Recently, I read an interview between Tim Ferriss and Daymond John about how he built up his multi-million dollar business, and from there I found myself watching and keenly studying the TV series Shark Tank. In Shark Tank, successful business people, including Daymond John, form a panel of investors. People come on the show to pitch to the sharks in the hope that they'll invest in their company.
There's a recurring theme I've observed amongst the entrepreneurs (can never spell that word...) pitching their ideas to the Sharks:
- They rarely have significant sales.
- They almost always over value their companies by offering too little equity in return for too much money without sales to support them.
- They are very often torn between wanting to cash-in on the company and get rich, or to keep working in the business and follow their passion.
- They rarely agree to surrender a controlling stake in their companies (51% or more). Offers from the sharks have been turned down because the owner has an emotional connection to their business and doesn't want to turn it over to someone else, yet without an injection of capital it will most likely fail.
- They very often over value "potential" growth
- $10,000 sales last year and growing somehow makes the business worth $500,000 to a million dollars, more often because they've already invested their life savings into the company and mortgaged their family home. The sharks might invest $20,000 or more in a company like that, but only in exchange for 100% equity, which the owners usually refuse.
- They're often unclear on what exactly they need the money for - is it for R&D, inventory, marketing, salaries? Quite often what they have has the potential to be a tidy small business, but doesn't have the kind of explosive growth potential that the sharks are looking for, and as such they would be unlikely to see a significant return on their investment.
The sharks respond very consistently - they are first and foremost investors looking to increase their wealth:
- They always ask for sales numbers - gross revenue, and net profits for the last year
- They want to know how many existing customers they have, or at least what contracts they've already secured
They immediately value the company by multiplying the net sales by the proportion of equity being offered.
- People usually ask for around $25,000-150,000 in exchange for 10-25% of their company
- This would value their company at $250,000 to a million dollars or more
- They are often found to only have $50,000-$100,000 in sales, from which the sharks would value their company at about double - $100,000-$200,000
- When asked why they think their business is worth so much more than the numbers suggest, invariably they'll talk about passion, or how much of their own time/effort/money they've put into the business
- The sharks invariably give them a harsh lesson in reality...
- Even really great ideas with no sales are usually rejected straight away
- When a company has significant sales, but is still in the early stages of development, the sharks will usually ask for a controlling interest in the company (51% or more, often 100%) in order to protect their investment
- Even with significant sales, the sharks will often look for a contract with a major brand or reseller for mass-market products rather than attempting to muscle into an established market
- Licensing deals are more attractive to sharks than selling widgets - they'd be more interested in owning a license they can sell to a major manufacturer than trying to bring a stand-alone product to market
- They will often offer to buy 100% of a company and pay the owner an ongoing royalty, which they usually refuse, despite the sharks offering to use their own capital and expertise to build up the company
- They always ask what their investment will be used for.
- Quite often the person has unrealistic expectations of what it will actually cost to develop their business.
- Sometimes they think the sharks will give them capital to buy patents, or produce inventory, or spend on marketing - they never do; they simply want to buy a share in what they perceive to be a profitable company with potential for great growth.
- The sharks won't invest if the money will simply be used to sustain the business, or keep if from collapse
- Patents are attractive, and will often make or break a deal
- They never invest in ideas with no substance to help turn it into a product
- They never invest in individuals/brands without a viable product/business to help them develop one
Studying the show has reaffirmed my belief in the importance of building a business for profitability, for two reasons: a business must have value to be profitable; I want to add value to the world, and a business must be profitable for it to be attractive to investors; I don't want to stare at a computer screen forever...
This may be less true on massive scales, for example a social network like Facebook/Twitter with literally millions of active users will be able to generate revenue by the sheer brute force of their volume, but before they had those numbers they had to prove themselves by building a popular product. When they were starting out, no one would go near them, but they scratched an itch, and it proved to be hugely popular. Had they taken their idea to investors and pitched them saying that although they have zero revenue, and only a few thousand users, they just need some capital to invest in infrastructure and they'll be able to get millions of users and generate tons of cash...
- Have an idea
I don't think so. It's probably more like:
- Identify a real human need
- Build something to satisfy that need
- Work your arse off for years developing and marketing your product to be revenue positive