So glad I have found our newsletter through Richard Patey! I have binge-watched all your content. Thank you for your thorough and generous information. Ready to partner with you or buy one of your future side projects!
I really enjoyed reading this post along with other topics you have covered since starting this series. This one really hit home as I've been trying to make this model work for some time now but keep running into stumbling blocks. I've never wanted to give up quite so much equity so that's comforting that you believe 50% is fair. I have also struggled with finding an operator that is willing to invest their time and energy for equity only and usually insist on a fixed floor expense of $500-$1K for a site in the size range as the one you discussed. How would you suggest finding an operator like the one you guys have found? Also, what happens if the operator underperforms? I'm curious how the contract you have with them reads, especially as it pertains to the equity component.
* You could say that we found the right person and that's why we did the partnership. I personally was not looking actively to do partnerships like this. The right person came by and he was interested.
* In my opinion, it's fair for the Operator to ask for a salary if the equity is low like 20%. Giving a higher equity may cause the discussion to shift away from salary
* I also strongly believe Investor track record is extremely important here. If the Investors do not have a history of buying, growing, and selling websites for significant sums of money then they purchased the sites for, then the Operator may not be interested. They may be hesitant to just accept straight equity because of this. In our situation, we are there to guide the Operator and have a strict goal of flipping the site is 12-24 mo. We have done this 100s of times so it provides a lot of confidence to the Operator.
* If the Operator underperforms, this is what we have in plain English in our agreement:
If both X and Y determine that Z is not performing his duties, they reserve the right to terminate the Operator relationship with Z.
Should the relationship with Z be terminated as such, Z will receive a prorated portion of the exit month's profit (if applicable). However, any accumulated equity share by Z to that point in time will be retained by X and Y to offset the impact of losing a site operator.
We right our agreements in plain English. It's a mutual agreement between parties.
* We found this contractor by sheer luck actually. We purchased a site from him 5 months ago and have been working with him ever since on projects where he is a contractor. We saw that he has a ton of talent so brought him on as an Operator.
Thanks Mushfiq, really appreciate the thoughtful reply. All of your points make completed sense and agree that your track record plays a huge role in giving the operator the confidence to prefer the straight equity route.
Thanks for sending over your operating agreement language, definitely important to spell things out beforehand and I like the way you've structured this. I hope to be able to leverage this at some point in the future if I can find the right operator.
Mark - You could also do some research on waterfall models. I have reverse-engineered these in other business scenarios to create an incentive-based system whereby the operator can choose his/her level of participation in the share of profit. Essentially the operator can elect anywhere from full pay and zero equity, to full equity and zero pay based on various payout structures.
The waterfall concept is used heavily in real estate investing and can be a little complicated but it might spark some ideas for you. Here's a primer.
Hi Smith, thanks for the introduction to this concept as I've not come across this before. I like the idea of the operator being able to determine their compensation mix.
I'm so grateful for these newsletter updates. I'm building a portfolio of sites also and it helps to see people of similar interests sharing their results and outcomes.
As for the rant you made about the industry not acknowledging other ancillary assets like an email list, social media accounts, digital products is interesting to me. Because in a brick and mortar business. There are assets owned by the business ( i.e special equipment, inventory, trademarks, etc ) that help in boosting the valuation of the business.
I would think in the online world having a responsive email list, social media following, digital products, etc would do the same for online websites. Hopefully these things get reconsidered.
Lastly, how did you find a site like this? I'm sure it wasn't on any marketplace with a monthly income in that range.
Unfortunately no in the website world. If a site has an email list that is not being used (let's assume) but growing rapidly, it does not increase the valuation. You only pay based on a multiple of revenue. This is because it's difficult to place a value on an email list.
On the other hand, for brick and mortar businesses, it's rather simple to place a value on equipment, land, inventory. However, it's hard to place a value on patents, trademarks, goodwill, etc. It's more normal in traditional business to spend the time to find the value of these assets.
Hopefully, this will change for the better. At the moment though, as a website buyer myself, I don't mind since I can pick up underutilized assets on the cheap.
As for your question where I get such deals, they are through my network.
