Aryaman Asthana
Many of us apprehend only one aspect of a Shark Tank agreement, the valuation. Entrepreneurs pitch their monetary valuation of the business proposition, seeking funding from Shark Tank investors in exchange for a certain “stake” in their company. As viewers, we tend to assume that we’re cognizant of the entire business transaction between the two parties solely based on these two aspects of the valuation. After all, the holistic trade-off is investment from a lender in exchange for part ownership in a business. Though, in reality, we all know that we have a relatively superficial understanding of these agreements. We neglect/misinterpret stipulations within the negotiations, strategies used by both investors and entrepreneurs to deduce a profitable valuation, key terminology, and agreement add-ons, and as a result, only partly know all of the details of the deal.
Why did that “shark” choose to partner up with another one?
Why did the “shark” lower the proposed valuation?
Hmm. That was a pretty good offer. Why didn’t the entrepreneur pursue that valuation?
Why didn’t the “shark” drop out of the deal?
To begin, let’s consider this valuation:
Seeking $500,000 for 20% stake in the business...
Understanding the valuation:
A stake (or other times referred to as equity) is the percentage of ownership of a business an investor would receive if they were to fund that company for a certain amount. In this example, if a “shark” invested $500,000 in this business, they would be compensated with a 20% equity stake in the company. A valuation determines the full-scale value of the business, and equity stake is a major facet of the valuation of a business. A $500,000 investment would warrant an equity stake of 20%, meaning for 100% equity stake (or the entire business), the business would be valued at $2,500,000 as a whole ($500,000/0.25 equity share).
Determining a valuation (“shark”) as fair or unreasonable:
Before “sharks” determine if a valuation is fair or not, they must see an investment as a lucrative opportunity and also be interested in pursuing a deal with the entrepreneur. They may also ask the entrepreneur about their professional background and expertise. Next, they must inquire into the logistics of the business as a whole and at its current state. Let’s suppose this business sells an eco-friendly dish soap. Oftentimes, “sharks” first examine the market value (the highest amount that someone is willing to pay for a product as well as the lowest amount that a seller is willing to sell at) of the business product or service. To do this, “Sharks” may ask about the retail price of one unit of their product, which is the price that consumers purchase the product for in retail stores. Consequently, “sharks” may ask about the cost of production of one unit of their product to determine the gross profit margin, or the percentage of the sales that the business receives from retail units sold.
Entrepreneur: “Each dish soap bottle costs $9.99 retail price. The cost of production is $4.50.”
Gross profit margin is calculated by subtracting the cost of production from the retail price and using that value to find a percentage that correlates to the retail price.
In this case, $9.99 (retail price) - $4.50 (cost of production) = $5.49
$5.49 (profit per sale)/$9.99 (retail price) x 100 = approx. 55% gross profit margin
A 55% gross profit margin for a retail product is above average retail margin, meaning an investment in this business would secure a relatively high rate of return. This also indicates a high market value because the business is maintaining an above average profit margin while also selling thousands of units of the product to consumers.
Next, a “shark” may want to consider the annual net sales revenue (or net revenue/sales) of the business. To deduce this, the “shark” needs a value that is indicative of the number of units of the product this business typically sells. The “shark” may ask for the average units sold of this product.
Entrepreneur: “We’ve sold around 18,000 units in the past 6 months of this product.”
If this business has sold 18,000 units of this product in 6 months, or 36,000 units in a year, the total gross sales revenue would be determined by multiplying the number of units sold by the profit per sale generated by the product. In this case, 36,000 units x $5.49 (profit per sale) = approx. $198,000 in gross sales revenue. By deducting allowances and other distribution and exportation expenditures that the entrepreneur mentions, the “shark” determines that the annual net sales revenue equated to around $150,000. With this knowledge, the “shark” may see the valuation as overpriced. A company valued at $2,500,000 only produces $150,000 in net sales revenue per year, meaning that it would take more than 16 years for the business to reach $2,500,000 in sales. This may compel a “shark” to propose a lower valuation (if they were interested), or if the entrepreneur was reluctant to lower his valuation, drop out of the offer. However, if the entrepreneur would have stated that the business recently entered a sales agreement with Walmart to sell $600,000 worth of the product, the valuation would be more appealing to the “shark” based on the sales forecast. The “shark” may perceive a potential to scale the company to exceed market demands and sales volume and capital capacity to generate more and more revenue over the years.
