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Shark Tank

What Shark Tank Gets Wrong: Valuation

Every week, my DVR records the latest episode of Shark Tank. And every week, when I’m done watching it, I wonder why I continue to do so. The show is not without its merits —  it’s compelling television. However, aspiring entrepreneurs whose views on business are formed largely through “Shark Tank University” are going to be ill-prepared to succeed. Tempted as I am to clickbait you with “The Five Things Shark Tank Gets Wrong,” I’m going to focus on one thing at a time. In this article, we’re going to take a look at what is likely the most contentious subject on every episode: valuation.

The Valuation Calculation is Wrong

Valuation, or the financial value ascribed to a business, is frequently a point in which the investors on Shark Tank push back against the entrepreneurs or even disagree among themselves. In that respect, the show mirrors the real world, i.e. different people will disagree as to how much a particular business is worth. We can talk about market dynamics and how rounds are actually priced in another article. The key point here relates to the specifics of the valuation calculation based on the data that is presented to the audience. On every episode, we are introduced to new entrepreneurs and each comes with a specific dollar figure to raise and the percentage ownership an investor will receive in return.

Those two numbers are sufficient to derive the valuation of the business, but the formula that is used on the show is wrong. While I believe that the “Sharks” know this, I suspect that the producers ask them to fudge the numbers to make it easier for the audience to follow along from home. It’s a shame because the show could easily add some graphics that walk through the calculation. But alas, the show is more entertainment than education.

Let’s take a look at how they calculate valuation on the show and then compare that with what entrepreneurs and investors do when they’re not on television.

An Example

Bob’s Road Trip Diapers launched 8 months ago and Bob has moved $50,000 worth of product in that time. Bob is bearish on gas station bathrooms and thinks that this business can own a (particularly off-putting) segment of the long-distance driver market so he’s asking for $100,000 for 33.3% of the company.

Mr. Wonderful cocks his head to the side and says, “So the imputed valuation for your poopy product is $300,000. You’re out of your mind! There’s no way this business is worth more than $200,000 right now.”

Mr. Wonderful says you're dead to him when he hears your valuation

Ah, But I Am Very Much Alive

If you’ve never raised capital or been an investor before, Mr. Wonderful’s math makes sense:

$100,000/33.3% = $300,000

It might make sense, but it’s wrong. It’s wrong because it doesn’t actually reflect the value of the cash that was injected into the business. If you have a business that is worth $0 and someone invests $100,000 — forget the percentage ownership for a moment — what is the new value of the business? Well, you started with $0 and added $100,000, which looks like this: $0 + $100,000 = $100,000. This is an extreme example because all of the value of the business comes from the new investment. However, it should be clear that it’s folly to dismiss the impact of new money in the calculation.

So let’s revisit the fake Shark Tank scenario from before. Mr. Wonderful is contemplating an investment of $100,000 so he can come away owning 33.3% of the business. What’s the actual valuation of the business as it’s being pitched?

$200,000.

At this point, some percentage of you who are reading this have one question: “Huh?” Don’t worry, the math is still pretty straightforward. But before we get to the math, it’s a good time to get clear on terminology because the valuation issue on Shark Tank results in part from ambiguity around the words they use.

Understanding Terminology

When discussing valuation, there are actually two numbers — and terms — that are used: pre-money valuation and post-money valuation. (To get you more comfortable with startup slang, I’ll drop the word “valuation” below.)

Fixing the Formula

On Shark Tank, the word “valuation” is regularly used in place of “post-money valuation.” In the real world, when investors and entrepreneurs discuss valuation, “pre-money” is what’s being discussed the vast majority of the time. Got it? Now we can get back to the math. When Bob walked into the tank, what value did he assign his business? He indicated that he wanted to raise $100,000 and give up 33.3% of the ownership in return.

Here’s our formula:

investor percentage ownership = investment / (pre-money valuation + investment)

Now let’s plug in the numbers:

33.3% = $100,000/(pre-money valuation + $100,000)

If we solve for pre-money valuation, we arrive at a number that is different than Mr. Wonderful’s: $200,000. Now let’s look back at fake Kevin O’Leary’s objection, which while fictional is actually consistent with his actual approach: “So the imputed valuation for your poopy product is $300,000. You’re out of your mind! There’s no way this business is worth more than $200,000 right now.”

