If you’re not one of the 5 million people who watch the reality series Shark Tank, you should absolutely start! If nothing else, it will give you valuable financial knowledge.
Every episode features a different small business owner pitching their idea to five savvy businesspeople, or “Sharks,” hoping to receive the capital they require advancing their enterprise.
Valuation–The Bottom Line for a Shark Tank Deal
The core idea of the television show “Shark Tank” is for either the Sharks (the investors) or the entrepreneurs (pitch their businesses) to persuade the other side to accept their business’ valuation and make a contract based on it.
The Sharks typically offer lower valuations in response to the entrepreneurs’ typically high prices.
While the Sharks and entrepreneurs assess the business, they see on the program differently, a good valuation of a business considers things like revenue, profitability, and the worth of rival enterprises in the same industry.
Factors that Determine Valuation
Forecasting revenue, profitability, and applying a firm valuation are the key factors in deciding how much to invest in the business and how much ownership each party is ready to consider. These factors include:
Earnings Multiple
Because the businesses featured on “Shark Tank” are not publicly traded, investors cannot evaluate equity shares or disclose earnings multiples for them. However, the Sharks can still calculate an earnings multiple by comparing the company’s profit to its valuation based on sales revenue.
The company would have an earnings multiple of 10, or ($1 million / $100,000), if it had a $1 million valuation and the owner made $100,000 in profit.
Comparative analysis is useful in this situation. Let’s assume that the corporation in our previous example sells apparel. The multiple can be compared by the Sharks to those of other businesses operating in the same sector.
Consider the entrepreneur who is making a pitch for a clothing line with $1 million in annual sales and $100,000 in profits. By applying the sector’s earnings multiples, the entrepreneur might use the measures of the specialized retail apparel industry.
Suppose the sector has a 12-fold average earnings multiple. Comparative analysis is useful in this situation. Let’s assume that the corporation in our previous example sells apparel. The multiple can be compared by the Sharks to those of other businesses operating in the same sector.
Consider the entrepreneur who is making a pitch for a clothing line with $1 million in annual sales and $100,000 in profits. By applying the sector’s earnings multiples, the entrepreneur might use the measures of the specialized retail apparel industry. Suppose the sector has a 12-fold average earnings multiple.
This would value the company at $1.2 million, or 12 x $100,000. Based on this estimation, the business owner can defend the agreement to give the sharks a $100,000 investment for a 10% interest in the company.
Revenue Multiple
In exchange for a portion of ownership, an entrepreneur will often want a certain sum of money. In exchange for a 10% stake in the business, an entrepreneur can, for instance, approach the Sharks for $100,000.
The Sharks then start to assess its value to see if it is fair.
Most of the time, the Sharks will vouch for the entrepreneur’s estimate of the company’s value at one million dollars in annual sales.
The Sharks would inquire about the previous year’s sales if the company was valued at $1 million in sales. If the answer is $250,000, it will take the business four years to reach a million dollars in revenue.
However, if the entrepreneur recently signed a sales agreement with Walmart to sell $750,000 in products, but last year’s sales were only $300,000, the value would be more alluring to the Sharks based on the sales prediction.
In other words, the valuation considers both the company’s sales pipeline and revenue from the prior year in addition to those figures.
Future Market Valuation
The same formula used to compute revenue and earnings multiples might also be used to determine a future valuation. That the numbers are forecasts, which can be erroneous, is the only negative.
The Sharks would probably inquire as to the entrepreneur’s sales and profit projections for the following three years. They would then contrast those figures with those of other clothing retailers.
The entrepreneur may have predicted that earnings over the following three years would cause net income of $400,000 in year three. A future valuation of $5.9 million in sales, or (14.75 x $400,000), would be appropriate if the forward profits multiple for the retail sector is 14.75 times.
The Sharks’ goal is to turn a profit and recoup their investment. If the Sharks agree that the company has a potential of producing $5.9 million in revenue by year three, a 10 percent stake for $100,000 would be alluring.
However, there is a probability that the business won’t turn a $400,000 profit by year three. As a result, the sharks would either request a larger ownership stake, make a counteroffer with a smaller loan amount, or suggest a mix of the two.
The Drama of Valuation
The show would lack drama and intrigue if the Sharks only evaluated companies based on financial data. But one thing that makes Shark Tank so well-liked is its appraisal of intangibles.
The Sharks value firms similarly to other seasoned investors, considering the complete picture, including the numbers, story, and experience. However, the numbers are frequently the most important aspect of this process.
A Valuable Lesson for All
The “Shark Tank” sharks are a superb example of seasoned investors who accurately assess the potential of many businesses before investing their money in any of them.
The most crucial lesson you can learn from this reality program is to be strict about basing your investment decisions on reason and thorough research rather than feelings or passing trends.
Whether you’re a budding entrepreneur or just looking for some light entertainment on a Friday night, Mr. Wonderful and the crew can teach you a lot about how the financial world operates.
