Private Equity Investment: eCommerce Business Valuation Using NPV and IRR

China’s general trade business and companies might be in a way impacted by the cancellation of GSP treatment, or called the Generalized System of Preference treatment. Although it also depends on what product category of export business, tariff percentage implies the enforcement of reduced profitability or increasing the prices. Pros and cons always come together. The momentum of growth on D2C cross-border eCommerce, on the other hand, is rising. The question is how to evaluate the cross-border eCommerce business potential if you spot this is indeed an investment and monetization opportunity.

Profit margin and cash flow are absolutely two golden metrics to evaluate an eCommerce company’s health status. Of course, it also works for the cross-border eCommerce valuation, although it deals with more variable cost elements. No profitability means negative cash flow. Cash outflow is greater than cash inflow. The company is still at a loss status. Investors might not be happy with this business smell.

However, good or positive cash flow at the moment in a way can’t reflect directly if it’s worth investing or not. It’s because the company’s current stage and the investment period length matter as well.

Identifying a good cross-border investment or not should look at two things. The further value and the return rate you can compare with other investment opportunities, such as stock, commodity, etc. Thus, in this article, I would walk you through how to evaluate a private equity investment opportunity in the cross-border eCommerce space. The approach is by using NPV and IRR. You can learn what elements you need to plug into your calculator to find the net present value and internal return rate.

Table of Contents: Private Equity Investment: eCommerce Business Valuation Using NPV and IRR

Private Equity Investment – What’s NPV and IRR

Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. People use this figure in capital budgeting and investment planning to analyze the profitability of a projected investment or project. NPV is the result of calculations you can use to find today’s value of a future stream of payments.

For example, you invest in a cross-border eCommerce business using US$30,000 in 5 years. The EBITDA is shown in the table listed below every year. Based on 11.9% of WACC, or called weighted average cost of capitalism, you can get the PV every year.

Note*: I would walk you through WACC calculation, which includes the cost of debt and cost of equity calculation in another article.

NPV or net present value basically is equal to the sum of PV over the 5 years minus initial investment or initial outlay. It’s US$43,548.

US$73,546 - US$30,000 = US$43,548

The internal rate of return, or IRR is a metric you need to use in financial analysis to estimate the profitability of potential investments. IRR is a discount rate that makes the net present value. Or NPV of all cash flows equal to zero in a discounted cash flow analysis.

NPV (0) = Sum of PV / (1 +IRR) ^ n

You need to use IRR to compare with WACC. It’s because your money might be having a higher monetization value in alternative investments when WACC is larger. So as long as IRR is equal to WACC, it’s a worthy investment that depends on your preference.

In Google Sheets, you can use the IRR function directly to calculate the IRR percentage. As long as the area range covers the initial outlay, PV every year.

Private Equity Investment – Organic Traffic CAGR

The question is how to forecast the EBITDA, right? You might have this question above. The most attractive part of cross-border eCommerce investment is the market demand and market policy matters. A market policy like GSP cancellation is one thing that you might not be able to control. But you can analyze the momentum of search demand growth. For example, the search volume of some core keywords related to your product from Google and Amazon implies the demand of the product you sell.

Regardless of operation taxes, depreciation, interest, etc, gross profit estimate every year plays a key role in the EBITDA estimate. And gross profit is directly related to customer demand.

Basically, the organic traffic volume of customer demand implies the possibility of order volume before investing in advertising. If there is no organic traffic of this product, est.COGS, conversation rate, cost per sale in a way has lost their meaning.

Take CBD products as an example. It’s a perfect sample to elaborate organic traffic CAGR value. It’s because of its stable rising and growth. It’s rather than fluctuating up and down in a huge percentage.

CAGR or compound average growth rate basically is a number for proving to you what the average growth rate is. Different from summarising 5 years traffic divided by 5, CAGR also considers yearly traffic basic affects the next year traffic number. So CAGR is more convincing in terms of being for a certain period of investment. And stability growth in the past can be more accurate to estimate in the future, like this chart of CBD.

Organic traffic CAGR = (End year traffic / Start year traffic) ^ 1/n - 1

The methodology is you can refer to one core product keyword over the past 5 years of historical search number. You might use Google trends or some search volume software, such as keyword planner. You just need to use the 1st year and last year’s numbers as a reference.

