The new season of ABC’s Shark Tank started a few weeks ago. If you are not familiar 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 and 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 business 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, without being too unfocused, to grow. 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 otherwise, 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 killer. 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 that has 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 true 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. Often, they will 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 it will help you gain a better understanding 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, there could be many different underlying problems that would likely to give the investor pause.
Marketing is essential, too. Knowing how to reach your target market best and demonstrating 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 and 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 $1,000,000 valuation. In fact, 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 best value their company.
Too often entrepreneurs opt to look at sales numbers and factor 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 value of the company 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 will often want 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 have 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, say, an online retail store, or maybe even a manufacturing business. Scalable companies not only have the potential to reduce costs, but they might 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 as it relates to the business, and what the company has accomplished to date. And, as mentioned above, your knowledge of the business financials are an essential part of the pitch. But investors value other things, too.
Keep in mind 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 factor into the investor’s decision, too. 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 own limitations.
An entrepreneur’s passion generally drives the startup idea. Quite often that passion is driven by a desire to solve a problem. Yet, 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, he or she might choose to invest; however, the equity ask might be 50% or more. The higher equity asks stems from the investors understanding of what needs to be done to turn your idea or product into a business. Such offers are always worth considering.
Investors willing to make an investment 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 own 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 important for you to 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.
P.S. In my personal opinion, sometimes Kevin “Mr. Wonderful” O’Leary is right. Licensing is the answer. But then, I’m a licensing guy, too. 🙂
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Startup entrepreneurs face a daunting challenge in forecasting cash flow, profitability, and return on investment. It can be so overwhelming that many just ignore the numbers and jump right into developing a product or service. Certainly, a refined product or service is a critical early step in launching the entrepreneurial venture; however, understanding the financial aspects of the business, including the inputs to the product or service development is paramount to forecasting cash flow and business profitability, is equally important.
In business, particularly in the start-up phase, “pro forma” financial statements provide a way for the entrepreneur and potential investors to see the financial forecast of a business given a set of assumptions. The pro forma financials will include a set of assumptions on which the numbers were based, a cash flow statement, an income statement, and a balance sheet statement. Together, these statements provide an approximation of business performance considering the assumptions. Most investors place little value on the numbers a start-up provides because the core assumptions may be inaccurate (Rogers, 2014). And if the assumptions are inaccurate, the financial performance will change. One of the best ways to understand how assumptions change the financial performance of a business is to build an interactive pro forma.
The interactive pro forma will allow an entrepreneur to quickly change assumptions and easily see the possible financial impact on the business as those assumption flow through the other financial statements. Once set up, it allows an entrepreneur to play a “What-if” game with assumption inputs and watch how those changes affect the business performance. The interactive pro forma is also a great tool to use when seeking outside investment. If the assumptions are challenged by an investor, they can be modified in real-time, and those modifications flow out to the other statements. This provides an instant view of the new business financials once new assumptions are in place.
Spreadsheet tools make building an interactive pro forma easy, although it does take some knowledge of the tools and a few hours to set up the models. Most of the time spent should be given to considering the assumptions. Assumptions are the most important part of the model and where entrepreneurs should put the bulk of their time.
Here’s one way to build an interactive pro forma:
- In a spreadsheet program, create a new workbook with four tabs. Label each tab as follows: Assumptions, Cash Flow Statement, Income Statement, and Balance Sheet.
- On the Assumptions Tab, list all of your assumptions about the business. Depending on the business one might choose product pricing, sales figures, monthly costs of operation, depreciation, taxes, insurance, etc. Make sure everything that could affect the business costs or revenue structure is included.
- On the Cash Flow Statement tab, include the beginning cash balances, your sources of cash, and the uses of cash for each month. Use the assumptions to drive the revenue (sources) and expenses (expenses) on this tab. Note that the cash that’s left over at the end of each month becomes the Beginning cash balance for the following month. The Cash Flow Statement shows how the business will use the money it receives each month.
- The Income Statement tab pulls data from the Cash Flow Statement tab but formats it differently. The Income Statement in a pro forma shows whether the business is profitable for a period by looking at the revenue and expenses based on the original assumptions (and cash flow).
- The Balance Sheet pulls data from the Cash Flow Statement and the Income Statement to provide a look at the assets, liabilities, and equity of a company at a point of time. It helps the entrepreneur better understand what the company owes (liabilities), what it owns (assets), and the equity held by shareholders.
The above points are over-simplified. The idea is to give an overview of the process. Each entrepreneur should develop his or her own pro forma to understand the specifics of his or her business better.
This said I have provided an example interactive pro forma workbook for an online publishing business for readers to download and explore. Some may have the skills and abilities to create a similar model, but others may need the help of a financial professional.
Using an interactive pro forma will help an entrepreneur get a better handle on his or her business by allowing the exploration of What-If scenarios what might impact the business. It is much better to explore these scenarios in advance of launch and develop contingency plans than it is to encounter the problems in “real time” without possible solutions waiting.
A few notes on this model:
- This is an example for use as is. It is not supported in any way. It is not intended to be a tool to use without customization based on the specifics of an entrepreneurial venture.
- This interactive pro forma is only an example to give the reader an idea of how such a tool can be developed. It is not based on a real business. I compiled this model for a graduate class, but I have developed similar models for entrepreneurial ventures. Each business venture is different, and so is the pro forma that is prepared for that venture.
- On the Pricing Assumptions tab, all of the “Bold Blue” text areas can be changed to demonstrate how the interactivity might work. No other data can be changed.
- The best way to explore this model is to look at the other statements before changing anything, then change one thing and see what effect it has on the model.
- In this workbook, I have included an additional tab to for calculations of revenue and expenses based on the pricing assumptions. This worked easier for me to build the calculations, but others might do it differently.
