The Sharks (investors) or entrepreneurs (pitch their business) must convince the other to accept their business valuation and make a transaction. Sharks fight entrepreneurs’ high values with lower ones.
A proper valuation of a company takes into account revenue, earnings, and the market value of other companies in the same sector.
“Sharks Tank” investors want a stake in the business and a cut of the earnings.
A revenue valuation incorporates last year’s sales and revenue and pipeline sales.
Investors calculate earnings multiples by comparing a company’s profit to its revenue valuation.
How Does Shark Tank Value Companies?
They features investors (or “sharks”) hearing financial pitches from business entrepreneurs. In exchange for their money, the sharks usually want a portion of ownership and earnings. In exchange for a part of the company, the entrepreneur receives financing and access to the investors contacts, suppliers, and experience.
By estimating the company’s sales, profits, and value, you can decide how much to invest and how much of the company to buy.
An entrepreneur usually asks for money in exchange for ownership. An entrepreneur may ask the investors for $100,000 for 10% of the company. The Sharks then decide its value.
The Sharks confirm the entrepreneur’s $1 million sales valuation. If 10% ownership is $100,000, then 10% of the company is $100,000, and 100% of the company is $1 million.
If a company is worth $1 million, the Sharks will ask about last year’s sales. If the answer is $250,000, the company will achieve $1 million in four years. If sales were $75,000, the Sharks might question the owner’s $1 million assessment. If last year’s sales were $250,000 but the entrepreneur had signed a deal with Walmart to sell $600,000 worth of product, the Sharks would be more interested in investing based on the sales prediction. The valuation considers not only last year’s sales and revenue but also the company’s sales pipeline.
“Shark Tank” companies aren’t publicly traded, so investors can’t buy shares or look at earnings multiples. With the company’s profit and sales revenue valuation, the Sharks can still figure out an earnings multiple.
If a company is worth $1 million and the owner makes $100,000, the earnings multiple is 10 ($1 million/$100,000). On the other hand, we have no way of knowing whether or not an earnings multiple of 10 is beneficial to the company.
Comparative analysis helps here. In our case, the company sells clothes. The Sharks can compare the multiples to similar companies.
Say an entrepreneur is pitching a $1 million apparel brand with $100,000 in earnings. Using the sector’s earnings multiples, the entrepreneur may apply its measures. Say the sector averages 12 times earnings.
At 12x earnings, the business would be worth $1.2 million. Based on this valuation, the entrepreneur may justify giving the sharks a 10% ownership for $100,000.
Future Market Valuation
Future valuations can be computed like sales and profit multiples. Forecasts might be wrong, however. The Sharks would question sales and profitability in the next three years. They compared that data to other apparel retailers.
The entrepreneur may predict that next year’s earnings will net $400,000. If retail had a 14.75x forward profit multiple, the future sales valuation would be $5.9 million (14.75 x $400,000).
Sharks want their money back and a profit. If the Sharks believe the company can make $5.9 million by year three, a 10% interest for $100,000 may be enticing. The company may not make $400,000 in year three. The sharks would likely want a bigger ownership percentage, a lower loan amount, or both.
If the investors only considered numbers, the programme would be dull. Shark Tank’s intangibles are part of its popularity. The Sharks weigh data, stories, and experience when valuing firms, but numbers are generally the most important.
Also essential are intangibles. Their value judgement can be influenced by personal and product stories. Investors may agree to an entrepreneur’s value without much debate if he or she has a compelling story of hard work and drive.
Investors ask for company-related inquiries. They may question how much the company’s product costs to make and sell. This helps compute margin. They’ll ask about marketing costs and prior year’s sales to determine product demand. Demand and sales growth are good. If sales decrease, stagnate, or improve slightly, the Sharks will inquire why. The Sharks will opt out if the justification is weak.
Risks to Valuation
The investors may say they can’t value the entrepreneur’s company using public company measures. Small businesses and public corporations have several differences.
A huge retailer may have thousands of stores, yet a small business may have only a few. Though the small businesses’ growth rate is justifiably higher, the risk is much higher owing to failure and liquidity risk. Liquidity is the ease of buying or selling an investment. If numerous buyers and sellers want an investment, liquidity is high. Illiquidity means few buyers and sellers.
Lack of money increases the investors’ risk, so they discount the payoff to make it worth it. The Sharks can base their proposals on a risk-adjusted discounted valuation.
They may offer 30% ownership for $100,000. Even if the Sharks’ income and profits show that they should have less of a stake, the risk of losing money when investing in a company they don’t know much about often makes their ownership stake bigger.
Their intangibles might also boost their ownership stake. Intangibles include experience, retail locations, and supply chains.