I would argue that just because a business has an asset, doesn't necessarily mean it has value. In the example of an underutilized email list, if the asset hasn't been monetized, a seller is going to have a difficult time proving its value. As it should be. If you cannot make the case for its value, or more importantly, the market doesn't recognize the said value, then perception becomes reality.
Rarely does a one-size-fits-all approach to valuation make sense, even if it seems to be the case today within the website market.
Similar to valuing real property (real estate), the process of valuing virtual properties will likely continue to become more complex and intelligent as this market matures.
Applying various valuation methods should be considered in the context of where the given property is in its lifecycle. For example, in the case where a property is relatively new and lacking an income track record, the cost approach is likely the most practical valuation method. This is the cost of domain + site setup + creative/content or, in other words, what it would cost to recreate a similar property.
Another way to look at the cost approach is to consider its break up value. In other words, if it were purchased and broken up into pieces (e.g. domain, content, brand), what is the sum of for which these assets could be sold?
The second method used for valuing real property is the comparable method. Simply put, what is the average or median price for similar properties sold in recent history (e.g. 6-12 months)? This method is already a significant factor for valuing virtual properties as there is a strong market providing liquidity and easily accessible comps.
The third method is the income method. In its simplest form, and what we are seeing most of in the current market, is a multiple of NOI plus a cap rate based on comparable sales or, the comparable method noted above.
I understand I'm not breaking new ground by sharing this information, but maybe some readers will benefit from being able to compare it to a more tangible and mature market like real estate. I also understand this doesn't address your concern regarding why most properties are only valued based on the income method and don't appear to take into consideration the value of the assets. My only answer to this is that it appears to be the same concern with real estate.
In real estate, the cost method is applied for new/stagnate properties - or those where the area is experiencing a boom and the value of the land far exceeds that of the structure built upon the land, or the income it's producing. The income method is used for mature, income-producing properties in steady markets.
I think we will see these calculations get more complex as this market matures and buyers become more aware of comparables based on a risk profile as well as cost of capital considerations.
So glad I have found our newsletter through Richard Patey! I have binge-watched all your content. Thank you for your thorough and generous information. Ready to partner with you or buy one of your future side projects!
Hi Mushfiq,
I really enjoyed reading this post along with other topics you have covered since starting this series. This one really hit home as I've been trying to make this model work for some time now but keep running into stumbling blocks. I've never wanted to give up quite so much equity so that's comforting that you believe 50% is fair. I have also struggled with finding an operator that is willing to invest their time and energy for equity only and usually insist on a fixed floor expense of $500-$1K for a site in the size range as the one you discussed. How would you suggest finding an operator like the one you guys have found? Also, what happens if the operator underperforms? I'm curious how the contract you have with them reads, especially as it pertains to the equity component.
Thanks again for your insightful posts!
Mark
Hey Mark.
Good to hear from you. Some thoughts:
* You could say that we found the right person and that's why we did the partnership. I personally was not looking actively to do partnerships like this. The right person came by and he was interested.
* In my opinion, it's fair for the Operator to ask for a salary if the equity is low like 20%. Giving a higher equity may cause the discussion to shift away from salary
* I also strongly believe Investor track record is extremely important here. If the Investors do not have a history of buying, growing, and selling websites for significant sums of money then they purchased the sites for, then the Operator may not be interested. They may be hesitant to just accept straight equity because of this. In our situation, we are there to guide the Operator and have a strict goal of flipping the site is 12-24 mo. We have done this 100s of times so it provides a lot of confidence to the Operator.
* If the Operator underperforms, this is what we have in plain English in our agreement:
If both X and Y determine that Z is not performing his duties, they reserve the right to terminate the Operator relationship with Z.
Should the relationship with Z be terminated as such, Z will receive a prorated portion of the exit month's profit (if applicable). However, any accumulated equity share by Z to that point in time will be retained by X and Y to offset the impact of losing a site operator.
We right our agreements in plain English. It's a mutual agreement between parties.
* We found this contractor by sheer luck actually. We purchased a site from him 5 months ago and have been working with him ever since on projects where he is a contractor. We saw that he has a ton of talent so brought him on as an Operator.
Thanks Mushfiq, really appreciate the thoughtful reply. All of your points make completed sense and agree that your track record plays a huge role in giving the operator the confidence to prefer the straight equity route.