What none of the Bobs who are on the show do is say, “I am in total agreement with you on the question of valuation. $300,000 would represent a 50% premium on top of the valuation I’ve assigned the business. So this will be an easy negotiation. I’ll take the $100,000 at a $200,000 pre-money valuation and give you 33.3% in return.”

Wrapping Up

There have been a few episodes of Shark Tank where entrepreneurs have referenced “pre-money valuation,” but to the extent that there was additional commentary, it seems to have ended up on the cutting room floor. I can only imagine what would happen to an entrepreneur who wanted to negotiate liquidation preferences! While I remain a regular viewer of the show, I’m disappointed that the Shark Tank platform isn’t used to demystify entrepreneurship more proactively. Oddly enough, HBO’s Silicon Valley, a work of fiction, rings true in many ways that “reality TV” doesn’t.

Butterfly on Leaves

Is That Gastroenteritis or Am I Starting a New Business?

I had forgotten the feeling.

It’s a sensation that quite literally feels like it’s emanating from the pit of my stomach. It is, at once, foreign and familiar.

Butterflies.

That’s a nice word for it. Adorable little things, flitting from flower to flower. Nothing about this feels adorable though. I don’t like it at all, but am comforted that it’s there.

It’s been a bit over a decade since I launched my first startup. Then, I had a strong opinion regarding online video. It was going to be big, I thought. Big enough that I should stop whatever it was that I was doing so that I could direct all of my intellectual energy to that one concept. Big enough that I should recruit, evangelize and proselytize. Big enough that every VC rejection had me shaking my head that they were wrong and I was right. And so I poured myself into this startup, which we called Twistage. We showed it to people and I was excited that we were building the future that we had envisioned. And then we launched…officially.

Butterflies.

While they would visit my abdomen from time to time, there were never so many beating wings as when we launched. So here I am again. Older, presumably wiser (though many of those close to me would beg to differ) and definitely more even keeled. And those damned butterfly wings are pounding in my gut. My heart rate is elevated, my body ready for fight or flight as I sit in a chair, the clackety clack of my keyboard competing with the whirring of the building’s HVAC.

“Are we ready?” Hell no. But, the thinking goes, if you wait until you’re ready, then you’re too late. Besides I’ve done this before and I know (intellectually) that you’re never ready because you’re never truly done. There is a feature you could add here, a rough edge to smooth there, and a whole new set of opportunities for you over the hill yonder. Unfortunately, your product won’t work for those people because it’s missing some other features that you dismissed as unimportant six months ago. “Are we ready?” I guess we’re as ready as we’re going to be.

Now, having run afoul of every content marketer, journalist, and editor on the planet, I present you with the lede (yes, that’s the way journalists spell it in this context) that I have so gloriously buried. Today, we are pleased to announce the official launch of Vendorful’s Smart Strategic Sourcing and Vendor Management. Does your organization completely lack or rely on an ad hoc purchasing process? Great, you’re right in our wheelhouse. Does your organization have a formal buying process that sits atop a foundation of RFPs and RFIs? (Don’t you hate RFPs and RFIs?) Awesome – you’re going to love Vendorful. Our solution takes away the pain of vendor discovery and selection.

Those of you who are stuck replying to RFPs and RFIs – don’t worry! We haven’t forgotten you. You can use our tools to manage your answer database, assign answers to colleagues who are subject-matter experts and collaborate across the organization with stakeholders who maximize your chances of nailing your RFP responses. Did I really just use the term “stakeholders” in a sentence? Man, I’m more bought into this enterprise world than I had thought!

There it is. I’ve told you. The proverbial cat is out of the bag. All that remains is for me to click a couple of buttons and it’s official. I’ll stop worrying about the Vendorful launch and refocus all of my anxiety around Vendorful adoption. How many people are clicking through to the site? Are you reading this? If so, that means you didn’t click the link above! Should I give you another link? Nah, that would be too pushy. How about in a subtle parenthetical? (Something like this: https://vendorful.com.) Ah geez, here comes the next round of butterflies….