The Valuation of Dropshipping Companies

Dropshipping companies have become rather popular in the past decade as a way of operating a trading company without the hassle of carrying inventory. It has also been a rather popular business model adopted by remote workers, as the business can be run mostly online and at first it can be run solo.

This business model eliminates the need for the retailer to manage stock or handle shipping logistics, positioning the retailer as a middleman focused on marketing and customer service. Instead, when a customer places an order, the retailer purchases the item from a wholesaler or manufacturer, who then ships it directly to the customer. This business model offers a low barrier to entry, making it appealing for new entrepreneurs. It simplifies the traditional supply chain by removing the need for physical storage space and the complexities of inventory management, allowing the retailer to focus on driving traffic to their store and converting sales. Source

We can date the first origins of this business model back to the creation of physical mailing catalogues and evolving into eCommerce thanks to the dot com boom of the ’90s. Dropshipping as a business model was made possible in its current form in the early 2000s by the expansion of eCommerce giants such as Amazon, eBay and Alibaba. Later, its growth was amplified by the availability of online eCommerce tools such as Shopify, as well as by easier and faster delivery options.  Source

Now, it has become one of the most used methods on eCommerce marketplaces like Amazon, AliExpress, eBay and others, with 30% of e-commerce stores now operating through a dropshipping model. This type of business is still set to grow, with 2.6 billion of online buyers in 2023 compared to 1.3 billion a decade earlier. Its market size is expected to reach $476 billion in 2026 according to Statista, growing at a 24% CAGR; according to Grand View Research, the market size could reach $1,253.79 billion by 2030 with a 23% CAGR.

Features of a dropshipping business for a potential acquisition

Historically, 10% of dropshipping businesses have succeeded beyond the first year, mostly due to low barriers to entry. One of the biggest hurdles of these new business owners has been to find reliable and quality suppliers that are willing to work with dropshippers and have compatible systems: low quality products, long-shipping times, unreliability in shipping, bad customer service can all affect the dropshipper’s image even without having any control over the supplier’s behaviour. The next most important task is to drive customers to purchase the products on sale. Both are complex activities that many new owners underestimate.

Dropshipping is certainly undergoing a change as it adapts to more saturated markets and its own popularity: while the business model is here to stay and experiencing fast growth, in the future, a different approach will be required for success. Those businesses owners who develop a brand, focus on a specific niche, and provide top customer service will come out on top. The days of selling only the latest trends, aided by crawlers and other online tools, will not enable the creation of resilient businesses, as customers are starting to favour sellers that also provide a service and/or expertise in the chosen niche: becoming specialised would ultimately raise the barriers to entry in the business, as customers would start demanding expertise. Source

With a gross margin on sales of 20 to 30%, software and other costs to pay that are lower than other businesses, the resulting profit margins can be 15-20%. Suppliers also tend to make a higher total profit (estimated at 18%) from selling to dropshipping companies rather than using their own online stores.

As mentioned, differently from other eCommerce sellers, a dropshipper holds no inventory and instead of having to handle product creation, storage, shipping, sales, etc, it can simply focus on sales. This way it can afford to have a simple cost structure and operations. A dropshipping business can be simply set up on Shopify, Woocommerce or similar platforms, which can be integrated on one’s own website, with plugins and other resources that aid with the development of a dropshipping business. The owner can also or even exclusively create accounts on Amazon, Ebay and others to sell goods. The larger the operations and the more platforms are used, the higher is the need for more sophisticated tools such as enterprise software to manage products, forward orders to the seller and provide customer service.

The main activities and related costs after set-up are:

• regularly selecting products by carrying out research on demand (also with the help of crawlers and online tools), carefully selecting and developing a relationship with quality suppliers
• managing orders by forwarding them to the supplier and managing returns and expectations
• providing customers service and be the middle man between supplier and customer
• sourcing customers through marketing activities

Dropshipping can be very time consuming as both managing orders and providing good customer service can take up significant time: however, most of these activities, once they are setup successfully, could be outsourced to a marketer, content manager, customer service and operation support assistant. Certainly, when a buyer seeks to purchase a dropshipping business, they wouldn’t want to buy a job but rather a smoothly operating business, therefore if the owner is still working 40-50 hours a week to keep the business running, it is probably too soon to sell and it would be best to start outsourcing some activities . A buyer may alternatively have better skills and resources available to streamline these activities, but the owner will end up selling the business at a discount.

