[Guest post by Brant Bukowsky, the founder of GrowthPartner.com -- a firm that provides angel investment and online marketing expertise to emerging companies. A serial entrepreneur, Bukowsky and his team have built three Inc. 500 companies in the last five years. He blogs at Angel Investment Journal.]
This is the first in a two-part series.
ABC’s reality show “Shark Tank” has helped bring the concept of angel investment to the mainstream. Millions of Americans who had never even heard the term now tune in each week to watch hard-working entrepreneurs pitch their investment proposals to self-made millionaires.
In the show, entrepreneurs are forced to sell their ideas and themselves before an imposing panel of investors. These small business practitioners must ask for a specific amount of money from the investors, who in turn seek a percentage of ownership stake.
Entrepreneurs typically unleash a torrent of impassioned pleas, tears and promises of future profits. The sharks, meanwhile, poke, prod and push to find holes or weaknesses in business plans and revenue models, all the while jockeying for position on the really standout pitches.
In essence, it’s reality television at its tension-building best. Too bad it’s giving viewers a warped view of what angel investment is really about.
Here are five ways that “Shark Tank” gets it wrong, along with the bad lessons it’s teaching entrepreneurs and angel investors.
1. Pre- and post-money valuations
In one episode, an entrepreneur says he is seeking $250,000 and will give up 1/3 of his company. The investor then questions the entrepreneur, asking how he can justify a valuation of $750,000 when they don’t have much in sales.
Here’s the problem: The shark isn’t correct in his valuation. The entrepreneur is not valuing the company at $750,000. He is valuing it at $500,000. This is the pre-money valuation or the valuation before the investment. Once the investment is made, the company would be valued at $750,000 — with $250,000 of that coming from the investor. And that $250,000 would get 1/3 of the post-money valuation. So the entrepreneur should not be forced to justify how the company is worth $750,000.
Instead, he should need to justify a $500,000 current (or pre-money) valuation.
2. Wacky company values
In the same episode, the investor claims valuations are based on a multiple of revenue or profits. However, this is not accurate in a startup or early-stage company.
Valuation amounts are generally placed on other things such as management, market potential, intellectual property and a few other key essentials. Sales can help justify a higher valuation, but they are generally given very little weight for startups and early-stage companies.
3. Unrealistic time frames
On “Shark Tank,” investors and entrepreneurs shake hands and seem to agree on a deal very quickly. But deals of any real merit are very rarely done without a significant amount of due diligence to help verify claims, checking out the entrepreneur and other things common in any due diligence process.
The idea of a quick shake and a sudden influx of capital runs counter to the measured and deliberate nature of angel investing. Angels didn’t make money by blindly rushing into business deals while relying on gut instinct alone.
4. One-track negotiations
When entrepreneurs and sharks are negotiating a deal, the focus is entirely on the valuation of the company and the investment amount. While these are clearly important to both stakeholders, the terms of investment deals in the real world of angel investing include a wide array of other cornerstones. We’re talking about things like stock options, liquidation preferences and so much more.
5. Adversarial relationship
For the most part, “Shark Tank” makes it seems like angels and entrepreneurs are pitted against each other. But it’s really not a zero sum game. Both sides are fighting earnestly for the same thing — to build a successful company with terms that provide mutual benefit and long-term growth.
Stay tuned for Part 2 of the series.
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* For series, references are published in the last installment of the series.