In part one of this post titled, How I Started, Grew & Sold An E-commerce Business For Quarter Million Dollars ($250,000), I wrote about how I came about the idea for the e-commerce website that I started, grew and sold, while on an international work-related trip.
The article goes in depth explaining the formulation of the idea, the facts I gathered about my industry during research, and an analysis of the product supply chain, which eventually lead to the value proposition (the business idea).
I then discuss the journey to search for a product distributor who would become my business partner, how and where I found one, as well as the establishment of the e-commerce portal itself.
This article picks up from that point onward, discussing the challenges we ran into once we went into operation mode, the invaluable lessons that only first-hand experience can teach, the exit strategy which was the $250,000 sale of the website, and finally my overall concluding thoughts on the entire experience.
I hope you find this discussion beneficial and of some value to you as you embark on similar entrepreneurial ventures.
There were several more challenges encountered in conjunction with this project, once we were in operation, and as a result several invaluable lessons were learned.
One of the biggest lessons I learned is when going into business that requires heavy technical work, such as the e-commerce website (programmed in PhP) we ran, it is better to find a programmer that will work with you on a profit sharing basis rather than payment per task.
A one and done programmer can disappear overnight on you, leaving you with no one to turn to for immediate help. If you are running a blog, you can get away with less frequent technical help. But when you are running a website with over 1,000 different products that change frequently (in size, quantity, branding, name, description, etc), as well as one that demands consistent improvement in process and technology, it is almost impossible to provide an ideal user experience without full time help by your side.
Finding a programmer who will work in exchange for a vested interest is difficult; the alternative is to have and be willing to fork out dollars constantly for work you want done on your website.
Pay Per Click Advertising (PPC)
We didn’t have the slightest idea about search engine optimization (SEO), so we focused on PPC to drive traffic to our website. If you ever get into PPC, make sure you spend ample time studying quality material discussing what it is and how to execute it effectively. If you can’t do it, hire someone who knows what they are doing.
PPC marketing can be very exciting, addictive and lethal at the same time. I almost lost my shirt doing this. I still don’t understand PPC marketing well enough to this day to be able to make a killing from it like some internet marketers do, and that’s why I only do it for one of my niche content websites. I spend a mere $10 a month on it, mainly because I haven’t found anyone else in the niche and therefore am able to generate a relatively high revenue to expense ratio or return on investment (ROI).
The site I use it on has been up for over two years and so far so good. I am keeping my fingers crossed but I know that it is just a matter of time before some competition catches up. Pardon the tangent.
Another lesson learned is to automate a business as much as possible, particularly one that involves several types of products and a constant back and forth interaction between you (the business) and the buyer (the consumer).
Here is an example why: my partner supplier had millions of dollars worth of merchandise in the warehouse, but the merchandise mix (both product and price) changed frequently. This became a nightmare for us. Updating inventory prices and quantities became like a full time job in its own.
We brought in a couple of programmers and paid them to do some work to sync the website’s product database to the warehouse inventory system. However, because the warehouse inventory system was such a manual process (manually updating Microsoft Excel spreadsheets), we now had to rely on the hourly warehouse employees to update the spreadsheet timely and accurately. You can guess what happened.
Growth is Not Always Good
Most companies want to grow, as did we, but growth should be planned so that it can be managed when you get there. When growth is unplanned for, it becomes unmanageable and you find yourself putting-off fires instead of proactively planning for and preventing them.
Instead of operating from a proactive approach, you relinquish control and become reactive to externalities, which at times make you completely helpless. This often leads to inefficiencies in the short term and disaster at some point down the road. Luckily as you will find out below, we were saved from disaster. However, we did encounter several painful inefficiencies.
For example, because our inventory update system was flawed, our website would indicate that product A is available and that we have 15 pieces of it in stock, 10 of product B and 5 of product C. Because our customers were mainly resellers, they typically bought each product in large volumes.
What started to happen frequently as we grew was that customer D would order 20 pieces of A, 15 of B and 10 of C. This had a few implications. First, we were not able to fulfill the entire order and therefore have an unhappy customer.
Second, because the website processed payment upon ordering immediately, we now had to refund money for the product we didn’t have. Not only did this take a lot of time to do, but we also had to incur credit card processing fees for refunds. Not to mention an unhappy customer. Credit card processing costs money per transaction, whether it is a purchase or a refund.
