This guest post on valuations was written by Dan Casey of PurchaseOrderFinancing.Com
During negotiations with the Sharks, no amount of experience and passion can bridge the gap when an entrepreneur can’t explain why the company is worth the valuation. Valuation tells prospective investors the potential worth of the company in the future. It’s the cost basis of their investment. TRANSLATION: a lower valuation provides higher profits on the investment. Valuation can be based on a wide variety of factors, but entrepreneurs diving into the Tank MUST be able to explain how they arrived at their final number. As a refresher, viewers can calculate the company’s valuations based on the offer they are seeking.
Getting Sharks to buy into Valuations
When Ice Age Meals and The Fish Call were asked how they arrived at their valuations, their responses made the difference between deal and no deal.
Ice Age Meals seeking $1 million in exchange for 10%
If 10% of the company is valued at $1 million, then 100% of the company would be valued at $10 million. ($1MM x 10 = $10MM)
I have no doubt that Frozen Paleo Meals is headed for greatness. All the Sharks loved the samples. Sales are skyrocketing and owner Nick Massie has ideas for strategically extending the brand into wellness programs. On paper, this seems like a slam-dunk for an investor. Unfortunately, when asked about the valuation, Massie stumbled. This was his moment to clearly justify his $10 million valuation and close the deal. Instead, he muddied the waters by talking about a potential partnership with CrossFit. Then he explained how their business is modeled after Amy’s Organics. When pressed further, he responded with “…believe in me.” That answer didn’t work. No amount of passion for his product would help and he left without a deal.
The Fish Call seeking $150,000 in exchange for 10%
If 10% of the company is valued at $150,000, then 100% of the company would be valued at $1.5 million. ($150M x 10 = $1.5MM)
Now let’s look at The Fish Call, a device used to attract big fish. The Sharks found the product intriguing even without real proof that it works. Inventors Jeff and Jack Danos explained they almost always catch more fish with it. Surprisingly, the Sharks were fine with that answer. They boast respectable sales of $330M in 5 months. The pivotal moment for Jack Danos was his explanation of how he arrived at a $1.5 million valuation. Without hesitation, he explained if they stay on track this year, they would do $750M in sales and net $300M. Then he took a 5x multiple to get to $1.5MM. This “5x multiple” is a standard industry method of determining valuation. How often have we heard about “5x multiple” in the Tank? Not often. This valuation method looks at the sustainable operating cash flow (EBITDA: earnings before interest, tax, depreciation and amortization) and applied a “5x multiple” typical for smaller companies. He showed passion AND business savvy which hooked a Shark.
Both companies presented interesting products with impressive sales, but only one could effectively speak to their valuation. This was the deciding factor. Hopefully budding entrepreneurs have learned this lesson.
Dan Casey, founder and CEO of accountsreceivablefinancing.com, believes every business has a story to tell. He’s been listening and helping small businesses grow exponentially since 2002 using a creative combination of finance tools. He’s been featured in publications including Entrepreneur Magazine, Entrepreneur Online, Small Business Trends Online, The Washington Post, Crain’s Chicago Business & American Express Open Forum.
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