Investing in a Traditional Vs Online Business? What are the differences?
There are many aspects to this question and we could talk all day about those but we’ll just hit on a few of the highlights and we’re going to start with the fact that traditional physical businesses almost always have a lot more physical assets than online businesses.
With those physical assets come a lot of kinds of problems actually or challenges and those are that a lot of the assets that you buy for a traditional business begin to lose their value, they depreciate, from the moment that you buy them. And that’s from inventory to think about signage to vehicles many kinds of equipment and even sometimes facilities and real estate.
All of those things require a lot of capital upfront and they begin to lose their value meaning that if you open the business today and had to sell it in a month, you wouldn’t get back nearly what you invested in it in many cases.
So online businesses, because they have fewer physical assets, have lower barriers to entry, there’s less capital involved in getting into an online business. And of course, the return on assets for online businesses is really not even a metric people look at because that ratio applies to businesses with assets and so return on assets is really good. Online businesses can be almost completely virtual, and the important thing there is that their location independent.
Many online businesses can be run from anywhere in the world where there’s an internet connexion and because their location independent, the staffing of the businesses is different in most cases. Many online businesses can get away with outsourcing freelancing everything and not having some of the overhead that comes with having full-time employees and the taxation and other kinds of regulations and requirements.
If you don’t have employees then you have another set of issues like turnover quality sometimes cost issues although a lot of times we can get less expensive employees via outsourcing freelancing. So that’s just one big difference. And it’s kind of an important one.
Marketing tools actually are kind of merging these days. There are very few physical traditional businesses that don’t make use of digital marketing kinds of tools so in the marketing respect they’re actually pretty similar in the kinds of techniques that they employ. Because online businesses are location independent it actually makes them more liquid. You can sell them more easily. And the reason is that the potential buyer pool is much much larger. Right. If you think about a location dependent business people who buy it more than likely are going to have some relationship or affinity to that particular location either they live there, they’re aware of it. They have the same citizenship or whatever. And when you sell an online business more people globally can become aware of the business being for sale and more people are eligible to operate it.
So that makes the sale of an online business more liquid. It doesn’t necessarily increase the value of it but because all online businesses that have that same characteristic are going to have the same potential value to buyers.
But it does make it more liquid because there are more potential buyers for it. So that’s one really important difference. I said earlier you can get in easier there’s fewer barriers to entry and then you can get out easier.
And so that flexibility is really important for entrepreneurs and that’s why you see so many people getting into online business get in pretty easy have pretty high returns get out pretty easy. So it makes it really attractive to people and that may be why you’re reading this episode. Now I should say that when online businesses reach a certain size or scale they start looking a lot more like traditional businesses and even just think about something like Google or Facebook. These mammoth companies started out really as online businesses but they have facilities they have employees they deal with the same kinds of bureaucratic and corporate issues as as their partner physical businesses.
They certainly do have different asset mixes and they certainly have different average margins on different kinds of products services that they sell. But the point is that when you’re at kind of a lower size and an entry point you’re going to that from that small to sort of medium level business, the differences between online and physical traditional businesses are quite substantial and then as you get bigger than that the differences tend to be not as clear so most of the people that probably are reading right now are thinking in terms of the smaller medium businesses and the really large one. So those are a few of the differences operationally Of course there are many many differences valuation wise.
It really varies, I mean physical businesses can have pretty wild valuations and online businesses can have very very large multiples in terms of their valuations as well. So it really varies from business to business. I will say that on average online businesses have higher multiples than perhaps a physical traditional businesses.