You’ve heard the term ‘valuation’ on ‘Shark Tank.’ What does it actually mean?

If you’re a fan of Shark Tank, you’ve heard the term “valuation.”

By definition, valuation is the process of determining the current or projected value of a startup or company, as well as the resulting number representing the startup’s worth. It’s typically an important calculation in equity-based fundraising as it plays a part in determining dilution, eventual share price and more.

Pay close attention to the ABC show’s dealings, and you may have figured out the basic formula the sharks use: The amount of money the entrepreneur is asking for combined with the percentage of equity they’re offering the sharks represents the value of the company.

So, if the entrepreneur is asking $100,000 with 10% equity, $100,000 is 10% of the company’s valuation — which in this case is $1 million ($100,000 x 10). This is how it works on the show — real life investors don’t necessarily use a formula. 

At this point, the sharks usually ask how much the company made in the prior year. The valuation is then divided by that amount. If the company made $100,000 last year, it would be $1 million ÷ $100,000 = 10. If the company continues to make $100,000 each year, it would take 10 years for the investor to break even.

But investors aren’t looking for companies that earn a consistent amount over the years, they’re looking for companies that will make significantly more in the next few years. Investors like the sharks have high-level connections and resources that can get the company to $1 million and beyond faster than without them, which gets factored in.

Except in this case, the show has no set formula. What you’ll often see on Shark Tank is the sharks negotiating for a larger percentage of equity — say, 20% or higher — because that’s the amount of value they believe they would bring the company.

Other factors are a company’s current momentum. If a company with a $1 million valuation made $200,000 the previous year and has recently gone viral on social media, there’s a good bet that they’ll hit $1 million before the five years it would take the investor to break even with steady earnings. In this situation, you might see the sharks fight over the startup, by offering more money at the same percentage of equity or for less equity.

All of this negotiating can be fun to watch, and it feels as if the founders who strike deals have won a prize. But it’s not free money. While some of the startups become household names like Hungry Harvest, Bantam Bagels and Scrub Daddy, it still takes a lot of work with no guarantee of success. And while businesses that go through Shark Tank do have a low failure rate, they’re companies that were extensively vetted as being potentially good investments before even appearing on the show.

TV vs. reality

When it comes to real-life startup valuation, there’s no set formula, according to Kimberly Klayman and Jessica Laderman Origlio of the Philadelphia-based law firm Ballard Spahr, a Technical.ly client, who delved into the topic with a guest post in 2023.

For some investors, Klayman and Origlio said, valuing a company is an artistic process, and includes valuation of a company before investment and well as post-money valuation, or the value of the company after it receives the investment. 

“As many startups are not yet profitable at the point when early-stage investors are investing — indeed many startups are pre-revenue at that point — calculating a valuation is not always simply crunching the numbers,” they wrote. “As a result, founders and investors have to use several methods for determining valuation, and experience in the industry helps with accuracy.”

A team with experience with successful startups in the past, whose product is on trend and who has a clear path to profitability is likely to receive a higher valuation than a less experienced team, especially in the pre-launch stage. 

Like on Shark Tank, investors will consider how much risk is involved and to what extent their investment may decrease the risk of success. Just as importantly, investors take into consideration external factors, such as the regulatory landscape and market conditions.

“Valuation can be highly industry- and even product-specific,” wrote Klayman and Origlio. 

In 2022, for example, the median early-stage VC valuation for biotech and pharma companies was $63 million, according to PitchBook’s 2022 US VC Valuations Reports. Enterprise tech, on the other hand, saw median valuations of $51.8 million in the same period, and consumer tech was even lower at $46.2 million. 

The reason for these industry variations is that it takes more for some industries to reach milestones. Life science companies have to get through regulatory approvals, so they need more money. Regulatory approvals and research and development (R&D) are often far less expensive hurdles for consumer packaged goods, regulatory approvals and R&D are often less expensive hurdles to entry. 

Market conditions similarly impact startup valuations, they said. In times of economic downturn — even if the economic downturn is merely perception — startups often see a cooling effect on valuations. 

Ultimately, VCs finance startups because they believe that they make money on exit, usually an acquisition, merger or going public on the stock market. Startup founders should be aware that when exit markets slow, there is often a corresponding drop in valuation for later-stage companies. A startup’s lawyers will help navigate all of this. 

Venture capitalism is just one of several ways to build a company

If you have a startup and dreams of a billionaire venture capitalist making a big investment and making your product a household name, there are a few things to consider:

• Equity means you share profits, and if you, as a struggling early stage-startup, give up a double-digit percentage of equity to an investor, that’s going to be a lot of money going to them if the company succeeds.
• Equity means you have to answer to your investor(s), and include them in business decisions.
• Investors are going to want to see growth fast, as soon as you have the funds.
• If the business does fail, you’ve lost your investor(s) a significant amount of money. That’s the risk the investor took, but it’s a lot of responsibility for you.

In some industries, like deep tech, VC may be almost required to succeed. Investment might be the way to go if the company is moving toward a mass production stage.

But it’s possible to succeed without giving up any equity to an investor. That was the choice Wilmington, Delaware, based Carvertise made early on.

“It’s like driving,” Carvertise founding partner Greg Star told Technical.ly in 2022. “If you don’t take the money, it’s like you’re driving the speed limit. If you take money, you’re driving 100 miles an hour on a 60-mile-an-hour road and if you have one small bump you fly off.” ]

VC advisor Pedro Moore counts Shark Tank’s own Daymond John as a client. Although venture capital is a big part of his business (he also manages the CAFE Fintech incubator program), he has advised some entrepreneurs not to do it if they have any doubts that the company will grow tenfold within about five years. Even if they have little doubt, founders who want control over their startups might want to look into other ways to grow.

“If the founders don’t want to relinquish control of their company or experience significant ownership dilution,” Moore said, “they should not pursue VC funding.”

In the case of Carvertise, the company became self-sufficient through its own sales (aka bootstrapping) as it grew into a national advertising company.

If you’re still thinking about pursuing VC investors, it’s a good idea to look into resources through local chambers of commerce, small business organizations or startup accelerators for help in making those calculations, and with deciding to pursue VC funding or other avenues.

And if you want to pitch to the Shark Tank sharks, like regional startups including Meat the Mushroom, NerdIT Now and The Little Burro, the show has a rolling online application — or go to the open casting call in Philly on August 11.