Did 5 multi-millionaire dragons get this valuation concept wrong?

[Realervz]

Okay guys, I am a fan of Dragons Den and I always have this burning question in my mind. So when a person walks into the den and ask for an INVESTMENT of let say 100k in exchange for 10% equity, the dragons will always says that he is valuing his business at 1 million. Their logic is 10% = 100k then 100% will be equals to 1 million. (Notice I bold the word "Investment")

I keep thinking about this concept and I think they actually got it wrong but how could all of this business savvy people get this wrong?

Let me explain:

Scenario #1 - Investment
I open a company and put 100k into the bank. Right now this company is worth 100k.
Today, I walk into the den to ask for another 100k to be INVESTED in this business in exchange for 50% equity, here, I am actually valuing the company at just 100k, not 200k as the dragons would say. Because the 100k I asked for is to be invested into this company, not for me to keep in my pocket. The business will only worth 200k once their 100k is being invested into the business. Make sense?

According to their logic, if the company is worth 100k now, they only need to invest 50k into the business to get 50% equity. Which means they are putting in 50k into a company which already has 100k in the bank to get 50% equity, and since now the total fund of the company is 150k (100k initial fund + 50k new investment) and the dragon has 50% equity of this company, they can immediately cash out their equity at 75k. See how unfair this valuation logic is.

Scenario #2 - Buying of equity
I open a company and put 200k into the bank. Right now this company is worth 200k.
Today, I walk into the den to ask one of the dragons to BUY 50% equity of my company at 100k. In this case, I am valuing my company at 200k, because the 100k is use to buy 50% of my equity and the money from the dragon will go to my pocket and not into this business. I think that's the only scenario that their valuation logic will make sense.

The dragons valuation logic is more like buying of equity but in the show everyone walks in to ask for an investment, the money they are asking for will ultimately be put into this business and not goes to their personal bank account.

So are the dragons wrong or am I missing something?

 

[japancool]

You're wrong.

Today, I walk into the den to ask for another 100k to be INVESTED in this business in exchange for 50% equity, here, I am actually valuing the company at just 100k, not 200k as the dragons would say. Because the 100k I asked for is to be invested into this company, not for me to keep in my pocket.

At this point, if they then wanted to buy the other 50%, how much would it cost them?

 

[Realervz]

You're wrong.

At this point, if they then wanted to buy the other 50%, how much would it cost them?

Notice is it not buying of equity in this scenario, they are investing and not buying. They can only dilute the my equity by investing more money. If they want to buy me out, it will be an entire different scenario which is scenario #2.

 

[japancool]

Notice is it not buying of equity in this scenario, they are investing and not buying. They can only dilute the my equity by investing more money. If they want to buy me out, it will be an entire different scenario which is scenario #2.

I'm asking you how much it would cost them to buy the remaining 50% AFTER investing 100k.

 

[Realervz]

I'm asking you how much it would cost them to buy the remaining 50% AFTER investing 100k.

After investing 100k, the business has 200k cash now. If we each own 50% equity of company that is worth 200k and he wants to buy me out then mathematically he will have to pay 100k for my remaining 50%.

 

[JEREMY HAWKE]

If your running many companies with the same level of success as the dragons then you might be right but your probably wrong

 

[cjd]

The Dragons and pitchers are valuing their business, not how much cash you put in it.

You could have put £100,000 into a business and it could have a net worth of zero or even a negative value (if it has debt). Or it could be worth millions (if it has potential and an order book).

A business with nothing but net assets in cash of £100,000 is worth precisely £100,000 and would be valued at that.

A business with no cash at all but a valuable world patent could be worth almost anything at all - perhaps billions.

When the pitchers are saying I'll give you half my BUSINESS for £50,000, it's a proxy for them saying that they'd sell it all for £100,000 (tho' of course they wouldn't in reality). The dragons are making an investment, the pitchers are giving away a portion of their business in the hope of making a bigger return than they would otherwise have made ie, they are also investing with the cash received.

