This exercise comes with some challenges though and might lead to disputes with the buyer over what are acceptable expenses that should enter into the calculation. Relevant charges should therefore always be accurately documented.

 

Arriving at a valuation

Yev Ivanko, VP of Acquisitions atRainforest, explains why these add-backs matter. If you take the typically used multiple of 4x or 5x earnings that buyers are willing to spend, it can be a big factor, he said. “If you had to pay an extra $50,000 that was purely a one-off, you add it back and it increases the final payout by $200,000.”

Ivanko regularly talks to shop owners that may fit Rainforest's criteria. If they are open to sell, both sides start negotiating on how to construct a deal. The term sheet needs to satisfy both the seller and Rainforest’s investment committee, which can take months."Within the team, we get into deeper discussions and valuation models to arrive at a final number," he said.

"It’s a seller’s market right now," Ivanko admits. Shop owners are very much in control when it comes to the final price for their businesses. But going with the highest bidder doesn’t automatically guarantee the best outcome. Out of nearly 100 potential buyers,10 might submit a term sheet, explains Ivanko. How to differentiate between them?

 

Finding the right buyer

Sellers need to consider their track records, and also how specialised the buyers are in a particular category, Ivanko said. How serious are they about a particular brand? Are they able to drive the performance of the brand? Some deals are structured as a combination of upfront cash and deferred payments over a couple of years. How likely is it that the buyer is still around in two years?

Signing a letter of intent is the first step to closing the deal. Over the next month or two, the due diligence team will go through the business after it has been taken off the market. At this point, the buyer might still uncover things and push for a renegotiation of the terms. There can still be a risk that the agreement breaks. To come in first, a buyer could have overpromised initially, only to get the preferential access.

What advice does he have for sellers who want to increase their SDE and valuation? It seems obvious, but it's about increasing revenues or decreasing expenses, Ivanko said. Most sellers cover the revenue side well, as they seek to drive growth, but could care more about their spending.

 

Keep an eye on your costs!

On the expense side, they have to think strategically and make sure that all of these costs contribute to the revenue. If owners prepare for a sale, they should optimise and squeeze as much revenue as possible from each item, he said. There's this software they once tried out, but that wasn't really working. Still they haven't shut it down and continue to pay for it. There are other redundancies, where two providers contribute the same thing.

One big factor is advertising.Business owners have to make sure that the ad spend is optimised, so that each keyword, each campaign is holding its own weight. "That’s where slack creeps in," Ivanko said. You can shut those that are not doing well, so it won't impact negatively and increase the profit.

With regards to logistics and supply chain, owners should ask themselves if they pay the correct prices to suppliers and freight forwarders. Some businesses haven't negotiated these prices in three years, he points out. "Maybe they have moved in their favour and they can squeeze out more of that relationship," Ivanko said.

 

SDE vs gross profit

The industry is shifting and some brands here in Asia, especially in China, are using their gross profit to determine the value of the business. Instead of adding back expenses, they just take the revenue of the goods they sold and discount everything that Amazon charges. “It is very objective and transparent,” Ivanko said. And it certainly saves a lo of time spent haggling with potential buyers.

 

 

Written by

Rainforest Life

Rainforest is a consumer brand platform with a strategic focus on acquiring micro brands and building them into exceptional brands of tomorrow.

Written by

Rainforest Life

Rainforest is a consumer brand platform with a strategic focus on acquiring micro brands and building them into exceptional brands of tomorrow.

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