OK. Let’s start with a problem:
– You’re an entrepreneur
– You have a slot on Dragon’s Den
– You value your company at Y
– You need a capital injection of X.
– How much equity in the company should you offer an investor?
Well, after the injection the company will be worth X+Y. Y was already there; X came from the investor. So, fair’s fair, the investor should get 100X/(X+Y) % of the equity. Simple stuff.
But every week on Dragon’s Den I see entrepreneurs asking for X in return for p% equity and every week I see the dragons claiming that this means the company was valued at 100X/p. Well, I’m sorry but those dragons are wrong! This means the entrepreneur valued his company at 100X/p – X.
Maybe the dragons just don’t understand corporate finance. I’m going to be generous and assume that they do. That would mean that the 100X/p is a myth that they deliberately perpetuate in an attempt to eke out a bigger share of the equity.
Last night (Sunday 20 August 2017), after years of waiting, somebody at last called them out. He did his best to go through all this, explaining how asking for a £600k injection into his company in return for 50% equity was equivalent to valuing the company at £600k. The dragons exploded with rage, telling him he’d valued the company at £1.2m and sent him away with a flea in his ear, attempting to give viewers the impression that he was two nuggets short of a happy meal.
But some of us know better. The myth has been blown. I just hope that all future entrepreneurs appearing on the program understand corporate finance better than the dragons pretend to.