What also started to happen frequently is because the warehouse inventory wasn’t reflected full time on our website, customers would view a product and not buy it because the website would show it as not available when in reality we could have 100 pieces of it in the warehouse. I know this because many of our customers emailed us asking when we would get more of product E, F and G. Lost sales from ready to buy customers on available items absolutely killed me.
In an attempt to fulfill customer demands, I started buying my own inventory, and a lot of it. Because I didn’t want customers to turn back unhappy, I tied up my own cash flow in perishable inventory. This was a huge risk. One bottle of designer perfume can cost anywhere between $15-100, and I had a ton on hand.
This is not only detrimental from a cash flow / working capital perspective, it is also a huge risk. Think about potential inventory breakage and obsolescence. I was also spending a lot of time analyzing which items sold most and during which seasons so I could plan my inventory purchases accordingly. A big time consuming activity.
Because of the entire mess collectively, we saw that our membership renewal rates were down the following year. Many refused to renew their memberships and others wanted a prorated refund before even a full year of their membership was complete. I don’t blame them. Why would I pay Sam’s Club an annual fee when they don’t have the items I want half the year?
In addition, we had six Better Business Bureau (BBB) complaints from unhappy customers. Suddenly, our operational risks “creeped” into becoming reputational risks. I know from experience that if we were to continue down this path, we would have potentially faced lawsuits. BBB complaints to attorneys are like blood to sharks.
Bottom line is that our membership was growing much faster than we had anticipated and we were simply not equipped with the PPT, or personnel, process and technology to make things work the way we wanted to. Sure we were making money, and volume was increasing (both sales and memberships), but the work and potential risks involved were becoming more than we were willing to burden.
Finally, I learned that you should be very careful in selecting the partner you choose to work with. I see more partnerships fail than succeed, and there is a very good reason for that. Partners must share the same vision and hold the same values and characteristics necessary to succeed in any venture.
For example, if you are determined, know how to persevere and don’t give up easily, select a partner who has the same track record as you. When one partner looses patience, or gets fed up because of obstacles that come your way (and they will no matter what business you decide to go into), there is a tendency to start getting frustrated, pointing fingers and giving up.
Take your time in selecting your partner. It is not easy finding one who has similar motivations as you and who can perform at a level you want to perform at. Perhaps that is one reason why most of my side gigs are self-operated ventures.
The best way I can summarize the root cause of ALL challenges we encountered was that although I took my time to research and develop a solid idea upfront, I jumped the gun on the execution. I aimed and fired without having completely researched or being ready for what came ahead. Maybe the first-mover anxiety got to me?
The Exit Strategy
One fine weekend afternoon I received an email indicating interest in our business, and whether we were open to discussing the potential sale of it.
I wasn’t thinking about a sale at this point, so I didn’t know what to make of the message right away. I sat on it and talked it over with my partner over the next few days. We realized it would be best for us to sell the business and move on, and perhaps try a similar concept down the road, except this time much better prepared before launch.
So about a week later I wrote the sender back asking for more information. I researched his company and came to learn that at the time he owned the second largest Ebay store. If you are familiar with how Ebay works, in addition to auctioning items, you can also have a store on Ebay’s platform. There are however several restrictions that Ebay imposes on you, such as restricting you from routing visitors to your personal website outside Ebay.
The buyer had initially indicated that his team was interested in establishing an online presence. They did not have their own e-commerce website and relied on Ebay for their online sales. If you are familiar with Ebay’s commission and fee structure (not to mention its payment system PayPal charges its own commissions), it is much more expensive to do business on Ebay than it is on your own website using your own credit card processor or merchant account service.
After a few more back and forths I started the due diligence process, except this was a seller side due diligence, or SSDD. Just a year before this, I had conducted buy side due diligence (BSDD) when I acquired a physical, local business in my community.
The sell side due diligence process involved preparing financial statements and getting them audited and opined on by a local accountant (CPA), hiring a local attorney to prepare the sell side documents including the main contract, which included indemnification clauses and customer disclosure requirements, researching an escrow company to hold funds during the transaction, a full list of assets included in the sale as well as transfer procedures for each (such as the back-end customer email list database), analytics accounts, email IDs and the DBA (the business name). I also contacted the State of Incorporation of the business for corporate dissolution documents and an employee identification number (EIN) transfer.
To ensure customers remained in good hands, I researched the buyer further by contacting them anonymously, purchasing a product from them and then subsequently complaining as a disgruntled customer, as well as researching them on the internet for any dirt I could find. After the process, I was comfortable in their credibility and knew our customers would be in good hands going forward.
