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Shark Tank Valuation Explained – Wisdom Wednesday #71

Entrepreneurship and investing go hand in hand. You can’t have one without the other. But you can learn a lot of valuable lessons about investing through entrepreneurship, and a show like Shark Tank can be a fun way to learn.

For those who don’t know how the show works, basically entrepreneurs seek venture capital for their businesses. The “sharks” are experienced entrepreneurs themselves, and they offer money for parts of businesses. As all business negotiations go, things often go back and forth in an exciting and gripping fashion. Potentially millions of dollars are made and lost in seconds.

shark tank valuation

Shark Tank is a wildly popular show and stars investing tycoons like Mark Cuban and “Mr. Wonderful” Kevin O’Leary. If you’re an entrepreneur about to pitch your company to these venture capitalists, you absolutely must know your stuff. Furthermore, it’s crucial that you know your numbers.

The name of the game in Shark Tank is valuations, and if you watch the show enough you’ll realize that’s all it really is about. Sure there are some great, hype-y stories, but in the end these venture capitalist gurus want to talk numbers. And if the valuation isn’t right, it doesn’t matter how much they like the company. Deal’s off.

Imagine, just imagine, how much success people would have in the stock market if they only did this same thing! The stock market works exactly like Shark Tank does. There are the hot stories and innovative products, but the real money is made when the price is right. When valuation is as low as possible.

Maybe you’re a fan of the show but you still don’t know how to value a stock. Read this post and I’ll explain it all. Share this post with someone you know who loves Shark Tank. They’d love to find out that their favorite time-killer can actually be educational and make them some money.

So any average deal on Shark Tank is presented like this: I, the entrepreneur, am asking for $xx,xxx for xx% of my company. Let’s use an example and say that I’m asking for $10,000 for 25% of my company.

What does this mean?

Well, to find out if this a good price for the sharks to pay, they need to do a few calculations. I’m making an offer, and this is based on what I believe the company to be worth. Oftentimes what the sharks think a company is worth is much more accurate than what the entrepreneurs think. The sharks are investors, while entrepreneurs are so emotionally attached to their creation.

So if I offer 25% of my company, that means I am valuing my company at $40,000. How does that calculation work? Well I am valuing 25% of my company at $10,000, or 1/4 of it at $10,000. So 4/4 of it would be $40,000.

Another way to do this calculation is to convert the percentage to a fraction, and then flip the fraction and multiply by the offer price. So 25% = 1/4… $10,000 x 4 = $40,000.

So how does this convert to valuation?

Shark Tank Valuation: Multiple

One of the very first questions that a shark will ask is how much profit is the businesses generating. Again, notice the emphasize on the numbers. This is business, not a game.

If in my hypothetical I am making $5,000 a year in profit, then my valuation is a multiple of 8. Simply it’s the value of my company divided by my annual profit, or $40,000 / $5,000 = 8.

Believe it or not but this is the biggest indicator of whether a shark will buy or not. Notice how they always try to negotiate for more % or less money, which always results in a lower multiple.

Check out this great resource with the statistics of every Shark Tank deal: http://www.sharktank.tvquotes.net/

You’ll see that 7 out of the 8 sharks on the show focus on low profit multiple companies. Not one averaged a multiple over 12 other than Kevin Harrington.

Now consider how I teach investing. The very first valuation metric I teach is the multiple (known as the P/E Ratio on Wall Street). I recommend finding P/E ratios at least less than 25, and in most cases less than 15. Notice how 7 of 8 sharks follow this advice. Coincidence that they are all successful? I think not.

Shark Tank Valuation: Revenue Multiple

The other big valuation metric that sharks use is the revenue multiple. This works the exact same as the earnings (or profit) multiple, just with revenue numbers instead of earnings. The sharks ask every entrepreneur what their revenue numbers are. What this does at the very least is make sure that the investor will have a chance to earn his money back.

The revenue multiple can be valuable because sometimes the earnings don’t tell the entire story. A company could be poised for explosive earnings growth in the future, but current expenses could be preventing that for now. The revenue numbers help us find those type of situations.

Also a low revenue multiple keeps investors away from companies that never will grow to satisfy the valuation. If I’m a shark and I just put $100,000 into a company, but the revenue numbers are only $5,000… chances are slim I’ll ever get my money back.

This is why sharks also use the revenue multiple, and why I teach it for evaluating stocks as well. In the stock market, the revenue multiple is called P/S or Price to Sales.

As you can see, these valuation concepts aren’t complicated at all once you understand them. It’s simple multiplication… and yet it’s all that Mark Cuban needs to increase his fortune. What really excites me about all this is that anyone can be a shark too. You just do it by investing in the stock market, and you evaluate companies the same way I teach here.

With simple multiplication and knowledge, you can become part owner of a large business that could continue to spit out cash and profits for decades. Companies like Coca-Cola or McDonald’s were phenomenal investments for people who bought 10 or 20 years ago, and they still pay out heavy dividends to reward shareholders. There’s no reason why other companies won’t do the same in the future.

So you have a choice. You can ignore everything I just said. Pretend that being a shark is unattainable.

Or you can take some action now. Get on my free email list, where I share all 7 valuations that I personally use to analyze businesses. And the sky is the limit from there.

**All Rights Reserved. Investing for Beginners 2014**
**Shark Tank Valuation Explained – Wisdom Wednesday #71**