Thanks for sending over your operating agreement language, definitely important to spell things out beforehand and I like the way you've structured this. I hope to be able to leverage this at some point in the future if I can find the right operator.
Mark - You could also do some research on waterfall models. I have reverse-engineered these in other business scenarios to create an incentive-based system whereby the operator can choose his/her level of participation in the share of profit. Essentially the operator can elect anywhere from full pay and zero equity, to full equity and zero pay based on various payout structures.
The waterfall concept is used heavily in real estate investing and can be a little complicated but it might spark some ideas for you. Here's a primer.
https://www.realtymogul.com/knowledge-center/article/waterfall-models-commercial-real-estate-equity
Hi Smith, thanks for the introduction to this concept as I've not come across this before. I like the idea of the operator being able to determine their compensation mix.
Hey Mushfiq!
I'm so grateful for these newsletter updates. I'm building a portfolio of sites also and it helps to see people of similar interests sharing their results and outcomes.
As for the rant you made about the industry not acknowledging other ancillary assets like an email list, social media accounts, digital products is interesting to me. Because in a brick and mortar business. There are assets owned by the business ( i.e special equipment, inventory, trademarks, etc ) that help in boosting the valuation of the business.
I would think in the online world having a responsive email list, social media following, digital products, etc would do the same for online websites. Hopefully these things get reconsidered.
Lastly, how did you find a site like this? I'm sure it wasn't on any marketplace with a monthly income in that range.
Thanks!
Thanks Samuel!
Unfortunately no in the website world. If a site has an email list that is not being used (let's assume) but growing rapidly, it does not increase the valuation. You only pay based on a multiple of revenue. This is because it's difficult to place a value on an email list.
On the other hand, for brick and mortar businesses, it's rather simple to place a value on equipment, land, inventory. However, it's hard to place a value on patents, trademarks, goodwill, etc. It's more normal in traditional business to spend the time to find the value of these assets.
Hopefully, this will change for the better. At the moment though, as a website buyer myself, I don't mind since I can pick up underutilized assets on the cheap.
As for your question where I get such deals, they are through my network.
I would argue that just because a business has an asset, doesn't necessarily mean it has value. In the example of an underutilized email list, if the asset hasn't been monetized, a seller is going to have a difficult time proving its value. As it should be. If you cannot make the case for its value, or more importantly, the market doesn't recognize the said value, then perception becomes reality.
Rarely does a one-size-fits-all approach to valuation make sense, even if it seems to be the case today within the website market.
Similar to valuing real property (real estate), the process of valuing virtual properties will likely continue to become more complex and intelligent as this market matures.
Applying various valuation methods should be considered in the context of where the given property is in its lifecycle. For example, in the case where a property is relatively new and lacking an income track record, the cost approach is likely the most practical valuation method. This is the cost of domain + site setup + creative/content or, in other words, what it would cost to recreate a similar property.
Another way to look at the cost approach is to consider its break up value. In other words, if it were purchased and broken up into pieces (e.g. domain, content, brand), what is the sum of for which these assets could be sold?
The second method used for valuing real property is the comparable method. Simply put, what is the average or median price for similar properties sold in recent history (e.g. 6-12 months)? This method is already a significant factor for valuing virtual properties as there is a strong market providing liquidity and easily accessible comps.
The third method is the income method. In its simplest form, and what we are seeing most of in the current market, is a multiple of NOI plus a cap rate based on comparable sales or, the comparable method noted above.
I understand I'm not breaking new ground by sharing this information, but maybe some readers will benefit from being able to compare it to a more tangible and mature market like real estate. I also understand this doesn't address your concern regarding why most properties are only valued based on the income method and don't appear to take into consideration the value of the assets. My only answer to this is that it appears to be the same concern with real estate.
In real estate, the cost method is applied for new/stagnate properties - or those where the area is experiencing a boom and the value of the land far exceeds that of the structure built upon the land, or the income it's producing. The income method is used for mature, income-producing properties in steady markets.
I think we will see these calculations get more complex as this market matures and buyers become more aware of comparables based on a risk profile as well as cost of capital considerations.
Very well stated!