How Is a Business Valued on "Shark Tank"? (2024)

What Is "Shark Tank"?

The underlying theme of the Shark Tank TV series is for either the investors (called Sharks) or the entrepreneurs (pitching their business)toconvince the other side to accept the valuation of their business and negotiate a deal based on it. The entrepreneurs tend to come in with high valuations, and the Sharks like to counter with lower valuations.

How entrepreneurs and the Sharks value businesses presented on the show varies, but a good company valuation considers certain factors such as revenue, earnings, and the value of companies within the same sector. In return for giving up a stake in the company, the entrepreneur gets funding, but more importantly, they get access to the Sharks, their network of contacts, their suppliers, and their experience.

How the Sharks determine the amount to invest in the company and the percentage of ownership each is willing to consider comes down to forecasting revenue, earnings, and applying a valuation to the company.

Shark Tank Valuation Methods

Revenue Multiple

Typically, an entrepreneur will ask for an amount in exchange for a percentage of ownership. For example, an entrepreneur might ask for $100,000 from the Sharks in exchange for 10% ownership of the company. From there, the Sharks begin to determine whether it's properly valued.

The Sharks will usually confirm that the entrepreneur is valuing the company at $1 million in sales. The Sharks would arrive at that total because if 10% ownership equals $100,000, it means that one-tenth of the company equals $100,000, and therefore, ten-tenths (or 100%) of the company equals $1 million.

If the company is valued at $1 million in sales, the Sharks would ask what the annual sales were for the prior year. If the response is $250,000, it will take four years for the company to reach $1 million in sales. If the response were $75,000 in sales, the Sharks would likely question the owner's valuation of $1 million.

However, if last year's sales were $250,000, but the entrepreneur recently entered into a sales agreement with Walmart to sell $600,000 worth of product, the valuation would be more attractive to the Sharks based on the sales forecast. In other words, the valuation doesn't only consider the prior year's sales and revenue but also what the company has in its sales pipeline.

Costs

As calculated by most businesses, revenue doesn't account for how much it costs to produce goods or services. It is only the dollar amount of total sales—so the Sharks ask about costs. For example, they might ask what it costs to manufacture the company's product and its selling price. This will help them calculate product margin. They will inquire about other costs, such as marketing, research and development, and salaries or wages paid to the owner or employees to get an idea of how much revenue the business keeps as profit.

Earnings Multiple

The companies on "Shark Tank" are not publicly traded, meaning they don't have equity shares or published earnings multiples for investors to consider. However, the Sharks can still use the company's profit compared to the company's valuation from sales revenue to come up with an earnings multiple.

For example, if the company is valued at $1 million and the owner earns $100,000 in profit, the company would have an earnings multiple of 10 or ($1 million / $100,000). However, there is no way to know whether an earnings multiple of 10 is good for the company, so the Sharks may decide to use a comparable company analysis to find out.

Let's say in our earlier example that the company is a clothing retailer. The Sharks can compare the multiple to those of other companies within the same industry.

So, let's say the entrepreneur is pitching a clothing brand with $1 million in annual sales with $100,000 in profits. The entrepreneur could apply the metrics of the specialty retail apparel sector by using the sector's average earnings multiples. Let's say the sector has an average earnings multiple of 12.

At 12x earnings, this would value the business at $1.2 million or (12 x $100,000). Based on this valuation, theentrepreneur can justify the deal for a 10% stake in the business for a $100,000 investment from the sharks.

Future Market Valuation

A future valuation could also be calculated in the same way the revenue and earnings multiples are. The only drawback is that the numbers are forecasts and can be inaccurate. The Sharks would likely ask what the entrepreneur forecasts for sales and profits in the next three years. They would then compare those numbers to those of other companies in the retail clothing industry.

The entrepreneur might forecast that earnings in the next three years would lead to $400,000 in earnings in year three. If the retail industry typically has a 14.75x forward earnings multiple, the future valuation would be $5.9 million in earnings or (14.75 x $400,000).

The Sharks ultimately want to get their investment back and earn a profit. If they agree that the company could generate $5.9 million in business by year three, a 10% stake for $100,000 might be attractive. However, it's possible that the business might not generate $400,000 in profit by year three. As a result, the sharks would likely demand a higher ownership percentage, counteroffer with a lower loan amount, or propose some combination of both.

Valuation of Intangibles

The show would be without drama or excitement if the Sharks valued a company solely based on figures. Valuating intangibles is one of the reasons the show is so popular. Much like other seasoned investors, the Sharks consider the whole package—numbers, story, and experience—in their valuation of companies, though the numbers are often the most significant part of this exercise.

But other intangibles are also important. An entrepreneur might have established a brand in their local area that became synonymous with quality and customer service. They might also have filed patents or have intellectual property that might have value. An owner's experience, access to retail outlets for selling products, or supply chains are all valuable, although not in a monetary sense.

Special Considerations: Risks to Valuation

The Sharks might say they can't apply the same valuation to the entrepreneur's company based on valuation metrics from publicly traded companies. There are several distinctions between a small business and a public corporation.

A large, established retailer might have thousands of stores worldwide, but a small business may only have a few locations. Though the growth rate is justifiably higher for the small business, the risk is much larger due to the risk of failure and liquidity risk in terms of anexit strategy. Liquidity measures how easily an investment can be bought or sold. If there are many buyers and sellers vying for an investment, there is ample liquidity. If there are few buyers and sellers, there's illiquidity.

The lack of liquidity creates more risk for the Sharks, which entails applying risk-adjusted discounting to make the reward worth the risk. As a result, the Sharks have much more wiggle room to base their offers on a risk-adjusted discounted valuation.

The Sharks could counteroffer with a higher stake in the company, say 30% ownership for a $100,000 contribution. Even if the valuation metrics (based on revenue and earnings) indicate that the Sharks should have a lower stake, the risk of loss from investing in an unknown company usually adds to the Shark's ownership stake.

The Bottom Line

Shark Tank is a popular reality show in which wealthy investors valuate startups who pitch for funding. The investors use several popular valuation techniques to debunk or concur with the owner's valuation and decide whether to grant them funding in return for an ownership stake.