Please check out this article if you like to use Google trends

Chapter 9: Big Picture Matters, Get Data from Google Trends Using Easy2Digital API

In Google Sheets, you can use the power functions. It’s very convenient for you to calculate the organic traffic CAGR

GMV and Gross Profit Forecast

GMV or gross merchandise value is equal to AOV multiply orders. In terms of organic traffic orders, we can set a bottom line conversion rate like 0.5% – 1%. If a business doesn’t have this conversion rate, you can immediately give up.

The reality is the business will not only rely on organic traffic. Particularly you aim to scale up while the profit margin has spaces for you to acquire new customers.

In general, traffic from organic can be 30% – 55%. So we can use 55% organic of total traffic and set 45% traffic from paid ads initially.

Plugging into selected digital channels’ cost per click and estimating a bottom-line conversion rate. You can get the orders from paid ads and the total costs from paid ads that include COGS.

Total orders and total costs from the organic plus paid ads. You can have total GMV and total gross profit, which reflect the profit margin. After considering the flat operation cost, you’ve already had the EBITDA per year.

Please check out this article if you are interested in scraping Amazon-specific hot product AOV

Chapter 21: Amazon Best Selling Product Scraper to Find Niche Products, Monitor Competitors, and Identify Potential Clients

The implication of Cross-border eCommerce Business Valuation

There are so many alternative investment options in our life. You can invest in property, stock, ETF, security, commodity. One eternal formula is don’t put all eggs into one basket.

Thanks to the Covid-19, cross-border eCommerce business is a very good option. And its IRR is an investment return rate you can compare with other projects. Comparing WACC is to see if it’s worth investing in this area when it might require more attention, energy, and effort. You might not be willing to invest the same amount of dollars having a lower return but more work is required. Unless this is your true love and personal favor.

In a way, cross-border e-commerce investment is more controllable and interesting. If you step back and look into the variable elements in this business valuation process, COGS, CAC, CPC, etc are optimizable. It implies although it’s a kind of investment, it can be more fun as a shareholder to give the advice to make the business develop and grow in the direction as expected. After all, very less investment can give you that space.

Thank you a lot!

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Q1: What is private equity investment?

A: Private equity investment is a type of investment where funds are raised from high net worth individuals and institutions to invest in privately held companies or buyout publicly traded companies and take them private.

Q2: How does private equity investment work?

A: Private equity firms raise funds from investors and use those funds to invest in companies. They typically acquire a significant ownership stake in the companies they invest in and work closely with management to improve the company’s performance and increase its value.

Q3: What are the benefits of private equity investment?

A: Private equity investment offers several benefits, including potential high returns, diversification of investment portfolio, access to specialized expertise, and the opportunity to actively participate in the growth and success of companies.

Q4: Who can invest in private equity?

A: Private equity investment is typically available to accredited investors, such as high net worth individuals, institutional investors, and certain types of financial institutions.

Q5: What is the typical investment horizon for private equity?

A: Private equity investments are typically long-term investments with an average investment horizon of 5 to 10 years. The goal is to create value over time and generate significant returns upon exit.

Q6: How are private equity investments structured?

A: Private equity investments are typically structured as limited partnerships, where the private equity firm acts as the general partner and investors act as limited partners. The general partner manages the fund and makes investment decisions, while limited partners provide the capital.

Q7: What are the risks associated with private equity investment?

A: Private equity investment carries certain risks, including the potential for loss of capital, lack of liquidity, and the dependence on the performance of the invested companies. Investors should carefully assess the risks and potential rewards before making an investment.

Q8: How are private equity investments different from other types of investments?

A: Private equity investments are different from other types of investments, such as stocks or bonds, as they involve direct ownership and active management of companies. Private equity investors have more control over their investments and can actively influence the company’s strategy and operations.

Q9: Are private equity investments suitable for everyone?

A: Private equity investments are generally considered suitable for sophisticated investors who have a high risk tolerance and a long-term investment horizon. It is important to consult with a financial advisor to determine if private equity investments align with your investment goals and risk profile.

Q10: How can I find private equity investment opportunities?

A: Private equity investment opportunities can be found through private equity firms, investment banks, and online platforms that connect investors with private equity deals. It is important to conduct thorough due diligence and seek professional advice before making any investment decisions.