If this convinces the “shark” to pursue an offer but still pose a risk to the overall outlook of the investment, they might negotiate for a royalty. A royalty allows the “shark” to demand a fixed amount of money to be returned to them for every one unit of the product sold. Royalties are beneficial because they almost guarantee a return on investment for the “shark” in case the business is successful or not, even if royalties are suspended after a “shark” is returned a certain fixture of total money.
In this case, if a “shark” accepted the valuation of the entrepreneur but asked for a $2 royalty on each unit of the dish soap sold, the past year the “shark” would have made $72,000 even if the business was on a downward trend and losing revenue annually. As businesses grow, the royalty takes a toll on the revenue that businesses generate and hinder the growth of a company.
If royalties don’t interest an entrepreneur, a “shark” may pursue a partnership with another “shark”. This allows for a “shark” to invest less money into a business while usually attempting to maintain the initial equity they might have received if they had pursued the offer by themselves.
All in all, there are many tenets of economics that play a role in Shark Tank investments and stipulations that are implemented within a valuation. By just considering the valuation as the overarching trade-off may obscure some of the broader trade-offs and stipulations that may or may not benefit or hurt the investor. Additionally, there are many factors in determining a fair valuation or agreement between an entrepreneur and an investor because there needs to be a reasonable compromise between the two parties to generate capital and develop a business. With this better understanding of a Shark Tank, we can fully understand the offers that appear on the iconic show.
Works Cited
August 20, 2021 by Dave Schools - Grow. “How ‘Shark TANK’ Revealed the Difference
between Gross Profit Margin and Net Profit Margin.” Launchopedia, 20 Aug. 2021, fundingsage.com/how-shark-tank-revealed-the-important-difference-between-gross-profit-margin-and-net-profit-margin/.
Cestare, Tommy. “The (Sorta) Comprehensive Guide TO ‘Shark Tank’ Terms.” Medium, The
Tommy Cestare Blog, 17 Mar. 2020, medium.com/tommycestare/the-sorta-comprehensive-guide-to-shark-tank-terms-5bb7706cc1a8.
Yu, Jea. “How Is a Business Valued on 'Shark Tank'?” Investopedia, Investopedia, 8 Sept. 2021,
www.investopedia.com/articles/company-insights/092116/how-business-valued-shark-tank.asp.
My family recently just started watching a lot of Shark Tank, so it’s ironic to see this post when I’ve been watching it so much. Having watched a lot of it in the past few weeks, I started out really confused on what the different terms mean, but slowly asking my parents questions it got easier to understand. I think the royalty factor incorporated in this show --which Kevin LOVES to do-- is an interesting and efficient way for them to get their money back. Because they invest their money for a percentage of the company, they won’t start making money until they sell their shares. With royalty, at least they can start making a percentage of the goods sold to ensure their benefit from the investment.
ReplyDeleteI knew next to nothing about the actual workings of Shark Tank, even though I am an avid watcher and fan of the show. I always wondered what all the terms they used meant, and how these deals would really affect the business, but I never bothered to look it up. This was so helpful! I think now I can watch Shark Tank and really understand the business side, rather than just laughing at the crazy people who come on there.
ReplyDeleteI never really thought that much about Shark Tank. Taking in how much economics and thought goes into investing into a company really surprises me. I only used to think that sharks invested a certain amount into a company and would receive the percentage amount of money back based on company sales and revenue. But the amount of thought that goes into invest, knowing if the company is selling enough product to be valued at a certain price point and making assumptions on if the company will be profitable and whether or not to ask for royalties in a product or not surprises me.
ReplyDeleteI used to watch Shark Tank when I was younger but not being able to understand what the words coming out of their mouths meant, it was a pretty interestingly boring show to watch. Now that I'm older and understand these concepts better it way more interesting. No little kid is watching a show like this understanding even half of what is going on. But now that I can actually understand what equity/stake in a company is the show makes more sense. I kind of understood that the "Sharks" were investing into the company or product displayed but I never knew why they were. Reading all the analytics and thought processes behind the decisions they make opens up to more understanding of what is happening even more.
