Valuing a business can be a complex task. Literally hundreds of books
have been written on the topic. However, your question is far less
complicated than most business-valuation questions because the core of
most valuation strategies involves discounting future cash flows. The
key to any calculation is, well, the cash flows. Your cash flows seem
predictable and simple.
We know that future cash flows are worth less than present cash flows.
For example, would you rather have $100 now, or $100 guaranteed
payable a year from now? Putting a value on that future cash flow
requires us to calculate the time value of money. For that we need a
Suppose you believe you can earn 10% on your money. If that is the
case, then you should discount future cash flows at 10%, which is the
amount of profits you are sacrificing by waiting for the payment. The
cash flows are guaranteed, so there is no need to adjust for risk. To
calculate the value that $100 payable next year, divide the cash flow
($100) by 1 + the discount rate (1.10). The resulting value is $90.91.
So if someone offers you $92 today or $100 in a year, and you believe
you can make 10% on your money, then you should take the cash now.
Why did I bore you with this? So that you?ll understand there?s a
theory behind the calculations I use to estimate the value of your
Your business delivers cash flows of roughly $27,000 a year. In order
to calculate a value, we must make some assumptions.
Assumption #1: The size of the cash flows is unlikely to change as
long as you perform the current services for the current client. That
may or may not be a safe assumption because markets can change in an
instant, but based on the information you provided, it seems
Assumption #2: You have a written, exclusive contract with the company
that pays you the commission. Such a contract would allow any
purchaser of the domain name to continue operating under your current
This assumption is important because if you do not have a contract
with the company that pays you $15 for the products, your cash flows
could stop at any time. The selling company could design its own Web
site to do the job you?re doing, decide to start sending you less
money per sale, or find an alternate service provider. If the guy who
does this is a friend of yours and may call the deal off if you sell,
then the domain name is of little value to the purchaser.
Assumption #3: At current levels, the stock market is not likely to
deliver exceptional returns over the next 10 years. But neither should
we expect declines. Let?s assume you have the option of investing your
money in the S&P 500 Index at an annual rate of around 8%. That
represents the hurdle rate, the rate you (or a buyer) could earn by
putting money into the market rather than depending on your package of
Please keep in mind that Assumption #3 relates to both the buyer and
the seller. If the buyer believes he can earn 12% with his money, the
discount rate will be higher, and he?ll be willing to pay less for
your business than you would demand. You can?t control what he thinks.
Your discount rate may indeed be different than his. In fact, each
buyer is likely to have his own distinct discount rate. But I?ve
assigned 8% as a starting point for the return assumption, with the
S&P 500 as a convenient proxy for the market. You can play around with
the numbers to determine an alternate value if you want. At the end of
this posting, I?ll direct you to an Excel spreadsheet that will allow
you to change the assumptions of the equation.
Also keep in mind that the discount rate must reflect both the
opportunity costs (the profits available through an alternative
investment) and the risk of the cash flows. Without more knowledge of
exactly what you?re selling, the resilience of the market for that
product, and the relationship between you and your partner, risk is
difficult to assess.
For better or for worse, revenue streams from referral sales are very risky.
They must reflect the risk that the product will not perform as
advertised, that competition, new technology, or
economic/political/social change will erode the market for the
product, and all of the myriad other risks inherent in any retail
In addition, you are the middleman, and the discount rate of your cash
flows must reflect the risk that you could end up with a smaller slice
of the pie or be cut out altogether. Additional risk always looms over
Internet businesses, simply because it is so cheap for others to enter
the market and compete.
Economic theory holds that when markets offer high profit potential,
competitors will enter those markets. Internet markets have few
barriers to entry, which makes it easier for those competitors to
start fishing in your pond.
Because of the risks of your business, I?m going to assume that your
cash flows are roughly three times as risky as the S&P 500. If you
believe the cash flows are safer than that, you can change the
discount rate in the spreadsheet to get another value. But unless you
have an exclusive, multiyear contract with a site that sells a
necessary service with little danger of obsolescence, it is likely
that your cash flows are at least twice as risky as the market, and
three times as risky is more likely. If you?re selling a hot, new
piece of software with a short shelf life, or a service that a large
company could decide to offer for free as a customer-retention tool, I
could be seriously underestimating the risk of your cash flows.
