Recently a middle-aged business owner was offered 3 deals in rapid succession. For me, this was a simple math problem: Which offer gave the owner the best valuation?
Every offer implies what the investor thinks your company is worth: your company’s valuation. Valuation is not just the total amount of money an investor offers, but the total value of the company implied by that offer. (I’ll do the math for you in a second.)
So which would you chose? The offers were as follows (you’d get what is bold, the investor receives the rest):
- You get $500,000 – Investor takes 20% of the company and a 15% royalty until the investment is paid back
- You get $1 million – Investor takes 30% of the company and a 10% royalty until the investment is paid back
- You get $4 million and a 10% royalty forever – Investor takes 100% of the company
To start, let’s keep the math simple. If $500,000 is the offer for 20%, then the total valuation is $2,500,00. That’s the cash paid divided by the percentage purchase, or $500,000 / 20% = $2,500.000. Do this calculation with each offer, and you’ll see that the base valuations within these three offers are strikingly different:
- The first values the total company at just $2.5 million.
- The second, at $3.3 million.
- The third … at well over the $4 million cash offer since continuing royalties could have netted him many millions more over his lifetime. In fact, by my calculation, the third offer put the valuation at nearly $6 million.
The entrepreneur could not decide. It was clear that he had a great deal of emotional attachment to his business. He was tempted by the $4 million buy-out offer, but hesitated to part with the business he had built from scratch.
In the end the deals all shifted a bit (as they tend to do on Shark Tank), but the entrepreneur walked away with something closest to deal number 1. He actually took the offer with the lowest valuation.
Why settle for less money from an investor who thinks your company is less valuable? This is a bit like selling your house at foreclosure prices.
I believe he took the deal because it was backed by 3 of the show’s angels, including Mark Cuban. Perhaps he also really wanted to continue building the business himself, rather than give up total control in an outright sale.
Or maybe he simply did not have a calculator handy.
For me, the best bet would have been the $4 million sale with a 10% continuing royalty. Why? Not only would the entrepreneur walk away with certain wealth, but a 10% royalty (which is typically taken out of top line sales) is equivalent to about a 30% ownership stake. (Read more about royalties.) So he could have taken the money and been assured of continuing payments … perhaps even very large payments for a very long time.
BONUS: Here’s a FREE Shark Tank valuation spreadsheet I created to show you all three Shark Tank offers from the episode detailed above. And when you are ready to calculate the valuation of your own company, please try my Capitalization Table.
Next time you go swimming with the sharks, I hope you’ll take a calculator (or my spreadsheet)!
Dedicated to your (highly valued) profits, David