ReplyDeleteI haven't watch much of Shark Tank but when I was watching I always felt like I was missing something and there was more to the show. I know somethings on hos business works but honestly this was surprising to me. This is now a big help for the next time that the show comes on.
ReplyDeleteI agree with Deon. I don't watch it much but I feel like I am always missing something when I do watch it. I really like how you had all the numbers and explained how they think things through and how they make the deals. So I do agree with Deon that the next time that I watch it, it will me much easier to understand what is going on now that it was explained to me with the numbers and the thought process behind each deal that they make.
Deletethat was Chloe Porter
DeleteI agree with everything you said and I really liked how you showed all the math and everything. One thing I am curious about that wasn't talked about in the paper is how much are the sharks worth not talking about net worth or how much they have but rather their time and expertise. If I was a business owner on the show I wouldn't care about the money they would give me initially but rather what they could do for me in a long term. All these sharks have connections and can get products on alot of shelf that most people can't. To me just being able to learn from the best and having them help you in sales would almost be worth it alone.
ReplyDeleteShark Tank is a very complex show and it involves a lot of aspects from the Economic world. One thing I love about this article is that you dove into the numbers to make it easier for us as readers to understand how the numbers work. Stakes, percentages, etc. This article definitely gave me a better understanding on how the numbers work on the show, and how much of a crucial decision it can be for the "Sharks" to partner with a company. "Sharks" are trained at how to choose a good deal, and they know what company/brand will be successful, and some who will take more time to reach their goals. One thing I found really interesting about this blog was the royalties, royalties and how they can affect the starting numbers for the company, and how much power royalties give "Sharks".
ReplyDeleteI really appreciate this post because as a viewer of Shark Tank, I never quite understood what all of the jargon was. Now, something I’m wondering is if the sharks get information on a product beforehand. Also, how long do we think the encounters with the Sharks actually last? As you said in your post, we only get the superficial information. If a Shark would want to calculate all the things you mentioned in your post, I know I personally would not want to take that huge leap without extensive background research and time to make accurate calculations. Also, to make a TV show that is going to bring in viewers, you need the show to be enticing and have a little bit of drama. How much of Shark Tank do you think is made up or scripted? Are the Sharks actually arguing over an investment that they don’t even know would be a good one (you don’t know what the future holds), or is it scripted to make it seem like the show/ business is exciting. In all, I loved the explanation of your posts and it will definitely help me the next time I decide to watch Shark Tank.
ReplyDeleteI haven’t watched much of Shark Tank, but I have been able to understand the general premise of the show. However, looking past the surface level or TV negotiations is now something that I understand is crucial to the business conversation happening in the show. The information in this post regarding the upsides to a shark wanting to take a deal like how they might want to have a royalty so they won’t have to wait on their return of investment. Also, how sharks say that they are out of the deal, after realizing that a company valued at a higher price isn’t able to generate close to that figure in a year of sales, were both very interesting reasons as to why the show is much more complex than it seems. Additionally, something that wasn’t mentioned could be the sales of the company for more than a year, or more than the information that the company supplies to the sharks. For example, a shark could decide the valuation of the company/product if their sales have decreased over different periods of time, or even increased, which could either entice the sharks to value the company/product less or even more. Another thing that most conversation on the show might not include when the sharks are trying to determine valuation. This blog does well at defining the business jargon used, and helps in understanding the true value of every product on the show from the sharks perspective.
ReplyDeleteI’ve seen shark tank many times and didn’t really understand the economic aspect of the sharks making deals and investing in these people’s inventions. I feel like the opportunity cost of a shark giving them money is hard to determine at times because you never know what the production possibilities are of that company. In Aryamand’s blog he talks about how the sharks have to determine if a deal is a “lucrative opportunity” and I highly agree with that 100% because it can be really hard to measure the opportunity cost of a person's business. The good thing about sharks for the businessman is they understand efficiency and possibly expand the PPC of that product and Aryamand talks about the marginal benefit that the sharks give them.
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