I've had the chance recently to watch that relatively new TV show called "Shark Tank". For those of you not familiar with the show, it's essentially a pitch show where entrepreneurs pitch their business to 4 or 5 investors for potential investment. The "angel" investors are called "sharks" and thus the entrepreneur walks into the shark tank to get grilled as they give their pitch. The investors are successful entrepreneurs who founded the Corcoran Group, Fubu Clothing, and some other companies. For the aspiring entrepreneur I highly recommend the show for its educational value and to understand the dynamics of the investor-entrepreneur relationship. Based on the questions the sharks ask the entrepreneurs you can really get a sense of the priorities of each investor.
One theme that is clear in the show is that most of the entrepreneurs are very weak in their valuation justification. In fact, most are just outright clueless in how they value their company. Some feel that if they have put up significant capital over several years or if they have put in a lot of time and energy in sweat equity then their company should be worth much more than it really is. Thus it is clear that most of the entrepreneurs have not consulted with valuation specialists or even done any market research as to what a reasonable valuation of a company in their space would be. When the sharks find this out they are usually very disappointed - because this reveals that the entrepreneur is not truly diligent and has not done the appropriate research to figure out a reasonable valuation. If the entrepreneur can't do this before a pitch session then his stock goes down in the eyes of the shark and loses out on the investment.
There are however exceptions. Some entrepreneurs come to the pitch and basically say "I have this business but I suck at numbers and valuation. I'm looking for an investor to provide capital and business consulting. I'm looking for an investor who will also be a co-owner and partner." The problem with this is that the sharks see blood in the water and go in for the kill - they give a low ball offer to the entrepreneur who usually accepts.
The take home message for the entrepreneur is to do your homework ahead of time. Like preparation for any presentation to an audience, rehearse ahead of time and anticipate the questions that you will be asked. What is the justification for your valuation? What is the value of your public competitors? What is value of your private competitors at their last investment round? What is the typical multiple in this space? What is your multiple? If you do some simple calculations and your multiple is 30x revenue while the typical public company in your space is 10x revenue then you know you have some issues with your investment proposition.