Friday, December 09, 2011

BLOG 117


I recently read an article in “Taxation” magazine that included, “no doubt we have all been surprised at the valuations that various entrepreneurs have placed on their businesses in the Dragons’ Den. Clearly, there is an area where, as accountants, we can assist our clients”. It also indicated that Dragons’ Den demonstrates that to secure finance or investment, a company needs some key features, namely good management, enthusiasm, a compelling product or service and potential market size.

I am note sure that I agree with either statement. I admit to watching Dragons’ Den but I see it as entertainment, not as a business video manual. The rules of the Den are somewhat odd. The entrepreneur cannot refer to his accounts; he is expected to remember the figures for the last five years. The amount of money he wants to raise is fixed; if the Dragons think he needs more, they cannot offer it to him. The entrepreneur is expected to go on his own (or with one or two others) he cannot bring along his accountant, lawyer, chief accountant and the rest of the team that most investors expect to be involved. If a Dragon makes an offer it must be accepted or rejected on the spot. I cannot recollect a Dragon ever agreeing to accept the deal on offer. Surely, in at least some cases, that deal must have been based on the advice of an accountant. Accordingly one could draw an inference that accountants are not actually very good at valuing businesses.

One could equally draw the inference that conventional valuation methods do not bear much relationship to the real world. I am fascinated by how little financial information the Dragons normally want. They ask for turnover and sometimes for gross profit and net profit, but do not normally seem to care what expenses have been charged in arriving at the profit figures – or indeed how much the proprietor is taking out of the business.

But the figures seem largely secondary to them. The sort of things the Dragons are interested in are the following. If the entrepreneur has a new product, is it patented and if so how secure is the patent? What is the risk that a major company could produce a competing product? What is the likely market? What is the profit per item? How long has the entrepreneur been trying to sell the product? How has he tried to sell it? Does he know who his competitors are and their prices?

The Dragons will form their own judgement as to whether they are likely to make a reasonable return on the investment and how quickly. They seem to invest on the basis of that judgement. However they rarely invest as a passive investor. Similarly, the entrepreneurs are rarely looking for a passive investor. They are looking for someone who will bring their skills and connections to the table along with their money.

Accordingly Dragons Den is not really about selling stakes in companies. It is primarily about finding a business partner who is prepared to devote some time and resources to help develop the business. That may well be why the Dragons are rarely, if ever, prepared to agree the deal that is on the table. The stake in the business that the entrepreneur is prepared to give up may well be predicated on a valuation of the business – although in many cases it seems doubtful whether much attempt at a valuation has been made. However the Dragon approaches the deal from the basis of the return he wants on his money and the value that he believes that he personally can create for the business.

Neither has much to do with the sort of valuations that accountants produce, which are formulaic and often take little or no account of the factors that draw the Dragon to a business. Indeed, normally the Dragons each place a very different price on the business from one another.

I also doubt that the programme demonstrates a need for good management, enthusiasm, a compelling product or service, and potential market size. Of course these are all important factors, but not as important as the Dragon’s own perception of the potential of the business.

I doubt actually that the programme demonstrates anything – except perhaps how difficult it is to turn an idea into a profitable business if the entrepreneur does not have a business background.



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