Top 3 Pitfalls When Buying an Online Business

hmed Raza made his first acquisition in 2013 — a software business.

He sold the business about two years later, learning a lot on the fly. Investors wondered if he could do it again.

So he started a small-cap private equity fund specializing in online business acquisition called Sitevestment. Two years later, he exited and started doing due diligence consulting for PE funds focused on e-commerce and SaaS acquisitions.

Not only did he have a knack for it, he enjoyed helping people get into acquisitions.

He formed Rapid Diligence in 2019 to help a range of buyers with online business acquisitions.

In this episode, he walks us through evaluating acquisitions for e-commerce, SaaS, and content businesses.

Though each category has unique criteria for what makes an attractive acquisition, Ahmed is always thinking about defensibility — which is essentially how easy it would be for a competitor to eat your lunch.

SaaS businesses tend to offer the most defensibility as a category, but there are a host of other issues that can come up during due diligence. Ahmed explains why it’s critical to work with an experienced software architect to review the integrity of the code and product architecture, as well as why documented processes are a guardrail post-acquisition.

He shares similar insights for e-commerce and content website acquisitions, including the three levels of affiliate monetization.

Check out:

‍✳️ About Ahmed Raza

✳️ Top takeaways from the episode

✳️ Episode highlights with timestamps

✳️ Links & mentions

Acquisition Entrepreneur: Ahmed Raza

💵 What he acquired: A software engineer and acquisition entrepreneur, Ahmed spent a few years helping companies do due diligence before he decided to make it a business. He now helps clients of all types acquire online businesses through his company, Rapid Diligence. The company has handled acquisitions ranging from <$100,000 through $100 million deals.

💡 Key quote: “A lot of business risks can be mitigated by doing due diligence. It may be expensive at times, but you have to accept those costs.”

👋 Where to find him: Twitter | LinkedIn

Ahmed Raza of Rapid Due Diligence — Ahmed Raza

Acquisition Tips

‍Top takeaways from this conversation

📈 It’s a challenging time for first-time acquisition entrepreneurs

COVID has nudged a lot of entrepreneurs (and would-be entrepreneurs) towards online businesses, which has increased the number of buyers interested in acquiring these businesses.

Ahmed draws a parallel between the market for online business acquisitions and the real estate market over the last several months. He says it has been harder to close deals with sellers who get multiple competing offers. These days, it’s also not uncommon for SaaS companies to receive offers above their listing price.

All in all, that’s not great for first-time buyers. “You're coming in, you have a hard budget of 50 grand, 100 grand, and it's difficult to acquire a good business because they keep getting snagged up by either institutional buyers or portfolio buyers,” Ahmed says.

👨💻 What you save on a micro SaaS acquisition could add up later on.

While it’s easier than ever to buy a SaaS business — thanks to marketplaces like MicroAcquire and forums like Indie Hackers — SaaS companies that sell for less than $100,000 are often missing important technical components and strong processes. For example, if a site doesn’t have a development environment in which changes are tested before they’re pushed live to users, it’s a risk for the future owner (who will likely have to invest money to create one). Even though that might cost only about $500, it’s something to be aware of in negotiations.

Ahmed notes that he often sees the risk of additional development costs for SaaS companies that sell for under $300,000, and hiring an experienced developer to fix the code if something goes wrong can get quite expensive.

“I would say there are a lot of benefits to SaaS, but that's the one downside I've seen a few times and that I'm most wary of, because [hiring a developer to fix code] could set you back a couple months in profit,” he explains.

🛒 De-risk an affiliate website by combining it with an e-commerce acquisition in the same niche.

Affiliate websites continue to be popular acquisitions, even though many are dependent on Google for traffic or only monetize through Amazon’s affiliate program. The issue in both of those cases is that a change from either tech giant could threaten the health of a business.

One way to guard against that is to buy a content site and an e-commerce store in the same niche. Then you can direct traffic from the content site to the e-commerce store, as well as to other affiliates, which diversifies the revenue streams.

“That's where these affiliate websites become super attractive,” Ahmed explains.

Episode Highlights

‍Inflection points from the show

[2:15] Once a full-time acquisitions investor: Founding and running Sitevestement, a private equity fund that specialized in online business acquisitions, was a significant part of Ahmed’s journey to becoming a due diligence expert.

[4:18] After the LOI: Rapid Diligence serves a wide number of clients at different points of the acquisition process, but about 70% approach the firm once they’ve sent a letter of intent. The remaining clients are usually first-time buyers who get help with the entire acquisition process.

[7:25] Evaluating e-commerce defensibility: When looking at an e-commerce deal, product defensibility is a major concern. Specialty products are attractive because they have a lower chance of being undercut by Amazon.

[9:26] Laptop lifestyle: Ahmed talks about the other critical aspects of an e-commerce acquisition like website traffic (how do visitors find the site — SEO? Ads?), revenue trends, and the operational aspects like whether it can be run from anywhere in the world.

[12:55] E-commerce channel expansion: Many sale listings for e-commerce websites tout the opportunity to quickly increase sales by turning on other channels, i.e. taking an Amazon-only e-commerce product and launching a Shopify website. But it’s rarely as simple as flipping a switch and you need healthy margins to make it work.

[15:32] Sticky SaaS: When examining SaaS acquisition opportunities, Ahmed says he’s primarily concerned with how much value the product is driving for the user and how easy it is to make a switch to something else.

[15:36] SaaS M&A metrics that matter: Ahmed talks through other elements that are important when looking at buying a SaaS business like referral traffic, how user growth would affect business financials, as well as how technically sound the business is (how good is the codebase?).

[21:34] Content fundamentals: For content website acquisitions, Ahmed looks at understanding the value the content provides to users and whether the content is evergreen or if it will date quickly. For example, “top 10” style sites used to be everywhere, but they fell out of favor with Google because of their dubious value, and the entire category suffered.

[28:29] The three levels of affiliate websites: Ahmed breaks down the different types of content sites that monetize through affiliates. The first and most basic level are those that just operate with Amazon links. Level two sites have diversified affiliate programs, such as Google AdSense or direct affiliate relationships. Level three is when the owner brings in an e-commerce website in the same niche, using the content site to drive traffic to the store and possibly other affiliates.

[35:27] SaaS FTW: With his background in software, Ahmed is personally drawn to acquisitions in SaaS over e-commerce or content businesses. But small SaaS businesses (<$300k) can be a risky investment because of technical issues, which can be quite common and will reduce profitability early on.

[37:38] The cost of due diligence: Rapid Diligence has done due diligence for $70,000 acquisitions all the way to $100 million businesses.

[40:53] State of the market: Ahmed says the market has become more competitive in the last year as more people became aware of the benefits of owning an online business during the COVID-19 pandemic. Prices are at an all-time high, and good businesses are often snagged up by institutional or portfolio buyers. This has created a challenge for first-time buyers.