- Formulas can be seen in each of the cells (mouse over it), but only the values in the “Bold Blue” text area can be changed.
Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur (3rd ed.). New York: McGraw-Hill Education.
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For many of us, the word “entrepreneur” conjures a vision of an individual working tirelessly to grow an idea into a business. This is certainly one type of entrepreneur, but there are other types of entrepreneurs, too. There are those who serve an entrepreneurial function in corporations, those who chose to buy a franchise, those who acquire established businesses, and those we mentioned earlier who start a business from nothing (Rogers, 2014). Each of these individuals is an entrepreneur, albeit with different skill sets and arguably a different level of tolerance for the financial risk in entrepreneurship. Understanding basic financial principles and the role these principles play in entrepreneurial ventures might help entrepreneurs balance their risk-reward tolerance when considering new opportunities.
Financial management is a valuable discipline for entrepreneurship, regardless of the entrepreneurial type. It is the single most useful toolset for mitigating business risk. Unfortunately, many entrepreneurs cite financial management as their weakest skill (Rogers, 2014). Why? It may be that some entrepreneurs see their strength as creating their venture’s product or service. In these situations, they may abdicate the responsibility of the venture’s finances. It is likely that the type of entrepreneurial activity factors into the value an entrepreneur places on the need to understand the underlying financial aspects of the venture.
Let’s look at each entrepreneurial type in a little more detail from the lowest to the highest financial risk related to entrepreneurial activity:
Corporate entrepreneurs, or intrapreneurs, are those who perform entrepreneurial functions within an organization. The work these individuals do can range from creating new lines of business and developing new opportunities from within an organization (as I did for the Boy Scouts of America’s National retail operations) to starting a separate venture with funding and direction from an organization. In both cases, the greatest challenge for the entrepreneur is walking the line between organizational culture and the entrepreneurial mindset needed to grow and develop the new venture (Gavin & Levesque, 2006). The business culture often does not allow for the level of out-of-the-box thinking necessary to get the new venture off the ground. While this approach might provide for the lowest financial risk for an entrepreneur, failure in this environment may well have different risks. The risk of an individual’s corporate social capital, the risk of advancement opportunities, or the risk of employment to name just a few.
Those entrepreneurs who purchase a franchise are buying into a system, methodology, customer base, and support network for starting and growing a business. The entrepreneur’s advantage in the purchase of a franchise is that theoretically all of the mistakes start ups make were identified and corrected in the franchisor’s concept development stage and therefore the business risk is minimized for the franchisee (Brown, 2012). Theoretically, the financial risk is lessened, too, if the franchisee follows the model. Although, demographic changes, cultural shifts, changes in consumer attitudes, or perhaps public-relations-related factors (think Jared of the Subway chain) not quickly addressed by the franchisor could significantly increase a franchisee’s financial risk. Still, the bulk of the financial risk is borne by individual franchisee’s business acumen, and that often falls outside the systems and models established by the franchisor.
Many people become entrepreneurs through the acquisition or inheritance of an established company. Acquiring an existing company might provide some distinct advantages for an entrepreneur including, an established customer base, fixed working hours, and a revenue stream. Plus, the entrepreneur gains the flexibility of being self-employed and his or her success is dependent in large part on the ability to manage and grow the business (Ruback & Yudkoff, 2017). This approach can be appealing for those entrepreneurs who are skilled with business management and who want some flexibility and responsibility but lack the desire to build a business from scratch. Although there may be systems and processes in place, the financial risk is greater than that of a franchisee because there is no franchisor network or formalized “learning community” to whom the entrepreneur may turn for specific advice and direction. The financial risk is less than that of a start-up entrepreneur because the venture is already running and presumably profitable with positive cash flow.
The start-up entrepreneur builds a business from the ground up. He or she starts with an idea, creates a product or service, develops a framework for delivery, acquires and retains customers, and hopefully, builds a successful business over time. Unlike the corporate entrepreneur, the start-up entrepreneur does not have a financial backing and functional support of a corporation. Moreover, the start-up entrepreneur does not have the systems, processes, or support network of a franchisor, nor the benefits that come with acquiring an existing business. The start-up entrepreneur does not have the safety nets possessed by the other types of entrepreneurs, even with sufficient start-up capital. The financial risk, then, is greatest for a start-up entrepreneur.
Each type of entrepreneur encounters some level of financial risk. Risk management is an entrepreneur’s responsibility and understanding entrepreneurial finance is the key to minimizing that risk. Considering knowledge of entrepreneurial finance is so often the difference between success and failure, all entrepreneurs should devote themselves to understanding the key financial indicators for their particular business. Regardless of the type of entrepreneur one may be, it is important to realize that successful entrepreneurs must have more than an excellent idea, the willingness to work hard, business experience, the financial backing of a corporation or the support of a franchise system. Successful entrepreneurs must have a solid understanding of financial management and put that knowledge to use in business every day.
Brown, P. (2012, September 19). Franchisees are Entrepreneurs. Retrieved September 09, 2017, from forbes.com: https://www.forbes.com/sites/actiontrumpseverything/2012/09/19/franchisees-are-entrepreneurs-let-the-debate-begin/#cb962052bf3e
Gavin, D. A., & Levesque, L. (2006, October). Meeting the Challenge of Corporate Entrepreneurship. Retrieved September 09, 2017, from hbr.org: https://hbr.org/2006/10/meeting-the-challenge-of-corporate-entrepreneurship
Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur (3rd ed.). New York: McGraw-Hill Education.
Ruback, R., & Yudkoff, R. (2017, January). Buying Your Way into Entrepreneurship. Retrieved September 09, 2017, from hbr.org: https://hbr.org/2017/01/buying-your-way-into-entrepreneurship
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