A Share Valuation has to be realistic

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Published: 25 Jan 2016

Did you see the first Dragon’s Den programme in 2016?

It beggared belief in the stance adopted by most of the candidates towards the valuation of the shares on offer to the Dragons.

Obviously there is some gamesmanship in the opening offer made, but to stick to such a high price without argument to support and not be prepared to reason or negotiate, meant that two of the promising candidates ended up with no cash or support from a Dragon.

The only successful candidate made an offer of a 10% shareholding in his company in exchange for a £50,000 investment, plus Deborah Meaden as a business partner with her contacts into the bargain. Two other dragons expected a larger share and so lost out in the negotiations.

So what are the lessons to be learnt?

Firstly, expecting a valuation of 10 to 20 times annual post tax profits for a small private company that has been in existence for a relatively short period of time, without substantial reserves, or in one case, no profits or reserves at all, is totally unrealistic. Such valuations are more akin to shares in profitable quoted companies.

Secondly, the Dragon is taking all the risk up front through the cash investment and use of contacts and experience.

Thirdly, the unsuccessful candidates did not realise that there has to be something in the deal for both sides. Two companies were valued at £2M and £2.5M. But this was based on what the companies could achieve. One company had no profits and the other made profits of £140K in the second year but had no intellectual property rights in the product being sold.

One candidate quoted Facebook as a company that has cumulative losses but still a $40 share price. The point is that the candidate’s company does not have the same size of following, exposure or database that Facebook has. Also, it is not the level of risk that the Dragons would normally take. Otherwise they would not be as successful as they are today.

So, the moral of the story is: There is no right answer in share valuation. It is a question of the candidates having realistic expectations and the Dragons weighing up the opportunities and risks involved.

David Cane of Sundial Tax & Finance Ltd provides a share valuation service and can be contacted on 0845 177 0036 or 07749 080 806 or email.