In any case, we?ll assume a discount rate of 24%, three times the
expected 8% return of the S&P 500. If you?re marketing a fad product
or something likely to draw in lots of competition, consider using a
discount rate of 32% or even 40%.
The value of a perpetual income stream is equal to the cash flow
divided by the discount rate. In this case, it would be $27,000 / 24%
or $112,500. But don?t get excited yet.
Unless you can demonstrate that your cash flows are likely to continue
uninterrupted for more than 20 years, the perpetual value is more than
what your business is worth.
Let?s go with a more reasonable assumption, that you are confident
that cash flows will continue for three years. Three years of $27,000
cash flows discounted at 24% is worth $53,495 today. The farther out
you try to predict cash flows, the less dependable the prediction.
Less-dependable predictions translate into more risk. So if you want
to assume five years of cash flows, you should increase the discount
rate. Assuming a higher discount rate of 32%, five years of annual
cash flows are worth $63,321 today.
Any business valuation must also reflect a terminal value, or the
value of the business?s assets after the cash flows are paid. Since
Web sites are simply intellectual assets with no intrinsic, physical
value, I?m assuming that once the cash flows dry up, the site will
have no value. If your domain has strong name recognition, you may
have some terminal value.
Suppose your domain name is well known, and repeat customers are
likely to continue visiting even after your collaboration with the
current seller ends. If you believe you could leverage that same
domain name into another business model, then the domain has some
terminal value. If your buyer is simply interested in the cash flows
and isn?t likely to make an entrepreneurial move to cash in on the
domain name, then to him, the name will have no terminal value.
If your goal is to sell the business, your best bet is to assume no
residual value, simply because any residual value for future use of a
Web site will be almost impossible to calculate. Alternatively, you
could rent the domain name for three or five years and assume control
again at the end of the contracted period so you can pursue your own
Below are some numbers I calculated based on different discount rates
and cash-flow schedules.
Monthly dash Flow Annual dash Flow Estimated S&P 500 Return Risk
Relative to S&P 500 Discount Rate Value Assuming Perpetual
Payments Value Assuming 3 Years of Payment Value Assuming 5 Years of
$2,250 $27,000 8% 3.0 24% $112,500 $53,495 $74,125
$2,250 $27,000 8% 2.0 16% $168,750 $60,639 $88,406
$2,250 $27,000 8% 4.0 32% $84,375 $47,690 $63,321
If you?d like to play around with the numbers, you can access the
spreadsheet at http://www.wecanwrite.com/CashFlows.xls.
P.S. If you?re a glutton for punishment and would like to learn more
about discounting cash flows and more complex business valuation, the
section below is for you. I pulled this section from a question I
answered for another Google questioner about business valuation.
Warning: Gratuitously complicated section to follow:
The discounted cash flow valuation is the sum of the company?s cash
flows, discounted at a set rate to reflect the risk of those cash
flows. The formula for a discounted cash flow is written as:
CFt/(1+r)t -- The cash flow for period ?t?, divided by one plus the
discount rate, raised to the power of t. The value of the firm or the
equity stake is the sum of the future cash flows, usually representing
fixed amounts for five or 10 years, and an estimated terminal value.
For additional details about how the process works, check out
The difficulty here is not in the calculation, but in the assumptions
of future cash flows and the discount rate. The discount rate is
probably the most difficult to determine.
Once you have determined your inputs, the calculator at
http://www.creativeacademics.com/finance/dcf.html will calculate a
value for you. Alternatively, you could come up with ballpark
estimates for your company and calculate an estimated valuation that
will serve as a check on the other calculated values.
As for developing your assumptions, I cannot help you in detail. This
forum is inadequate for providing instructions, as the determination
of the cost of equity, cost of capital, and cash flows are tasks both
complex and company-specific. The access you have to company financial
data and the quality of that data will determine the difficulty of
calculating the cost of capital and estimating cash flows. However,
any advice I give you without spending hours examining your company?s
books and familiarizing myself with its operations would have little
practical value. If your stake has a substantial value, I?d advise
hiring an accountant to help you determine the inputs. Alternatively,
if you have good data and don?t mind crunching numbers, I have
provided some links that can help you do the math. Warning: This is
not for the faint of heart.