 

[Mark T Jones]

As a semantic argument you are kind of correct.

They are buying equity.

 

[WaveJumper]

And of course, what they are also looking at is how long will it take to get their investment back if they put in a 100k generally they looking to get it back in 12/24 months not ten years down the line. What cjd is saying above is correct you need to look at the bigger picture many factors come into play when making an investment in fact I have seen some episodes where they investing solely on the 'worth' of the pitcher with those emortal words from Debra "your so investable" summing it up

 

[Deleted member 335660]

Okay guys, I am a fan of Dragons Den and I always have this burning question in my mind. So when a person walks into the den and ask for an INVESTMENT of let say 100k in exchange for 10% equity, the dragons will always says that he is valuing his business at 1 million. Their logic is 10% = 100k then 100% will be equals to 1 million. (Notice I bold the word "Investment")

I keep thinking about this concept and I think they actually got it wrong but how could all of this business savvy people get this wrong?

Let me explain:

Scenario #1 - Investment
I open a company and put 100k into the bank. Right now this company is worth 100k.
Today, I walk into the den to ask for another 100k to be INVESTED in this business in exchange for 50% equity, here, I am actually valuing the company at just 100k, not 200k as the dragons would say. Because the 100k I asked for is to be invested into this company, not for me to keep in my pocket. The business will only worth 200k once their 100k is being invested into the business. Make sense?

According to their logic, if the company is worth 100k now, they only need to invest 50k into the business to get 50% equity. Which means they are putting in 50k into a company which already has 100k in the bank to get 50% equity, and since now the total fund of the company is 150k (100k initial fund + 50k new investment) and the dragon has 50% equity of this company, they can immediately cash out their equity at 75k. See how unfair this valuation logic is.

Scenario #2 - Buying of equity
I open a company and put 200k into the bank. Right now this company is worth 200k.
Today, I walk into the den to ask one of the dragons to BUY 50% equity of my company at 100k. In this case, I am valuing my company at 200k, because the 100k is use to buy 50% of my equity and the money from the dragon will go to my pocket and not into this business. I think that's the only scenario that their valuation logic will make sense.

The dragons valuation logic is more like buying of equity but in the show everyone walks in to ask for an investment, the money they are asking for will ultimately be put into this business and not goes to their personal bank account.

So are the dragons wrong or am I missing something?

Yes I like Dragon’s Den, my entrepreneurial students have been on it. One got money from an angel watching the program.

As a hobby I am also a share trader.

I think this valuation business is just a bit of fun as just because you put €100k capital into a business it does not mean it’s valued at this.

A business is valued in terms of buying and selling it by a combination of assets and potential profit over a given period, normally 5 years.

The €100k put into a start up is mere capital to be used to earn money through sales. If you tried to sell the business with only a year of sales and no profit you are unlikely to get £100k back.

You only need to look at share prices on the Stock Exchange to see that some companies share price multiplied by the shares can be a lot less than the assets it has.

Yes the Dragon is saying that if you want me to put €100k into a business for 10% then the entrepreneur is valuing it £1m. In reality it is the entrepreneur just saying how much money they need to get it off the ground. They may need this money to set up production facilities or create a website or fit out a shop. They may have some savings of their own or may have credit facilities to help, but still need more capital.

 

[Mark T Jones]

It's actually a great stock question to ask. As an investee it's either a challenge or an opportunity to justify your valuation (The actual basis of the question soon disappears)

If you ever get the opportunity though, don't waste t by telling them they are wrong!

 

[OldWelshGuy]

It's a finger in the air and a straight maths calc, and technically they are not investing at all as every penny 'invested' in a business is actually a loan, not an investment as that's how the dragons work.

 

[Mark T Jones]

It's a finger in the air and a straight maths calc, and technically they are not investing at all as every penny 'invested' in a business is actually a loan, not an investment as that's how the dragons work.

