Can someone please explain to me the financial mathematics of the T.V. show "Shark Tank"?
Hello, I have been watching a lot of "Shark Tank" but I don't understand some of the financial mathematics within the show.
Lets say that a person owns a company, worth $5 million dollars. He pitches to the sharks for 20% in exchange for $1 million. But then, the sharks ask, what do you need the money for? And the company owner replies that he wants to use the money to reinvest in the company for stuff like inventory, marketing, etc.
But I don't get it. The company owner gains nothing by reinvesting his new cash assets into the company. Lets compare the financial status of each party before and after the deal.
Before deal: 1. Company Owner (owns 100% worth $5 million) 2. Sharks (owns 0% worth $0 million)
After deal: 1. Company Owner (owns 80% worth $4 million) (Then uses the new $1 million to reinvest into the company) (Company now worth $6 million) (But 80% of $6 million dollars valuation is only $4.8 million) 2. Sharks (owns 20% worth of company, including the new invested cash from primary owner) (Essentially making their worth $1.2 million because 20% of $6 million valuation is $1.2 million)
Essentially, if the primary owner reinvested his new $1mm cash in the company in exchange for no shares/ownership rather than pocketing it in his bank. Causes the sharks' ownership of 20% (originally only worth $1mm) to go up, making it $1.2mm
How does reinvesting the cash received from the sharks increase the net worth of the primary owner? For the sharks, its easy money. They can just buy and sell their shares fast...
Enterprise value = market value + debt - cash
Growth opportunities.
OP I think you are mixing up quite a few valuation concepts. The fair value of the company is not necessarily derived simply from the Enterprise Value formula. Rather, it is often calculated as a multiple of EBITDA or through discounted future cash flows.
The candidate seeking investors on Shark Tank needs the money. With the money and the strategic benefit of having a shark (access to a wide network of industry contacts, business knowledge, source of future funding), the candidate hopes to be able to grow the company (through purchasing more inventory to be able to sell higher volumes and benefit from economies of scale) and its EBITDA. When he decides to sell the company or bring in further financing in the future, he will own 80% of a much more valuable company (because EBITDA and/or projected future cash flows will have increased significantly).
Having a smaller piece (equity ownership) of a larger pie (his company) will be much more valuable than owning an entire small pie (his current situation, as he owns 100% of his $5M company).
Oh and to address the comment: "For the sharks, its easy money. They can just buy and sell their shares fast..."
In reality, no, they can't do that. Not only are they shares of a private company, they are highly illiquid (hence why the candidate has to go on Shark Tank to seek funding). The sharks would likely have some difficulty selling the shares quickly. And even if they were able to, they would likely have to sell them at a discount to compensate the buyer for the lack of liquidity and the risky nature of a start-up business.
oh my.
There is a pre money and a post money valuation when it comes to venture/growth equity. They are not buying existing shares, the company is issuing new shares for the cash. A = L + E
A shark giving $1m for 20% implies the pre-money valuation is $4m. So the owner before and after is still worth $4m, the company is just worth $5m "post-money".
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