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Payback time and how much you should pay for a domain name

If you are considering investing a sizeable sum in a domain name, it will be important to know how long it will take for you to earn your money back.

The basic payback period formula is very simple. Just divide the cost of the domain name by how much you realistically think it will earn you annually to arrive at the payback period. So for example, a domain name that will cost you £5,000, and that you project will earn you £2,000 a year, will pay for itself after two and a half years.

There is something in financial theory called the time value of money. It's business speak for a bird in the hand is worth two in the bush. Basically, a sum of money now is worth more than the certainty of receiving the same amount of money at some time in the future. What's more, that amount of money at some time in the future is worth more than the same amount of money at a date even further into the future.

If you think about it, it is self-evident. If I offered you £50 in your hand today or £50 to be collected in a year's time, you would take the £50 now and eliminate the risk of what might happen between now and a year down the road.

For a large investment in a domain name, bear this in mind because understanding the time value of money will extend the payback time - maybe even to the point of making the purchase financially unviable.

That said, a domain name is quite unlike most capital investments. Unlike machinery for example, a domain name is more likely to appreciate rather than depreciate over time - so at the end of the payback period you may have not only earned your money back, but be in a position to sell the domain name for more than you paid for it.

Is there an optimum payback time? Not really - except the quicker the better. Textbooks often quote three years or less and I wouldn't really want to wait any longer than three years for a domain name to repay its purchase price.

A quality domain name could pay for itself very quickly indeed, providing you get it for the right price in the first place. American entrepreneur, Rick Schwartz, has made millions out of domain names and it was one of his earliest domain name purchases that opened his eyes to the amazing value of a good domain name.

Back in August, 1997, Rick bought for US$42,000, despite knowing that the seller had paid just US$5,000 for it a week earlier. Those who knew about the deal thought he was mad - until the domain name paid for itself in a matter of weeks. Talking to about this eureka moment, Rick said, "It was akin to buying real world property and paying off the mortgage not in 30 years but in 30 days!"

When working out payback time myself, I like to turn things on their head. I start with the price, select an arbitrary payback time based on how quickly I would like to see my money returned (for example two years), and then I work out how much the domain name would need to earn each year for that to happen.

If the numbers stack up, I'll go ahead. If I know the domain name itself will retain or see an increase in its market value over that period it becomes a no brainer because then I will have an asset that is both appreciating and one that acts as a revenue stream for me while it is appreciating.

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