There are many twists & turns between an offer in the Den & the deal that is done!

 

[Realervz]

As a semantic argument you are kind of correct.

They are buying equity.

I think you did really read through what I wrote and understand my argument here.

The Dragons and pitchers are valuing their business, not how much cash you put in it.

And of course, what they are also looking at is how long will it take to get their investment back if they put in a 100k generally they looking to get it back in 12/24 months not ten years down the line. What cjd is saying above is correct you need to look at the bigger picture many factors come into play when making an investment in fact I have seen some episodes where they investing solely on the 'worth' of the pitcher with those emortal words from Debra "your so investable" summing it up

I think this valuation business is just a bit of fun as just because you put €100k capital into a business it does not mean it’s valued at this.

A business is valued in terms of buying and selling it by a combination of assets and potential profit over a given period, normally 5 years.

Of course I know that the value can be in other tangible and intangible form such as the current net profit, the size of customer base, intellectual property or evening how promising the pitcher is etc. but currently I am just arguing that their valuation logic wrong, so for simplicity purpose I just use 100k cash to represent the worth of the company.

Investment
To use a more realistic example to illustrate this argument:

Let's assume that I have this business that generates a net profit of 10k a month and I have 150k worth of asset including factory and I also have a patent to my product. The dragons see huge potential in my business and they truly thinks that my business is worth 200k at this point of time.

Assuming that I also thinks that my business is worth 200k currently and I ask them to invest another 100k into this business (which will technically makes it worth 300k after the investment). Currently, I own the full 100% equity and if I propose a 33.3% equity for their 100k, they will say that I am valuing my business currently at 300k when in actual I am just valuing it at 200k. It will only be 300k after their cash is in. Their 100k investment will dilute my equity to 66.6% and give them 33.3% in equity. See where am I coming from?

Then according to their valuation logic, they will counter propose for 50% equity instead for their 100k. Using their logic, if they put in 100k into a business that is already worth 200k and get a 50% equity, if the deal is agreed, it will mean that they will own 50% of the business which is worth 300k after their investment and this will make them 50k richer instantly (Invested 100k and get 150k in value). How can this valuation logic be right?

For simplicity purpose, we will not talk about the dragons is also investing their time, network and expertise etc., just money (because I am arguing that the way they value the business before their cash is being invested into the business is wrong)

Buying of equity
On the other hand, if this is not an investment but buying of equity, then their valuation logic could be right.

For the same case above, both me and the dragon thinks that the company is worth 200k and he is interested to BUY 50% equity from me, then it straightforward, I sell him 50% equity at 50% of the business worth, at 100k. Business is worth 200k, you want half of it, you pay me half its worth, easy?

The big difference here is this 100k will go directly to my pocket, and will not be invested in the business because I am selling them the equity and not asking for an investment.

But in the show, everyone going there is asking for an investment, not looking for someone to buy their equity. The money from the dragon will be invested into the business. So how could they use the valuation logic of buying an equity?

I need someone who are logical enough to understand what I am trying to say here and tell me which part did I get it wrong or it's the dragons who are wrong the entire time.

Because logically, I can't be wrong unless I missed out something which I am waiting for any genius to correct to tell me. But then how could these successful business ppl get it wrong the entire time and none of them thinks that they are wrong.

 

[Fagin2021]

I think the basic problem is that you are continually using 'value' and 'worth' as interchangeable terms and they are not.

 

[fisicx]

@Realervz - you are way overthinking this. It’s reality TV, the words they use on the show aren’t the same as they use when setting up the contracts. When a dragon says they will be investing they mean buying equity.

