How does investment into a private company work?

Question

My question is inspired by Dragons' Den, an investment TV show in Britain, where an entrepreneur asks investors for money.

The entrepreneur (E) goes on the show and says, "I want 100k for 25% of my company".

The investor (D) agrees to "buy 25% of the company for 100k" and sometimes comments that "your company is (or is not) worth 400k".

To me this sounds like a transaction, where E already owns a company worth 400k and can therefore pocket the money from D and give D 25% of the profits every year.

However what actually appears to happen is that the 100k is invested into the company to fund some growth plan. So is it actually the case that E's company is worth 400k only AFTER the transaction? Is the 100k added to the balance sheet as cash and would the other 300k be listed as an IP asset?

And if this is the case, why do they make the apparently inaccurate statements on the show, which make it look like a sale of shares instead of an investment? (Maybe this is similar to issue/sale of stock on the primary/secondary market?)

Answer 1

To me this sounds like a transaction, where E already owns a company worth 400k and can therefore pocket the money from D and give D 25% of the profits every year.

There is nothing objective (like a piece of paper) that states the company is worth 400K. It is all about perceived value. Some investors may think it is worth something because of some knowledge they may have. Heck, the company could be worth nothing but the investor could have some sentimental value associated to it.

So is it actually the case that E's company is worth 400k only AFTER the transaction?

It is worth what someone pays for it when they pay for it. I repeat- the 400K valuation is subjective. In return the investor is getting 25% ownership of the product or company.

The idea is that when someone has ownership, they have a vested interest in it being successful. In that case, the investor will do whatever he/she can to improve the chances of success (in addition to supplying the 100K capital). For instance, the investor will leverage their network or perhaps put more money into it in the future.

Is the 100k added to the balance sheet as cash?

Perhaps. It is an asset that may later be used to fund inventory (for instance).

... and would the other 300k be listed as an IP asset?

No. See what I said about the valuation just being perception.

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Note that the above analysis doesn't apply to all Dragons Den deals. It only applies to situations where capital is exchanged for ownership in the form of equity.

Answer 2

Each company has X shares valued at $Y/share. When deals like "Dragon's Den" in Canada and Britain or "Shark Tank" in the US are done, this is where the company is issuing shares valued at $z total to the investor so that the company has the funds to do whatever it was that they came to the show to get funding to do, though some deals may be loans or royalties instead of equity in the company. The total value of the shares may include intangible assets of course but part of the point is that the company is doing an "equity financing" where the company continues to operate. The shareholders of the company have their stake which may be rewarded when the company is acquired or starts paying dividends but that is a call for the management of the company to make.

While there is a cash infusion into the company, usually there is more being done as the Dragon or Shark can also bring contacts and expertise to the company to help it grow. If the investor provides the entrepreneur with introductions or offers suggestions on corporate strategy this is more than just buying shares in the company. If you look at the updates that exist on "Dragon's Den" or "Shark Tank" at least in North America I've seen, you will see how there are more than a few non-monetary contributions that the Dragon or Shark can provide.

Answer 3

However what actually appears to happen is that the 100k is invested into the company to fund some growth plan. So is it actually the case that E's company is worth 400k only AFTER the transaction? Is the 100k added to the balance sheet as cash and would the other 300k be listed as an IP asset?

The investor gets 25% of the shares of the company and pays $100k for them, so Owner's Equity increases by $100k, and the company gets $100k more in cash. The $400k number is an implicit calculation: if 25% of the company is worth $100k, 100% of the company is worth $400k. It's not on the books: the investor is just commenting that they feel that they are being over-charged.