In these the early childhood days of the Internet, most e-commerce and Web service business owners have no idea what their companies are worth. Given the prices paid for some acquisitions and IPO values for Web based businesses – some just months old – one might think that there is no rationale or reason behind these valuations.

That is simply not true.

Everything that has substance has a measurable value. Water has a measurable value to the water company, air has a measurable value to airlines and oxygen bars, dirt has a measurable value to everyone…it’s called real estate. Just because one doesn’t know how to measure the value of an

e-commerce business – that doesn’t mean that the values placed on these companies are arbitrary.

On April 22, 1889 they had a little race called the Oklahoma Land Rush. Those with the fastest horses and best knowledge of the territory staked out the most strategic riverside, farm and ranch land. Many of the most desirable plots were taken by "Sooners," so called because they crossed into the territory sooner than was permitted. Late arrivals often found that the only land left was hard pan and waterless. It was chaotic and more than a little dangerous for the thousands of entrepreneurs who struck out into the former Indian territory to own some of the two million acres put before them. A few years later oil was found on some of this land (much of it the "worthless" land others passed over because you couldn’t grow anything on it). Those who staked it became wealthy beyond their wildest dreams. But for most, this land turned into productive farms, towns and a place to raise their children.

I took this digression to illustrate that the Internet is in the midst of its own Oklahoma Land Rush. For a lucky few, those who go public with a huge multiple, this era will make them wealthy beyond their wildest dreams – but for most, e-commerce should give them the same thing that the land gave our great, great grandfathers – a good living. What was the value of 640 acres in the Oklahoma Territory in 1889? What was the value of the same land in 1919 when they found a dome of oil under it? Is value an arbitrary concept? No.

There is only so much real estate on the Web. If you owned the name and develop the site called pets.com, realestate.com, or baseball.com, etc. then you were probably a "Sooner" and struck oil. The value of each Web based business is directly tied to the originality of the business, its depth of financing and the business savvy of the founders. Amazon.com proved that it isn’t the name that’s important – it’s the real estate you’ve staked out.

The texts define Fair Market Value as the price a willing buyer will pay and a willing seller would accept, when neither is under any compulsion to buy or sell. This presumes an orderly marketplace. When it comes to the Web – you can flush Fair Market Value down the porcelain receptacle. It’s all about Strategic Value – that price a 25 year old buyer with more coffee than blood in his vanes would be willing to pay, with someone else’s money, to snuff out the competition or to grab market share before some other 25 year old coffee burning, crazed buyer gets it. It’s a price that a venture capitalist will pay to get 17% of a business with no employees, no revenues and little prospect for profits in our lifetime.

The Strategic Value of your Web based business is paramount. This is not an orderly market and it’s not going to become one for some time. But Strategic Values can be calculated and predicted if you know what’s happening in the market for similar businesses. A Chinese vase sitting up in your grandmother’s attic covered with dust has one value and another on the auction block at Sotheby’s. That vase will be sold for a price that is consistent with other Chinese vases of the same era and of a similar quality. The same is true of Internet companies. By comparing your company to the market for similar businesses – one can start to approximate the value of your enterprise against Internet businesses of a equivalent size, quality and uniqueness.

In business valuation circles the most tried and true appraisal methods are the Market Approach, the Income Approach and the Cost Approach.

The Market Approach approximates a company’s value base on its past profit performance by utilizing a multiple derived from similar companies that are publicly traded. We use public companies because the SEC makes them publish their stock price, their number of shares and their sales and profits. Appraisers would rather use "comps" from similar private companies, but private companies rarely disclose this kind of information. After deriving a multiple based on the PE ratios of the most similar public companies, a value is rendered on the subject private company based on a multiple of their past earnings.

Since a private company’s stock is not liquid, the valuation is then discounted by the appraiser for a "Lack of Marketability". This discount can range as high as 60% of the public company’s price, but most often is only 30% - 40% off of the public company value. This is kind of a moot point because most e-commerce companies (except adult entertainment houses) don’t make much or any profits. Many have never made any profits and may not do so for years.

The Income Approach utilizes projections to obtain the "present value" of the projected future income stream. Since the "future net income" for most Internet business is almost impossible to predict, the Income Approach is very difficult to use.

The third method is the Cost Approach. Now, the Cost Approach does not work too well with most kinds of businesses, the kind with bricks and mortar...but it has applications in valuing Internet e-commerce enterprises. If an e-commerce firm has been in business for three years and burnt through $1.3 million of investor funds, and is no closer to break even that it was three years ago – what is it worth? The answer could be $1.3 million, because this number would approximate the amount that a buyer would have to spend to develop a similar site and set it up in business himself. The opportunity value could be much higher if the site has some significant market advantages or technical innovations. Most Internet entrepreneurs would not be satisfied with only getting their investment back – but if you’re mortgaged to the hilt and there is no other source of money – one might have to sell at "cost" just to recoup some angry or impatient investor’s money Often, it is not the cost of programming and developing the database that is the deciding factor – it’s the marketing cost. Many Internet pioneers are simply not prepared for the high cost of marketing their site. It can run many times more than the original programming and design expense, just to let people know that you exist. It is a good idea to track the cost of developing your site carefully, in case it becomes an point of valuation sometime later. Nobody plans to fail, but many fail to plan.

