The new season of ABC’s Shark Tank started a few weeks ago. If you are unfamiliar with the show, it’s a business “pitch show.” Each week several entrepreneurs pitch their businesses to a group of investors (also known as “Sharks”) hoping to secure funding for their venture. Although it is dramatized, like all reality shows, I am a fan because it aligns with my own experience as an entrepreneur. I believe aspiring entrepreneurs can learn a few lessons from the interactions those pitching on the show have with the Sharks.
Here are just a few of my Shark Tank takeaways for aspiring entrepreneurs and those looking to grow their businesses through outside investment:
1. Know your true opportunity.
Too many entrepreneurs go into business chasing what they perceive to be a market opportunity only to learn that the market is not significant enough to warrant an investor’s interest. Think about where the business could go to grow without being too unfocused. But be realistic. Just because there are millions of dog owners in the market does not mean you will sell every one of them your new dog product.
It is also critical to have a keen knowledge of your competition. You should consider how easy it might be to knock off your product or service offering or move into your market. This is especially true if your competition is larger than you and the market opportunity is right. Competitors with deep pockets can be a startup killers. It is essential to understand how your business is realistically different.
Keep in mind that investors want to maximize their returns. If you’re targeting a market with limited potential, there’s little chance you’ll be funded if the investor doesn’t see a market opportunity, you may be missing. Invest the time to understand the real opportunity before seeking outside investment.
2. Live and breathe your numbers.
Your business financials are the lifeblood of your company. Investors will want to know your financials inside and out. Your customer acquisition costs, cost-of-goods, operational costs, cash flow, inventory turn, and revenue growth are all key. You should also understand where improvements can be made within the operation that will increase revenue and profitability.
Investors want to know you are intimately associated with your money before they will invest theirs. They will also want to know how and when they might see a return on their investment. They will often ask “What if” questions about your financials and financial projections to look at the best case, the probable case, and the worse case business scenarios. With tools to run these scenarios in place, and having run various scenarios yourself, will not only help the investor understand the possible outcomes but also help you better understand your business financials.
3. Sales. Sales. Marketing. Sales.
Sales will tangibly show an investor that your business may be a viable investment. If your company has sales, it demonstrates that there is some market opportunity for the product and services your business offers.
Sales numbers can also tell an investor a lot about a business. If a company has been operational for two months, for example, and sold 50,000 units of a $19.99 item, it might suggest that the entrepreneur has found the right market for the product. Conversely, if those 50,000 units were sold over three years, many underlying problems could likely give the investor pause.
Marketing is essential, too. Knowing how to reach your target market best and demonstrate it by consistently driving new customers to the business is vital. Keeping the customer acquisition cost low and the sales conversion high should get the attention of investors.
Know that few investors will invest much in an unproven idea. Investors want to see that the business has sales and steady growth. Operations can be improved, and costs can be reduced, but sales are necessary to keep the company going. Investors want to invest in winners; sales provide one measure of possible long-term success.
4. Be realistic with your valuation.
Most of us overvalue our businesses when seeking investment. Not everyone has a $1,000,000 valuation. Few startups do. There are many ways to arrive at a business valuation, and the more common formal method discounts the cash flow over a period and then compares the ROI of the investment with a risk premium to the safest investment in the market. It can be complicated to calculate, and few entrepreneurs take the time to learn how to value their company best.
Too often, entrepreneurs opt to look at sales numbers and factor in some fuzzy math. Some might argue, for example, that steadily increasing sales from $250,000 to $800,000 over the last three years and being “on track for $1,500,000 this year” puts the company’s value at $1,000,000. Maybe, but highly unlikely. The cost of goods and operating costs need to be factored into the valuation.
Investors consider risk and opportunity in the valuation of a company. If the opportunity is excellent, but the risk is high, the investor often wants more equity to offset the associated risk. This includes those situations where the investor will need to invest not only money but time and energy into the business to see his or her return. The risk-reward factor is important, but financial fundamentals are the baseline measure for any entrepreneurial investment.
5. Understand how to scale.
Many entrepreneurs think having a product or service that they are selling is, in fact, a business. While in the strictest sense of the word, this might be true, investors are looking for a “business operation” in which to invest, not a corporate structure. It is not enough to have chosen to incorporate and has made a few sales.
It is important to remember that most investors seek opportunities where the business has some structure that will enable it to scale. Scalability is key to maximizing an investment return. Investors look for companies that already have or are implementing systems and operations for scalability. For this reason, many investors will not invest in service businesses because they are more difficult to scale than an online retail store or maybe even a manufacturing business. Scalable companies not only have the potential to reduce costs but also increase revenue and, in turn, profitability.
6. You are your pitch.
Having a solid business pitch is essential, but it’s about more than just the business. Clearly and succinctly communicating your business operation, what products and services it offers, how those products and services are delivered, who the customers are, and what problems your offerings solve for customers is essential. Equally important is your background and experience related to the business and what the company has accomplished to date. And, as mentioned above, your knowledge of the business financials is an essential part of the pitch. But investors value other things, too.
Remember that when pitching, you are not only pitching your business; you are pitching yourself. It is good to be professional and prepared but don’t come across as aloof or too argumentative. Have passion, but be realistic. Tenacity is good, within limits. How you conduct yourself in the pitch and in “real life” will also factor into the investor’s decision. Be humble, kind, and honest. Listen and be coachable. And be personable. Investors are investing in you, particularly in the early stages. You need to be as investable as your business.
7. Know your limitations.
An entrepreneur’s passion generally drives the startup idea. That passion is often driven by a desire to solve a problem. Sometimes those who are motivated to solve a problem may not be or have the desire to be a great business person. You may have created a great product, but you may not have the business knowledge or experience to grow the business opportunity. If an investor sees the value in the product, they might choose to invest; however, the equity ask might be 50% or more. The higher equity asks stems from the investor’s understanding of what must be done to turn your idea or product into a business. Such offers are always worth considering.
Investors willing to invest in you to help you build structure and sales of your product likely deserve a higher equity stake. In such situations, investors may well be bringing more to the table than you might be. In these circumstances, it is essential to consider your strengths, weaknesses, and interests and then determine the real value you bring to the opportunity. This is the time to be honest with yourself. Don’t forget that 40% of a company making money is worth a lot more than 100% of a company that is not making money.
8. Investors bring strengths and weaknesses.
Each investor will have his or her strengths and weaknesses. They know them, and you must know them, too. Whenever possible, learn more about an investor, his or her likes and dislikes, how they have invested in the past, what they’re looking for in an investment, and what they feel they can bring to the table. Knowing this will help you choose the best investor match for your business and enable you to tailor your pitch to the investor.
As an entrepreneur, it is just as vital for you to know how you might leverage the strengths and downplay the weaknesses of a given investor in your venture. Choosing the wrong investor can be the kiss of death for an entrepreneur. Finding the best match is critical for success.
Although not every investment pitch will be made to a Shark like those on the show, entrepreneurs can learn from watching others pitch and listening to the questions asked by the investors. I watch little television these days, but I do try to catch Shark Tank each week, and when I’m traveling, I am guilty of binge-watching reruns of the show on CNBC. I am so surprised when I hear entrepreneurs tell me they have not seen the show. I think they’re missing out. I learn something every time I watch Shark Tank. If you’re an entrepreneur, I know you will, too.