If you’re reading this article, there’s likely a pitch book on your desk extolling the virtues of a particular website that has come into the orbit of your private equity fund. Perhaps a partner has asked for some operational due diligence as a potential investor.
We’re here to help, of course, starting with this quick overview of private equity due diligence for SEO.
Websites & Organic Traffic as an Asset
Let’s start with the essence of the deal: the website on offer. What’s it worth? What are the risks?
Notwithstanding the protests of various digital agencies, websites are a commodity at this point in the game. They can be easily built and replaced, at minimal cost. This frequently involves using a software package such as WordPress, WooCommerce, Shopify, Magento or their IBM / Microsoft counterparts.
The value of a website is from it’s various types of traffic and how well it generates revenue from them.
Traffic is broadly split into two types, organic and paid. Organic includes both people directly keying the website’s address into the browser, people finding it on search engines, and various forms of referrals from social media. Paid involves advertising.
Organic traffic takes time to build but serves as a recurring source of value for the company. As your website gains a reputation for quality, you will get a steady stream of free visitors each month. Organic traffic also tends to convert into sales relatively well; since most organic visitors have shown signals of purchase intent in the referral process (eg. searching for relevant products). You can value this as an annuity.
Paid traffic can be scaled up faster but requires a constant advertising budget to operate. The value of this traffic lies in the degree to which you’ve optimized your digital marketing efforts. You can create value through advertising buying strategies and efficiently converting visitors into customers.
Each different type of traffic has some unique risks, which forms the basis of your due diligence efforts.
SEO Due Diligence for Organic Traffic
The digital due diligence process generally focuses on understanding the risks and opportunities for a website’s organic traffic. This generally forms the core of the website’s valuation.
To begin, the website can generate recurring traffic from three sources:
search engines
social media
brand awareness (direct traffic)
Your due diligence project should be focused on understanding how much traffic the website gets from each source, the potential risks of disruption, and the growth opportunities.
Search engine traffic is very dependent on Google’s algorithm for ranking websites. This (unpublished) ranking logic can be a source of havoc every few years when the rules change. Portfolio companies can lose a large share of their traffic if their SEO strategy is not longer supported by Google.
Search engine rankings are based on website authority, as measured by content quality and external signals (such as people linking to your articles or sharing them on social media). This is a competitive process, so you website can rise or fall based on the actions you and other website owners take within your content niche.
Value Creation for Organic Traffic
A good SEO campaign can provide a powerful value creation platform for a newly acquired website, especially if a SEO audit hasn’t been run recently. A good SEO campaign will involve updating content, publishing new content, and reaching out to promote your content on other websites to earn links. This is often an excellent potential investment opportunity.
One area that should be clarified in this process is your content strategy: going forward, what keywords are you targeting and what do you intend to publish in terms of content? Are you going to use strength to pursue highly competitive ” head” keywords (“women’s shoes”)? Or are you going to use analytics and maneuvering to find less competitive keywords in the “long tail” (red leather women’s pumps with silver buckles)? The rest of your SEO strategy needs to be aligned around this.
Content marketing is the act of creating attractive content for your target audience and promoting it on social media. This is generally a good idea for growing organic traffic.
Due Diligence for Paid Traffic
The bad news about SEO is it takes a while to rank a website, which may prompt squirming at your board meeting.
The good news about SEO?
A competitor is highly unlikely to buy out the market from underneath you, which happens all the time with paid traffic.
There’s also the risk of getting set up by bidding from related entities and captive traffic sources, which get re-priced after the deal closes. You’re going to need to fully understand where your traffic is coming from and ensure you can control the source going forward.
Conversion optimization does create recurring value for the portfolio company, whereby you’re able to turn a larger share of paid traffic into paying customers.
One risk that doesn’t show up in the financial statements. Paid traffic tend to be for more volatile high value keywords; these are a honeypot for competitors, so don’t assume you can hold these slots long term. Constant testing and innovation is required to keep your place.
Competitive Perspective
Technical complexity aside, websites are an area where a private equity firm can do well. The underlying nature of the business is very messy and operational, with many nuances involved in SEO due diligence and value creation. You need a good analyst with the time to pick deals apart.
Financial leverage is rare in this space, due to the notable risks of losing traffic when Google’s algorithm changes. Target company valuations reflect that, however, at 2 x – 5 X annual EBITDA. While your banking partners may not like it, an equity investor can get IRR’s of 30% or higher on your capital.
No hedge fund or asset management firm has the patience to sort this out. Most investment banks have never bothered to learn the space. Most investment bankers glaze over when you mention how to rank websites. Venture capitalists are too focused on driving rapid growth to care about cash flow assets.