Last night, a middle-aged company owner was offered three deals in rapid succession.
For me, this was a simple math problem: Which offer gave the owner the best valuation of his company? Every offer implies what the investor thinks your company is worth. In other words, this is your company’s valuation as seen through the eyes of the investor.
So which would you chose? The offers were as follows:
- $500,000 – in exchange for 20 percent of his company and a 15 percent royalty until the investment was paid back.
- $1 million – in exchange for 30 percent of the company and a 10 percent royalty until the investment was paid back.
- $4 million plus 10 percent of future sales – in exchange for 100 percent of the company.
The valuations within these three offers are strikingly different. The first values the company at just $2.5 million. The second values it at $3.3 million. The third values it at well over $4 million 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.
It was clear that the entrepreneur had a great deal of emotional attachment to his business. He was tempted by the $4 million buy-out offer, but he hesitated to part with the company 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 three of the show’s biggest 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.
Financially speaking, the best deal would have been the $4 million sale with a 10 percent continuing royalty. Why? Not only would the entrepreneur walk away with certain wealth, but a 10 percent royalty (which is typically taken out of top-line sales) is equivalent to about a 30 percent ownership stake.* So he could have taken the money and been assured of continuing payments — perhaps even very large payments for a very long time.
* BONUS: Want more? Here’s a free valuation spreadsheet I created to show you all three offers.
Next time he goes swimming with the sharks, I hope he takes a calculator (or my spreadsheet)!
Dedicated to your (highly valued) profits, David
PS: I’m a serial entreprenuer and a fractional CFO. Just click over to my page for help with angel investors or valuation. And if you have a specific business finance question, click here to ask me anything, or subscribe to my small business newsletter at www.RockSolidFinance.com