Our firm uses a valuation method for Internet commerce companies that we feel helps establish a good model for most entrepreneurs to bracket the value of their own business. For this method we utilized a modified version of the Market Approach. But instead of deriving a multiple based on publicly traded Internet companies’ Price Earnings (PE) ratio – we utilize a multiplier called the PR or Price Revenue ratio. In today’s market, an Internet company’s profits are irrelevant. It’s their growth and the number of quality eye’s landing on their site that matters. While I am sure that you could find some Internet companies that have been sold for big bucks despite very little revenue – these are more the exceptions than the norm (and will be less so in the future). Revenues are a measure of advertising support, subscriptions and/or commerce on the site. If a site has enjoyed strong revenue growth, it’s profitability will surely be lagging, because they would have had to spend heavily on marketing and programming to get them there.

Top line revenues are the key indicator of value in the current climate for Internet commerce companies. For ISPs the key indicator may be the number of subscribers. For search engines the key indicator may be the number of hits they receive. But for e-commerce companies, revenues have to be the benchmark that you rely on when determining value. For start-up e-commerce companies, one would have to use the present value of their projected future revenue stream as your basis for value. But for mature e-commerce companies, current revenues (trailing 12 months) might be a more reliable indicator of present value.

Our firm studied the Price Revenue ratio of 36 publicly traded Internet companies. What we found was that, to no surprise, these publicly traded companies are valued at many times more than their incomes. Most of these corporations had revenues under $100 million. Relatively small income compared to the manufactures and retailers which presently dominate the stock exchanges, and generate billions of dollars in sales. However, the market capitalization of these publicly traded Internet companies, with relatively few assets and virtually no profits, is often higher than many companies on the Fortune 500.

To determine the midpoint for these 36 companies, our firm used the mean instead of the average ratio, because the numbers were skewed by a few companies (like eBay and Infospace.com) with outrageously high stock prices, relative to their actual revenues. Our 36 guideline companies had mean revenues of $53.65 million, a mean stock price of $50 per share and mean numbers of shares outstanding of 37.7 million. The resulting revenue per share was 1.37 and Price Revenue Ratio was 43.31. That means that these 36 publicly traded companies are trading at approximately 43 times their annual revenues. Wow! As a comparison, General Motors’ PR Ratio is 3.4, with $168 billion in revenues and $258 billion in assets.

But, 43 is a realistic benchmark for publicly traded Internet commerce companies today. As the industry matures, and becomes less speculative, this multiple will come back closer to those of other high growth industries like biotechnology and high tech.

Now, before you start popping champagne corks and making deposits on Ferraris, you should know that privately held corporations usually sell at a deep discount to their publicly traded counterparts. If your firm is venture capital funded and is growing rapidly that discount might be no more than 30% to 50% of the public multiple. For self-funded, non-profit or non-commercial, non-mainstream Web based businesses, that discount can be as much as 80%. Therefore, if we take our publicly traded benchmark of 43, the discounted multiple on revenues would be 30 (high) to 21 (low) for well funded, fast growing, mainstream Web based businesses. If your Web business was generating $1 million in revenues, you might enjoy a selling price of between $21 million and $30 million. This would be very rational in today’s market for well established Internet commerce companies and service providers.

For adult entertainment, new age or other fringe Internet businesses, the multiple would probably shrink down to 10 to 20 times your most recent 12 month income. For example, if you had a Metaphysical bookstore on the Web, and it generated $500,000 in revenues in 1999, that business should be worth between $5 million and $10 million. In comparison, if you owned a bricks and mortor, Metaphysical bookstore in Greenwich Village, with sales of $500,000 a year, the most you could probably get for it would be one times revenues. For most businesses generating $500,000 in sales, $5 - $10 million would seem ludicrous, but this is the Web and standard appraisal methods do not apply. It’s more like wildcat oil exploration than it is business as usual.

Knowledge is power. Remember, that those strategically minded Internet corporations offering to buy your private Web enterprise are often ripe with cash, funded at a multiple many times greater than what they are offering you. If you know that they are enjoying a valuation 50 times their revenue, then at least you now have an understanding of what your added revenue is worth to them.

The optimum benchmark would be an index that shows what privately owned Internet companies sold for as a percentage of their revenues or their income, but since this information is virtually impossible to get, we must rely on approximations, as with PR Ratios and the Cost Approach.

In the end, a plot of land, a vase or an Internet corporation is worth what someone is willing to pay for it. Valuation multiples and cost approaches are only tools that can help you approximate the value of your business against the market for similar businesses. Many of you will all too soon find use for this article because the Internet will go through a huge consolidation over the next 10 years, that will see the largest players cultivating more and more of the territory. We recommend that you cut this article out and keep it on file, you may need it sooner than you expect.