If you’re one of the millions of people who has helped make Shark Tank one of the most successful shows on television right now (it just entered its ninth season), chances are you have an interest in investing.
After all, the show’s real hook is that it shows viewers one of the processes that successful investors go through before deciding whether or not a company is worth their hard-earned money.
While a lot goes into making these decisions, you need to at least know the following three terms if you’re ever going to learn to think like a shark.
What is ‘stake?’
Perhaps the most common term you’ll hear on Shark Tank is “stake.”
You may hear one of the contestants say that they’ll offer “5% stake” in their company for a certain amount of money from the sharks.
Valuation is arguably the most important factor on the show. It’s almost always the biggest point of contention, too
For example, in this popular clip, you’ll hear the entrepreneurs ask for $500,000 in exchange for a 4% stake in their company.
In response, Robert Herjavec counters, agreeing to the $500,000 investment but asking for an 8% stake in the company instead.
The stake that someone has in a company refers to what percentage of it they own.
If you own a 10% stake in a company worth $100,000, your stake is worth $10,000. If that company doubles in value, your stake stays the same (10%), but it is now worth twice as much, as well, $20,000.
Equity and stake, in certain contexts, can mean the same thing, which is why you’ll hear the two words used interchangeably on the show.
Unlike the other term, “equity” is used in several other contexts.
You’ve probably heard of people having equity in homes or cars. This refers to how much of it they’ve already paid off relative to how much is still left on the loan.
For the sake of understanding Shark Tank, though the two mean similar things.
Valuation is arguably the most important factor on the show. It’s almost always the biggest point of contention, too.
In this episode, two entrepreneurs undergo a lot of scrutiny for claiming that their idea for a new suitcase is worth $28 million.
The sharks seem to think its true value is closer to about $5 million.
Why is this number so important?
First, it determines the price of the stake or equity being offered. In that last clip, the entrepreneurs are offering 5% equity in exchange for $1.4 million. That’s how they get to the $28 million overall valuation.
As you’ll see, by lowering the valuation to $5 million, the corresponding equity becomes much cheaper, too. That’s great for the sharks but not such welcomed news for the entrepreneurs hoping to leave with as much money as possible.
The second reason is a direct extension of the first: the valuation justifies the amount of money the entrepreneurs can ask for. The more the entrepreneurs can convince the sharks what their company is going to be worth, the more likely the sharks will be to show interest and pay up.
How do the Sharks come up with valuations?
On every episode of Shark Tank, the sharks ask questions about what kinds of sales the entrepreneurs have already seen. Obviously, this goes a long way towards helping the sharks decide how much a company is going to be worth.
However, what they’re really trying to figure out is how many sales the company will be able to do after they exchange their money for equity.
They’ll also carry out a market-based valuation. This means they look at similar companies to the one being presented.
On the show, you regularly see that some of the sharks are less likely to pay for equity in a company from a market they aren’t already familiar with (e.g. Kevin O’Leary has a background in mortgages, wine, and books). That’s because they are less comfortable carrying out market-based valuations.
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