How Shark Tank Valuation Models Work

If you’ve ever watched a Shark Tank segment, you may have seen the entrepreneur or investor quickly jot down the valuation numbers of their company. To be able to pitch to Sharks, you need to understand the valuation process. You don’t want to undervalue your company, which will negatively impact the investor’s impression of you and your business.

Problems with Shark Tank Valuation Models

When valuing a business, you need to consider the time the company will exist. If the business is new, the valuation is more difficult to calculate than if it has been around for a while. This is because it is more difficult to determine future earnings. Therefore, you need to use a risk-adjusted discounting model.

Entrepreneurs, however, are often passionate about their businesses and believe their vision for the future will work out. Nevertheless, Sharks know that most small businesses fail. Therefore, they will require a high rate of return on their investment to justify the risk. In the end, the entrepreneurs put value on their business, and Sharks are willing to invest in this kind of optimism, provided that they can get a reasonable rate of return on their investment.

Another example of a company that didn’t get a reasonable valuation is Chef Big Shake, a frozen-burger business that sold shrimp, fish, and chicken burgers. Shawn Davis asked for $200,000 to buy a 25% stake in the company, but the sharks could not see the benefits of investing in his business.

One of the biggest problems with Shark tank valuation models is multiples. While multiples can help investors decide, they don’t want to pay too much for an intangible asset that may not materialize in the future. Furthermore, investors don’t typically value synergies or affiliation.

As a result, the Shark Tank valuation isn’t an accurate reflection of a startup’s true worth. It’s merely a rough guide to the potential sale price of the company. Startups should remember that finding a shark on Shark Tank is the first step in a long journey.

Defensibility

Defensibility comes in a variety of forms for different businesses. Sometimes it comes from a strong patent, secret formulas or ingredients, relationships with distribution channels, or progress in branding. Defensibility is an essential aspect of investing in a business. Defensible businesses have a competitive advantage, which can help you make the right decision when investing in a company. The doorbell that connects to a smartphone is a classic example.

Pre-money valuation

When it comes to pre-money valuation, Sharks often get the wrong idea. They assume that it is a simple math problem when it is an intricate process. One example of a complicated calculation used by Sharks is when Daymond John, founder of the clothing company FUBU, offers a contestant $1.5 million for a 25% stake in the company. A viewer may think this is the equivalent of $6 million, which is far from the case.

In this example, the pre-money valuation for the company is $1 million. This is the value of the foundation of the company. Suppose you raise $1 million from an investor. In return, the investor will get 100 percent of the company’s value. The post-money valuation will be $30 million.

Pre-money valuation models help identify potential investment opportunities in startups. The pre-money valuation will give you an idea of how much the company is worth, which is usually a fraction of its market value. The post-money valuation will include the cash infusion and increase the ownership value. However, the valuation will move in the opposite direction if there is no capital market.

Ideally, the capital requested by the company should be proportional to its current revenue. Companies with higher revenue are more likely to attract investors than those with lower ones. Investors want to make long-term bets and will be looking for investments that will give them a return.

Knowing that a pre-money valuation is just a preliminary step in the negotiation process is important. When negotiating with investors, it is essential to understand their valuation methods and be prepared to defend them. The success of your startup depends on how well you prepare for this phase.

Intangibles

Intangibles are not easily categorized into monetary assets. This makes them very difficult to value. However, it is possible to develop a model to love them based on their option characteristics. These assets include undeveloped patents and natural resources. As you can see, a company’s intangibles are precious and can often fetch a higher valuation than tangible assets.

One popular valuation model is the one used in Shark Tank, which is based on the percentage of ownership. The Sharks usually object to unrealistic valuations and make their offers based on lower valuations. However, valuation models that emphasize the brand impact or proprietary technology are rarely accepted by Sharks.

There are five primary methods used to value intangible assets. These methods include the cost, market, and income approach. Each technique requires some adjustments for comparability. Intangibles should be valued at fair value rather than their market value. While GAAP allows firms to estimate their cost per acquisition, IFRS requires a firm to consider intangibles’ importance at the purchase time. As a result, intangible assets must be valued at fair value and included in the acquirer’s balance sheet. They must also be subject to periodic impairment testing.

In the first model, entrepreneurs offer a certain percentage of equity in exchange for a specific price. The offer price is equivalent to the equity percent times the value. Then, the implied value is equal to the offer price/equity.

Communication of value proposition

Sharks who invest in startups are interested in the value of their products and services. However, calculating the exact valuation of a company is a difficult task. There is no tried and true formula to calculate the value of a business, but using financial data can help investors estimate a company’s value.

Entrepreneurs typically have a strong passion for their company and believe that the vision they present will come true. However, Sharks are aware that most small businesses fail. Therefore, they will require a high rate of return on investment before they invest. Entrepreneurs need to make their company appealing to the Sharks.

The Sharks use a variety of methodologies to arrive at valuations. Generally, they consider a company’s sales and profits, as well as its future potential. They use the multiples similar businesses have achieved in the market based on the company’s financial performance.

A $25 million valuation on Shark Tank is often laughed at. While it is important to remember that startups are still in their early stages, it is also important to realize that the value of a business is not necessarily defined by its valuation. Startup companies often have untapped potential and need to be valued accordingly. A $25 million valuation might be a good starting point if the founders want to raise money for a startup.