 

[WaveJumper]

As above and almost all the deals 'agreed' or screen never go through once the dragons have their teams go through the books. On a slightly different vain I think the equivalent show on Australia's network must more interesting and the dragons much more friendly

 

[Mark T Jones]

As above and almost all the deals 'agreed' or screen never go through once the dragons have their teams go through the books. On a slightly different vain I think the equivalent show on Australia's network must more interesting and the dragons much more friendly

My biggest gripe on the UK show is the heavy bias on making the dragons - particularly Peter Jones - look clever or funny, often at the expense of the applicant.

 

[Realervz]

@Realervz - you are way overthinking this. It’s reality TV, the words they use on the show aren’t the same as they use when setting up the contracts. When a dragon says they will be investing they mean buying equity.

But they always asks why do you need this X amount of money for? What will you use this X amount of money on which implies that this amount of money has to be put back into the business. If they are just buying equity like you said then they have no rights to asked how will I be using it for because is it for me and will be going to my bank account for selling them the equity and not be invested back to the company.

 

[WaveJumper]

But they always asks why do you need this X amount of money for? What will you use this X amount of money on which implies that this amount of money has to be put back into the business. If they are just buying equity like you said then they have no rights to asked how will I be using it for because is it for me and will be going to my bank account for selling them the equity and not be invested back to the company.

You thinking is going completely off the rails now

 

[WaveJumper]

My biggest gripe on the UK show is the heavy bias on making the dragons - particularly Peter Jones - look clever or funny, often at the expense of the applicant.

Yes I know what you mean this is why I like the Australian version no big egos and many a time if they are not actually taking on an equity stake they will often mentor and introduce them to leads just to help them onto the ladder

 

[Realervz]

You thinking is going completely off the rails now

Like how? Did you read my full argument and understand where am I coming from?

 

[MarkOnline]

But they always asks why do you need this X amount of money for? What will you use this X amount of money on which implies that this amount of money has to be put back into the business. If they are just buying equity like you said then they have no rights to asked how will I be using it for because is it for me and will be going to my bank account for selling them the equity and not be invested back to the company.

But it isnt going to them personally, the money will be going into the ltd company to ensure its continued success and future growth. Both parties are on a promise of future riches, in either dividends, equity sale or both. The pitcher isnt asking for money for what he already has, he is asking for money for what the business will become, usually underpinned on what the business has achieved so far and how it demonstrates the pitchers chances of a delivering on those future promises.

 

[Mark T Jones]

Like how? Did you read my full argument and understand where am I coming from?

The problem really is that your argument is semantic and rather esoteric - it doesn't bear any relevance to the real world of equity investment

It wold be better placed as a muse in Time Out

 

[Realervz]

The problem really is that your argument is semantic and rather esoteric - it doesn't bear any relevance to the real world of equity investment

It wold be better placed as a muse in Time Out

You might be right, maybe in the world of equity investment they are not so specific and logical in the valuation thing, but I still hold my argument because 1+1 has to be equals to 2.

 

[gpietersz]

I think what is missing here is a simple expalanation.

Suppose a company's shares are trading on the stock exchange at £1, and it has a billion shares.

That means you can buy a one billionth ownership of the company for £1. That means the entire company (all the billion shares combined) are valued at £1bn. This is called its market capitalisaion.

Now suppose a company has a thousand shares. Someone buys a 100 shares for £100k. That imples the shares are worth £1,000 each, and the company is worth £1m.

Now suppose the company has 900 shares. A 100 new shares are issued to a new investor for £100k. This means a 100 shares are created (so there are now a thousand shares) and the investor paid £100k for those 100 shares. Effectively the company creates a 100 new shares and sells them to the new investor.SO now there are a thousand shares, and the investor paid £1000 each, implying the company is worth £1m

 

[japancool]

After investing 100k, the business has 200k cash now. If we each own 50% equity of company that is worth 200k and he wants to buy me out then mathematically he will have to pay 100k for my remaining 50%.

PRECISELY.

 

[Realervz]

If they are just buying equity like you said then they have no rights to asked how will I be using it for because is it for me and will be going to my bank account for selling them the equity and not be invested back to the company.

