What is “Shark Tank”?
The underlying theme of the Shark Tank TV series is that either an investor (called Sharks) or an entrepreneur (pitching a business) accepts a valuation of their business to the other side and negotiates a deal based on that. It's about persuading them. Entrepreneurs tend to enter with high valuations, and Sharks prefer to counter with low valuations.
How Entrepreneurs and Sharks values the companies featured on the show varies, but a good company valuation takes into account certain factors such as revenue, profits, and the value of companies within the same sector. In exchange for giving up a stake in the company, entrepreneurs get funding, but more importantly, access to the Sharks, their connections, suppliers, and experience.
How the Sharks decide how much to invest in a company and what percentage of ownership each will consider ultimately comes down to predicting revenues and profits and applying a valuation to the company.
Important points
- Investors who host Shark Tank typically require a stake, or percentage of ownership, in the business, as well as a share in the profits.
- Revenue valuations are often determined by considering prior year sales and revenue as well as sales in the pipeline.
- Sharks calculates earnings multiples by comparing a company's earnings and the company's valuation from its earnings.
How to evaluate a shark tank
Revenue multiple
Typically, entrepreneurs ask for a sum of money in exchange for a percentage of ownership. For example, an entrepreneur might ask the Sharks for her $100,000 in exchange for her 10% ownership of the company. From there, the Sharks will begin to determine if it's properly valued.
Sharks usually confirm that entrepreneurs value their company's sales at $1 million. If 10% ownership equals $100,000, then one-tenth of the company is worth $100,000, and therefore one-tenth (or 100%) of the company is worth $1 million, so the Sharks can reach the forehead.
If the company's sales are valued at $1 million, the Sharks will ask what their annual sales were for the previous year. If the response is he makes $250,000, it will take him 4 years until his company's sales reach $1 million. If the answer is $75,000 in sales, the Sharks would likely question the owner's $1 million valuation.
Earnings multiples are used by venture capitalists, angel investors, and other investors to evaluate startups seeking funding, along with other financial performance measures.
However, if last year's sales were $250,000, but the entrepreneur recently signed a distribution agreement with Walmart to sell $600,000 worth of products, the valuation based on projected sales would be more attractive to the Sharks. It will be. In other words, the valuation considers not only the previous year's sales and revenue, but also what the company has in its sales pipeline.
cost
As most companies calculate, revenue does not take into account the cost of producing goods and services. The Sharks ask about the cost because it's only $1 of total sales. For example, you might ask how much your company's products cost to manufacture and how much they sell for. This will help you calculate your product margin. They ask about marketing, research and development, and other costs such as salaries and wages paid to owners and employees to understand how much revenue the business keeps as profit.
Revenue multiple
Companies featured on “Shark Tank” are not publicly traded, so there are no stocks or published earnings multiples for investors to consider. However, the Sharks can still calculate their earnings multiple using the company's earnings compared to the company's valuation from sales revenue.
For example, if a company is valued at $1 million and the owners earn $100,000 in profit, the company's earnings multiple is 10 or ($1 million / $100,000). However, there's no way to know if a 10x earnings multiple is good for the company, so the Sharks may decide to use comparable company analysis to find out.
Comparable company analysis compares the financial performance of multiple similar companies to determine whether the company being evaluated is valued correctly.
Continuing with our example, let's say the company is a clothing retailer. Sharks can compare its multiples to those of other companies within the same industry.
So, let's say an entrepreneur is pitching a clothing brand with annual sales of $1 million and profits of $100,000. Entrepreneurs can use the average revenue multiple for the specialty retail apparel sector to apply metrics for that sector. Let's say the average earnings multiple for this sector is 12x.
If profits are 12 times, the business is worth $1.2 million, or (12 x $100,000). Based on this valuation, the entrepreneur can justify a deal to acquire his 10% stake in the business with her $100,000 investment from the shark.
Future market evaluation
Future valuations can also be calculated in the same way as earnings-to-earnings multiples. The only downside is that the numbers are predictions and can be inaccurate. The Sharks will likely ask how the entrepreneur projects sales and profits for the next three years. We then compare those numbers to those of other companies in the Retail Clothing industry.
An entrepreneur might predict that the next three years' revenue will lead to $400,000 in revenue in the third year. If the retail industry's normal expected earnings multiple is 14.75x, the future valuation would be $5.9 million in earnings, or (14.75 x $400,000).
Sharks also ask for previous year's sales and sales pipeline to estimate future demand for the product or service.
The Sharks ultimately want to recoup their investment and make a profit. If they agree that the company could generate $5.9 million in business by his third year, acquiring his 10% stake for $100,000 could be attractive. . However, it is possible that the business will not generate his $400,000 profit by the third year. As a result, the Sharks are likely to request a higher percentage of ownership, make a counter-offer with a lower loan amount, or a combination of both.
Valuation of intangible assets
If the Sharks evaluated companies based solely on numbers, there would be no drama or excitement in this show. Valuing intangible assets is one of the reasons this show is so popular. Like other experienced investors, Sharks consider the whole package – numbers, story and experience – when valuing a company, but the numbers are often the most important part of this valuation.
But other intangible assets are also important. An entrepreneur may have established a brand that is locally synonymous with quality and customer service. They may also have applied for patents or otherwise own valuable intellectual property. Although not in a financial sense, the experience of the owner, access to retail stores to sell the product, or supply chain are all valuable.
Special considerations: Risks to evaluation
The Sharks may say that the same valuation cannot be applied to the entrepreneur's company based on the metrics of a publicly traded company. There are some differences between a small business and a corporation.
Large established retailers may have thousands of stores around the world, but small businesses only have a few locations. It is natural that growth rates are higher for small and medium-sized enterprises, but the risks are much greater due to the risk of failure and liquidity risk in terms of exit strategies. Liquidity measures how easily an investment can be bought and sold. When there are many buyers and sellers competing for an investment, there is plenty of liquidity. Illiquidity occurs when there are few buyers and sellers.
The lack of liquidity creates greater risk for the Sharks, and a risk-adjusted discount must be applied to get the reward commensurate with the risk. As a result, the Sharks have much more leeway to make an offer based on a discounted risk-adjusted valuation.
The Sharks could make a counteroffer for a higher stake in the company, such as a $100,000 donation for 30% ownership. The risk of loss from investing in unknown companies is typically added to Shark's ownership, even if valuation metrics (based on earnings and earnings) indicate that Shark's shareholding should be lower. .
When did “Shark Tank” air on TV?
The first episode of “Shark Tank” aired on August 9, 2009 on ABC in the United States. However, this show is an American version of the international show Dragon's Den. The first iteration of this format is believed to be Japan's “Money Tigers” in 2001.
Who is the richest “shark” on Shark Tank?
Mark Cuban is the richest member of the Shark Tank family, with an estimated net worth of over $5.1 billion as of June 2023.
What are some successful ideas that sharks have passed on?
The Sharks' ratings aren't always accurate. Notable examples of ideas that were rejected on the show but were hugely successful include “The Ring,” “Coffee Meets Bagel,” and “Chef Big Shake.”
conclusion
Shark Tank is a popular reality show where wealthy investors evaluate startups pitched for funding. Investors use several common valuation techniques to debunk or agree with an owner's valuation and decide whether to give their money in exchange for ownership.