The value of a dropshipping company may also involve various intangible assets, such as websites, accounts on eCommerce platforms and mailing lists. It’s important to verify whether assets can be easily transferred: some platforms such as eBay may bar a change in company name, as an example, which would make the account not transferrable and therefore without value, in cases where a name change is necessary (such as when the business carries the owner’s name). As dropshipping businesses are often started by a solo entrepreneur, one also needs to pay attention to the legal form of the business: in many countries, it is possible to form a company as a solo entrepreneurship linked to the name of the founder. However, this could complicate a future company exit, or it would force the owner to sell the operations as assets, possibly at a lower value. Certainly, a buyer would not want to deal with too many legal hurdles, especially for a small business. Additional characteristics that could influence a transaction is the presence of physical assets or a mixed revenue structure of dropshipping and traditional eCommerce business with inventory: it becomes complicated for buyers to know how the business would change if it became a wholly online dropshipping business.

Additional factors that could influence a sale are any business relations or presence of employees that are specifically linked to the current business owner, as these relations may not be maintained in case of a company sale. Additional questions that could form part of the due diligence are: what agreements are in place with the suppliers? Can the new owner replicate the cost structure? Are there growth possibilities or is the market saturated?

Many M&A transactions involve an earn-out paid out after the transition period is completed: the previous owner is expected to train the buyer to manage the business independently, which, depending on the complexity of the business, may take 1-3 months. For businesses that are more risky, with unstable earnings or sudden growth, an additional earn-out may be in place, in case the business falls short on set targets.

Valuation methods for a dropshipping business

While it is possible to value a dropshipping business with classic valuation methods, the DCF method involves creating a financial plan and discounting projected cash flows: creating a financial plan for a business that can change its product range at the click of a mouse, with constantly changing trends, is not sustainable, especially when the new owner may have the skills to use the current company assets to alter the business significantly. It is instead industry practice to use the market approach and only the current or recent past earnings, with adjusted multiples for dropshipping businesses. The same applies to online businesses such as affiliate websites, blogs, traditional eCommerce businesses and Amazon FBA businesses.

Typical multiples reported for these businesses are in the range of 2-3x of yearly Seller’s Discretionary Earnings (SDE) of the previous 12 months or more commonly in the 25-40x range of monthly SDE TTM, which gives similar results. A Seller’s Discretionary Earnings are the company’s profits with the addbacks of benefits the owner has paid out to himself/herself, such as salaries or other elective expenses that aren’t necessary for running the business.

Seller’s Discretionary Earnings (SDE) TTM = Net profit of past 12 months + Owner’s benefits and wages

However, selecting a profit for the past 12 months only applies to businesses with stable earnings, It is also important to chose the right SDE that is is sustainable for valuation purposes, either by averaging the profit over the past year or years, or by excluding outliers. The stability of earnings itself, and the amount of time the seller was able to keep earnings stable through changing algorithms, as well as an upward trend in profits would lead buyers to use higher multiples, as well as the preference of traffic through SEO rather than through paid advertising. In addition to profit, which forms the basis of the calculation, other factors that can influence the multiple used according to Alidropship, is the profit trend as previously mentioned, the number of social media followers, the number of products and the website traffic, as well as the length of the company’s operating history. Not to forget is also the level of automation in the business vs. the number of hours the owner need to run the business.

In our research, we found a wide variety of multiples. In addition to that, dropshipping is only one form of online business or eCommerce, while these ranges often include a variety of different websites or online businesses. It’s also worth mentioning that some online businesses may have multiple different revenue streams.

Digital Exits reports highlights that the higher the sale price, the higher the multiple demanded (on average), with occasionally some premium multiples reported for some transactions above the $2m valuation benchmark. According to Empire Flippers, the average sale multiple for online businesses reported in 2022 on their site ranged from 33x for other online businesses, to 34.4x for eCommerce sites to 38x for content websites, which have reported an increase in the past few years but have slightly decreased compared to 2021. Some sale of Amazon FBA businesses on their site have reported up to a 66x multiple, as they tend to be more streamlined than other eCommerce or dropshipping businesses.

As Empire Flippers also mentions, the appetite for dropshipping businesses changes year by year. Nevertheless, we can use the minimum and maximum multiples of online businesses as a basis to value a dropshipping business.