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What do Shark Tank investors look for in a business

The Sharks are a great example of experienced investors that analyze correctly the potential of investments.

By FlexInvestPublished 3 years ago 5 min read

Are you one of the 5 million who watch the reality show Shark Tank? If not, you should definitely tune in! It will teach you a lot about the world of finance, if nothing else.

In every episode, different entrepreneurs with small businesses pitch their proposition to five successful business people, known as ‘Sharks’, hoping to get the cash investment they need to take their company to the next level.

If the Sharks like the idea, they usually ask questions such as, “What is the amount of sales you have made this year?”, “At what price are you selling your product?”, “How much does it cost to produce every unit?”. All these help them to make an accurate valuation of the company.

It all comes down to this: the company’s worth and how much ownership an investor should receive in exchange for cash to help that company grow. Once you watch it, you will realize that the Sharks are potential investors – just like you!

Looking at it from the financial perspective, every episode of Shark Tank can teach a little bit of how the analysis of investment opportunities work.

How do you calculate the value of a company?

We’ll begin by saying it’s not straightforward. When thinking about the total value of a company, Sharks consider many factors like the entrepreneurs’ potential, the size of the market, the scale of the ‘problem’ the company solves, the company's future earnings and revenue potential, their intangible assets (like the value of the brand, patents and people), among others.

This is the reason why tech companies tend to appear more attractive as one of the investment opportunities. They usually have a higher potential valuation than consumer products, because they don’t have to deal with supply-chain issues or inventory and manufacturing costs.

So how do they do all this math in seconds? Well, even if the value of a company involves a lot of details, it is made simple through their investment proposals.

For example, picture yourself entering the set of Shark Tank. Say you walk in asking for $100,000, in return for a 10% stake in your company. These values suggest that the total valuation of your small business is $1million ($100K/10% = $1M).

You may consider that you have a heck of a business and it is the most successful of them all. But you will often see counter offers made by the Sharks because they have a better idea of what a company is worth than the entrepreneurs.

Now let’s say that the Sharks feel that your business is worth only half of that. They would counter with an offer of $100,000 for a 20% stake, instead of 10%. That gives your company a valuation of $500,000 ($100K/20% = $500K).

Wait, stake or equity? Don’t worry. Those terms are used interchangeably and they both refer to the ownership of a company.

What about “the multiples”?

The Sharks also talk about ‘the multiple’ when discussing the entrepreneur’s valuation. To calculate it, they’ll ask how much profit the business is generating. Then, they’ll divide the valuation by the annual profit. On Wall Street, this is known as the P/E ratio.

Quick… remind me! P/E ratio simply measures how much you are paying for a company’s earnings, the higher the ratio the more expensive the company is. You can get to know a little bit more of these technical terms checking out our Financial Lingo 101.

The other big valuation metric that the Sharks use is the revenue multiple. This works exactly the same way as the earnings (or profit) multiple, just with revenue numbers instead of earnings. This lets investors know how likely they are to get their money back. In the stock market, the revenue multiple is called P/S or Price to Sales.

Other words to look out for

Venture Capitalist: The Sharks are smart investors that appear in the show as venture capitalists. These are investors that provide cash to startup business that are in an expansion process but are not capable to get into markets of equity. They do take a risk by trusting their money in beginner projects, but they also have the chance to earn a great return on their investments if these small companies become a success.

Patent: When entrepreneurs appear on Shark Tank with unique products or inventions, potential investors will almost always ask one question: Do you have a patent for this product? A patent gives the product’s creator or inventor exclusive rights to the product or invention for a specific period of time. During that time, others can’t make the product or invention and sell it as their own.

Royalties: If someone has a patent or copyright of a product, nobody else can use or sell it, unless they pay for royalties. A royalty is a sum of money paid to the owner of the asset protected by a patent in exchange of the permission to make use of it with commercial or any personal purposes. Royalties are important for the entrepreneurs who own the invented products or services presented in the show because they’ll get money every time someone buys or uses them.

Niche market: A niche is a small market segment, where a specific product is focused, according to the needs, wants, and demographics of the target audience.

Margin: The difference between the cost and price of a product. The profit margin shows how much a company earns from every dollar sold. Sharks usually have a great interest on knowing the margins of each product. In order to make an investment decision, they need to know if entrepreneurs are paying too much for what they’re getting, and if they’ll get a good return.

What happens at the end of Shark Tank?

Inevitably, some (most) of the entrepreneurs sell a stake of their company for less than they would have liked.

However, the Sharks do offer invaluable PR and marketing advice, and the entrepreneur might badly need the cash to keep the business afloat.

Those who don’t get a deal still get some sort of reward. Appearing on Shark Tank is basically a free, 10-minute commercial with a guaranteed audience of 5 million people.

The Takeaway

The Sharks of “Shark Tank” are a great example of experienced investors that analyze correctly the potential of different companies before putting their money in any of them.

The most important lesson you can take from this reality show is to be disciplined in making your investing decisions based on logic and well done analysis, rather than emotions or trends.

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