You thinking is going completely off the rails now

Assume my logic is wrong by saying the equity owner should keep the money rather than invest back to the company, and you are right by saying that the equity owner SHOULD invest back the money back into the business when he SELL the equity to the dragon. Now, if the dragons wants to buy the entire 100% equity from the equity owner, should the equity owner still invest the money back into the company when the whole business is fully belongs to the dragon now?

So just because he is selling part of the business and not the full business, he has to invest it back to the business?

 

[Realervz]

You're wrong.

At this point, if they then wanted to buy the other 50%, how much would it cost them?

I'm asking you how much it would cost them to buy the remaining 50% AFTER investing 100k.

PRECISELY.

@japancool, honestly I am not sure what insight are you trying to provide after asking me all those questions.

 

[NickGrogan]

but I still hold my argument because 1+1 has to be equals to 2.

In the world of investment 1 + 1 rarely equals 2.

You're treating a business as a bank account, if I put £1 in and you put £1 it's worth £2.

But it's a business, so this doesn't work.


Buying part of a business is simple and easy, buying a whole business is completely different.

If someone wants to buy a 1000 shares in a traded company, they can do it online and it's quick and easy and the price they pay will be the same as everyone else.

If the same person wants to buy 100% of the company, then they will have to pay a lot more for the shares, the share price will rise. It could rise by 5% or 50%.

Where did this extra value come from?

 

[gpietersz]

So just because he is selling part of the business and not the full business, he has to invest it back to the business?

No, see my answer above. It is the difference between buying the equity from a current shareholder (possibly the only current shareholder) and buying the equity from the company.

Its the same as if a company buys its own shares, keeps them instead of cancelling them, and resells them. The money goes to the company.

 

[Financial-Modeller]

The value of a company may not be equal to the value of the assets it owns less the liabilities owed (net asset value).

Raising capital is different to selling shares.

 

[Financial-Modeller]

My biggest gripe on the UK show is the heavy bias on making the dragons - particularly Peter Jones - look clever or funny, often at the expense of the applicant.

The primary purpose of the show is entertainment.

Given the longevity of the show, they seem to succeed.

 

[John Hemming]

Many years ago they tried to persuade me to do the pilot show for Dragon's Den. I thought most of the ideas people would put up would be rubbish and did not think of the entertainment value.

However, in many ways I don't like the idea of making entertainment about humiliating people about having foolish ideas. Hence I don't regret not agreeing to do it.

 

[WaveJumper]

This thread is just a get my post count up

 

[Fagin2021]

You're treating a business as a bank account, if I put £1 in and you put £1 it's worth £2.
But it's a business, so this doesn't work.

That, in a nutshell, is where the OP is going wrong.

 

[The Byre]

See where am I coming from?

Yes - and I'll set the cat amongst the pigeons by saying you are correct.

Well, sort of correct - and a bit wrong at the same time! As a mathematical zero-sum equation, you are perfectly correct - but a business is not a mathematical equation but an organic thing made up of people and some physical assets. But mostly people! An investor buys people.

And forget shares in public companies on the NASDAQ - that's just betting. That's just brass-ring gambling. Nobody really 'invests' in some lunatic fintech startup or Bitcoin, or any of the other whacky fugazi trotted out on CNBC - those are wild bets. I could say "I'll invest in this poker hand." but it is still gambling.

I invested a Dragon's Den level of money in a business about five years ago. What did I get for my money and other assets that I put in? Well, I got the person running it (who made all the right noises) and I got her client base - all of that was just so many people. (A bit like Solent Green!) I also bought her enthusiasm and drive.

I know a couple of trust fund managers and they invest in people. They do not gamble on the stock markets, they do however buy shares in companies AFTER studying the PEOPLE that are involved and their client base. They do not just look at the figures, they sit down and talk to the management and they sit down and talk to their clients. PEOPLE.

