How to Value / Evaluate a Website (part 1)

zurich-airport-main-lounge-september-2009-switzerlandI was recently thinking that buying a website is a form of investing too. And some of our competing investing blogs say that investing is an art. Does this mean that you should pay on a website the value asked by the artist owner? No way!

A search on Google using the keywords “web site valuation method” shows that there are almost 11 million search results. If you type “website valuation method” you get only 6 million search results. Obviously this is an interesting topic and many people  are asking the same question – “How much is worth the website I want to buy or to sell?”

The answer is not simple. The problem is that there are many methods but no definite result. It is simple – everybody has a different idea of how much a website is worth. The seller is usually over-optimistic, as most of the internet research points show. A past course on entrepreneurship that I had on my MBA said that entrepreneurs are actually bound to be over-optimistic when valuing their businesses because of the following factors:

a) Psychological post-decisional bolstering

We all hate admitting to ourselves that we made the wrong choice and let a better opportunity pass us by! Individuals tend to reassure themselves that they have made the right choice by justifying the decision ex post.

 b) Role models

‘I can do it, therefore, so can you’. How many successful football and basketball players want to encourage more youngsters to follow that career path? Yet most of us know these industries can only offer jobs to a very small proportion of players and high paid jobs to an even smaller proportion? Likewise with superstar musicians or actors/actresses. We all know somebody who is a musician but few of us know any superstars!

c)  High internal locus of control

People with this attribute believe that one’s career performance is mostly determined by factors within their own control, for example, how hard you work or prepare or study, etc. In the case of entrepreneurs with high locus of control, over-optimism stems from their belief that they can take action which can effectively overcome the ‘externally imposed’ odds of survival.

 d) Risk taking

 Despite the common view of entrepreneurs as risk takers, both McClelland (1961) and Bhide (2000) argue that entrepreneurs studiously limit the downside of their activities so that risk taking is on average moderate. That is, what Bhide calls a ‘heads I win, tails I don’t lose very much approach’. This may make entrepreneurs fear risk less. This ‘feel good’ effect may cause the entrepreneur to underestimate the exposure to risk.

 e) Entrepreneurial euphoria

 The buzz and excitement of running a business and living the ‘dream’ may cause entrepreneurs to blur the line between vision and reality. Over-optimism can occur when entrepreneurs replace vision for reality thereby ignoring warning signs which indicate that the venture may not be proceeding along the ideal path.

 f) Capital market myopia

 Sahlman and Stevenson (1985) define capital market myopia as ‘…a situation in which participants ignore the logical implications of their individual investment decisions. Viewed in isolation, each decision seems to make sense. When taken together, however, they are a prescription for disaster.’ Sahlman and Stevenson are in fact talking about a business shakeout caused by overshooting of investment. In other words, a case where each investor observes a market gap in the current market but does not factor in that there are many other investors who observe the same opportunity.

All these pre-conditions tend to make the web site sellers over-estimate the value of their sites. Of course, the buyers are in most cases aware of these factors and tend to be over-pessimistic, with the result of the evaluation processes being a sort of bargaining, rather than a precise scientific calculation.

(to be continued)…

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