The website was generating approximately $60,000 in annual earnings or profit at the time, and after toggling around we agreed on a sale price of just under $250,000, which is approximately four times the annual earnings or EBITDA (earnings before interest, taxes, depreciation and amortization), a term frequently used in the business community, specifically in the mergers and acquisitions industry.
To ward off a bit, a niche content website generating the same amount of revenues would have sold for more than four times its earnings. That is because a content website is less time consuming to manage, and does not involve “heavy” offline expenditures and hassles such as inventory, warehousing costs, supply chain, etc. Content websites also tend to generate more free traffic organically from search engines rather than relying on paid advertising like many e-commerce websites do. Remember, I almost lost my shirt in PPC marketing!
As the sale date approached, I realized more and more that the buyer was not so much interested in our website as he was in our customer database. They had clearly done a net acquisition cost analysis on a per customer basis and decided that they were getting a good deal buying essentially 1,500 customers for $250,000. At this point I was kicking myself knowing that I could have made more on the sale! You will see why below.
Although not directly related to this article, this is an interesting concept to highlight. In the 90s, there was a trend in the corporate world where one company would buy another one that was not profitable but had a large amount of operating losses from previous years. Corporate tax accounting rules allow companies to deduct operating losses from previous years in years of profitability. Back then, buying sinking companies because of their large loss carry forward balances was allowed, and everyone started doing it until the government realized and modified the legislation.
Think about this for a minute. Let’s say company A sucks, has $20M in losses from previous years and is no longer making money. Company B is a profitable rock star company and has no loss carry forward from previous years. Let’s say company B makes $40M a year.
Since company A doesn’t make money, company B feels they can buy company A at a greatly discounted price. They are most likely right in that assumption. Company A is a sinking ship and is looking to get out. Company B offers $5M to acquire it and company A agrees. Let’s see what this transaction does for both.
Company A cashes out and avoids continuing losses. Company B makes $40M a year and pays collectively 40% of its earnings in taxes (Federal, State, City, County / Local all combined). Because company B bought A, it can now deduct company A’s carry forward losses of $20M from its current year income of $40M, arriving at a net profit of only $20M.
So instead of paying 40% tax on $40M, which is $16M, it now pays 40% tax on just $20M, which is $8M. So by paying $5M to buy company A, company B ended up saving $8M in taxes, a net saving of $3M on the whole gig. Is $3M worth all that hassle???
Did the buyer care about my website? Maybe or maybe not. But they did get what they wanted, and that is loyal, regular and recurring customers at a dirt-cheap per customer acquisition cost.
Long after the sale, when my mind was finally a bit relaxed and off the roller coaster emotional ride, I was convinced the buyer bought our website for its customers. It enforced my realization that they were not at all interested in the e-commerce platform that we had created, but rather the underlying asset which was our list of 1,500 loyal, regular and recurring customers (similar to carry forward net operating losses).
Think about this from the buyer’s perspective. They essentially paid $166 per customer acquisition ($250,000 divided by 1,500 customers). This is genius. How much are you willing to pay to acquire a customer? I guess that depends on the industry you are in.
After several discussions with my now ex-partner, I learned that in the wholesale designer fragrance market, the lifetime value of a good customer can exceed hundreds of thousands of dollars. Grant it that my ex dealt with bigger fish, but still.
When I thought about it from the buyer’s perspective, they could easily make $166 back on just one single sale to a retail customer, let alone a wholesale one. It all started coming together. Although the buyer may have been looking to establish an online presence like they said they did, I am convinced that the customer list was the main driver of the acquisition.
Should we have persevered and hung on? I don’t know. What could have, should have, may have, I really don’t know. All I know is that it was a blast. It was a fun and adrenaline pumping roller coaster ride from start to finish (also quite taxing especially when we started really growing). It gave me a true taste and appreciation for entrepreneurship in its purest sense, and I realized all-time high satisfaction levels in my “entrepreneurship career”.
Sure, the sale also gave me the ability to brag about a quarter million dollar sale at a bar / nightclub (how do you think I picked up my wife?), however, if you break down the money earned to an hourly wage, I am willing to bet that someone flipping burgers at McDonalds likely makes more with a lot less stress. But see others just don’t realize that – I bet you didn’t? But now you do.
I had caught the entrepreneurship bug, and I warn you, it is pleasantly malignant!
P.S. NO, that is not how I found my wife.
If you have not read part one of this series, you may have been lost from the get-go.