So never mind some asinine reality show, let's talk about real companies and real investors. For the sake of reality TV, the whole thing has to be presented in Mickey Mouse simplicity - were it otherwise, Mrs. Avangny Goat-Habit of 17, Oil Drum Lane, Solihull would be totally lost and switch over Murder-Death-Kill on Quest-Red or Ugly People with Deformed Genitals on Channel 4.

A real-world investment is nearly always a very complicated beast, filled with fixed-rate payments and profit shares and get-out clauses and timed buy-outs and asset valuations and roll-overs and how many fingers am I holding up - all good stuff but waaay too much for the Goat-Habits of Solihull.

It has to be that complicated because we are buying people. We are buying their commitment, their know-how, their ability, their track record.

We are also doing something else - we are adding ourselves to the company. MORE PEOPLE!

Adding an experienced business person to some young gun wannabe is sometimes a golden symbiotic pairing. Drive, energy and enthusiasm combines with assets, know-how and in-depth expertise.

So when I Dragon says "So you are valuing your shove-ha'penny franchise at £2m!" what he or she is really saying is "So you value YOURSELF at £2m!" and that can never be an equation!

 

[Realervz]

I think what is missing here is a simple expalanation.

Suppose a company's shares are trading on the stock exchange at £1, and it has a billion shares.

That means you can buy a one billionth ownership of the company for £1. That means the entire company (all the billion shares combined) are valued at £1bn. This is called its market capitalisaion.

Now suppose a company has a thousand shares. Someone buys a 100 shares for £100k. That implies the shares are worth £1,000 each, and the company is worth £1m.

Now suppose the company has 900 shares. A 100 new shares are issued to a new investor for £100k. This means a 100 shares are created (so there are now a thousand shares) and the investor paid £100k for those 100 shares. Effectively the company creates a 100 new shares and sells them to the new investor.SO now there are a thousand shares, and the investor paid £1000 each, implying the company is worth £1m

This is what I am trying to talk about the entire time, a perfect explanation. Your explanation are the same as mine but I am not sure if you are at the same page as me.

Using your example above, the company is worth only £1m AFTER the £100k investment (£1000 x 100 new shares issued). BUT the problem is the dragon always says that it is worth £1m BEFORE their investment.

If we using the same example but different figures, a company has 1000 shares currently worth £1k which meant it is worth £1m. Now I want to issue 500 new shares to the dragon for a £500k investment in exchange for 33.3% equity, which mean AFTER the investment, 1) The company will have 1500 shares, 2) the value will increased to £1.5m, 3)the dragon will own 33.3% of the equity (500 of 1500 shares).

But if I were to tell them this in the den, an investment of £500k for 33.3% of the business,
they will say that I am valuing my business at £1.5m but in actual fact I am only valuing at £1m. The business will only be worth £1.5m AFTER their investment.

Then they will think if the company has 1000 shares worth £1k each (£1m valuation), because the company is value at £1m, to ask for £500k investment I have to offer 50% equity, which translates to 1000 newly issued share to them. In that case, the company will have 2000 shares which them owning 1000 shares which is equivalent to £750k in value after only investing £500k.

See what I mean?

 

[NickGrogan]

Who said that any new shares are being issued?

Issuing new shares doesn't increase value, it increases the number of shares.

If I form a new ltd company, issue 1 billion shares and sell you two shares for £2, what is the company worth?

 

[Realervz]

Who said that any new shares are being issued?

Issuing new shares doesn't increase value, it increases the number of shares.

If I form a new ltd company, issue 1 billion shares and sell you two shares for £2, what is the company worth?

Company is worth £1bn. But what is the point of this question?

New share issued or not doesn't matter. If new shares are issued, using the above example, they will get 500 newly issued share out of the 1500 share which is 33.3%. If no share is issued, then they will share the current 1000 share in the company, he will get 333 shares which still equals to 33.3% isn't it?

Share issued or not doesn't matter to the actual argument of their valuation logic.