Shark Tank is a wildly popular show with star 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, especially your numbers.
The name of the game in Shark Tank is valuation, 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.
Imagine how much success people would have in the stock market if they only did this same thing! The stock market works almost exactly like Shark Tank does. There are the hot stories and innovative products, but the good deals are made when the price is right.
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. Your favorite time-killer can actually be educational and make you some money.
The average deal on Shark Tank is presented like this:
The Typical Shark Tank Valuation Formula
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 usually so emotionally attached to their creation; it’s their baby.
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.
25% = 1/4… $10,000 x 4 = $40,000.
So how does this convert to valuation?
Shark Tank Valuation: Earnings Multiple
One of the very first questions that a shark will ask is how much profit the business is generating. Again, notice the emphasize on the numbers. This is business, not a game.
If in my hypothetical business, I am making $5,000 a year in profit (or “earnings”), then my valuation is an earnings multiple of 8. Simply, it’s the value of my company divided by my annual earnings, or $40,000 / $5,000 = 8.
Believe it or not but this one of the biggest reasons why sharks will immediately turn down a deal. Notice how they always try to negotiate for more % or less money, which always results in a lower multiple.
Looking back at the earliest seasons of the show, you can find out that 7 out of the 8 sharks on the show focused on low earnings multiple companies. Not one averaged a multiple over 12 other than Kevin Harrington.
Now consider the stock market. One of the very first valuation metric investors learn is also the earnings multiple (known as the P/E Ratio on Wall Street).
I generally recommend finding lower P/E ratios than higher ones, all else equal. 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 way 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.
In addition, 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, at least not for a long, long time.
This is why sharks also use the revenue multiple, and why I teach it for learning how to evaluate 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 in the 80’s and 90’s, and they continued to pay out fat dividends for decades. 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 our free email list, where we share several easy valuation ratios to help you learn how to find great investments. The sky is the limit from there.