8 Shark Tank Takeaways for Entrepreneurs

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 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. 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. 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 limitations.

An entrepreneur's passion generally drives the startup idea. Quite often that passion is 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, 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 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 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. 🙂

 

___

Featured Image Source: Getty Images/Phillip Faraone

 

David Harkins is a business strategist, speaker, and teacher.

He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below:

Financial Ratio Analysis and the Entrepreneur

Lenders, and often investors, will calculate one or more financial ratios when reviewing an entrepreneur’s financial statements to gain a quick understanding of the health of the business before determining whether to lend or invest. Within an industry, there will be “good” and “bad” benchmarks against which the venture will be measured (Rogers, 2014). Investors and lenders will consider the particulars of a business and likely weight the importance of the ratios differently when comparing to the industry benchmarks.

Many financial ratios could be applied, but the following appears to be most common types (BDC Staff, n.d.):

Leverage Ratios. Leverage Ratios provide an indication of the long-term solvency and highlight the extent long-term debt is used to support the venture.

Liquidity Ratios. Liquidity Ratios measure the businesses ability to cover its debt and provide a high-level overview of financial health.

Efficiency Ratios. Efficiency Ratios provide insights into operations and help to spot problem areas related to inventory management, cash flow, and collections.

Profitability Ratios. Profitability Ratios evaluate the financial viability of a venture and provide a measure of comparison and performance to the venture’s industry.

There are other ratios, of course, and as mentioned before investors particularly have ratios they rely on more based on their experience and industry knowledge. For example, a recent interview with an investor uncovered a preference for knowing the Customer Acquisition Costs. Customer Acquisition Costs are not often viewed as part of a Financial Ratio Analysis, but such factors are often important measures for both investors and entrepreneurs alike.

The entrepreneur, investor, and lender can gain useful information and financial trends on a business venture when using Financial Ratio Analysis. However, it is important to note that financial ratios have little meaning without comparison (Peavler, 2017). For example, a company can compare its ratios to those average ratios of their industries, but the best and most accurate comparisons come from using benchmark companies—high performing companies within their industry. Comparisons against these companies can create and encourage stretch goals for a business.

While Financial Ratio Analysis does provide numbers for performance comparison, it does not provide causation factors (Peavler, 2017). Moreover, identifying why certain ratios that are out of line with the benchmark comparisons is critical because it provides a starting point for correcting problems and improving financial performance.  Ratio analysis can have value for entrepreneurs but depending on where the venture when it is seeking funds, these ratios may or may not be helpful in securing financing.

Entrepreneurs seeking early-stage financing are more likely to encounter investors who value continual improvements in customer acquisition costs, improvements in customer engagement at the various points of contact, and repeat purchase or purchase frequency. These measures help the investor gauge the interest in the offered products and services and are often a good predictor of long-term revenue.

Conversely, established entrepreneurial ventures—those that have several years financial history—looking for ongoing financing are likely to find as much emphasis placed on financial ratios as is placed on the customer measures noted above. This particularly true with bank financing because bankers are more risk adverse and financial ratios when properly utilized, provide a more objective measure of a venture’s performance compared to its industry thereby giving bankers a greater level of comfort when lending money.

Entrepreneurs are often motivated to launch a business in part because of their interest and expertise in a specific domain area. However, many entrepreneurs may be less skilled when it comes to the business finances beyond the basics of revenue and expenses. As an entrepreneur’s business grows, understanding key aspects of finance becomes increasingly more important, particularly should he or she seek outside investment or financing. It is important to understand the basics of Financial Ratio Analysis and how it can be used to determine the health of a business before seeking investment or financing. Yet it is equally important to understand that Financial Ratio Analysis is only one tool in an investor or lender’s tool-box. And while it is an important tool, it is not the only tool that might be used, particularly by investors, when determining the probability of long-term success of an entrepreneurial venture.

 

References

BDC Staff. (n.d.). 4 Ways to Assess Your Business Performance Using Financial Ratios. (Business Development Bank Canada) Retrieved September 29, 2017, from bdc.ca: https://www.bdc.ca/en/articles-tools/money-finance/manage-finances/pages/financial-ratios-4-ways-assess-business.aspx

Peavler, R. (2017, February 28). Limitations of Ratio Analysis. Retrieved September 30, 2017, from thebalance.com: https://www.thebalance.com/limitations-of-financial-ratio-analysis-393236

Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur. New York: McGraw Hill Education.

 

___

Featured Image Source: Getty Images/DNY59

David Harkins is a business strategist, speaker, and teacher.

He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below:

Startup Funding Option: Strategic Alliances

Entrepreneurs often look to friends, family, their bank account, and even credit cards when funding a startup, but many perhaps overlook this startup funding option: The strategic alliance.

A strategic alliance is a cooperative arrangement between two or more businesses for the mutual benefit all involved businesses. The idea is that each involved entrepreneur or business entity brings something to the alliance which enables a greater opportunity for near-term successes for all parties than the parties might achieve individually. While it is possible one company might invest in another to gain access to products and services more quickly that it might develop the same for itself, the more likely scenario is one in which two companies with complementary services align to improve long-term revenue generation opportunities.

For example, one entrepreneur with design experience might align with another entrepreneur with software coding experience to form a structured partnership to pitch new software projects to a prospective client or develop a software-as-a-service (SaaS) application to offer to a broader customer base.

Another example might be a larger company that needs support products or the services provided by a startup and agrees to partner to gain access to that startup’s offering. More specifically, a mapping software company may find it has difficulty selling its software for certain business applications. It could partner with a business consultant who understands how to apply business thinking to the software tools to help a prospective customer better understand the software’s value. When a sale occurs, the consultant helps implement the software and train the client.

There are challenges to strategic alliances, of course, particularly among startup ventures. The biggest obstacles appear to be a difficulty in finding suitable cooperating partners, an inability to assess the upside and downside of the alliance accurately, the challenge of properly structuring the arrangement, and the fear that cooperation might result in an expropriation of business (Hsu, 2007). Moreover, some alliances can pose a challenge to future investment funding if investors have a conflict with one or more of the alliance partners, or if cash flow rights to alliance partners dilute the opportunity for investors (Ozmel, Robinson, & Stuart, 2012). However, if entrepreneurs are open to such alliances, these obstacles can easily be overcome with the support of experienced business mentors, attorneys, and accountants.

Simple strategic alliances might occur with a “memo of understanding” that outlines what each party in the alliance will bring to the table, while a more complicated partnership might involve a formal agreement which holds each involved party accountable for providing the products and services to be delivered jointly to a customer. The most complex alliance might require the formation of a joint entity such as a corporation or limited liability company where all parties have ownership relative to their level of responsibility and risk in the alliance. The structure chosen is dependent on the products and services offered, the desired outcome of the collaboration, and the level of tolerance for risk by the parties involved.

While strategic alliances do provide an option for funding a startup or small business, it is important to remember that most strategic alliances do not usually result in a direct investment for an entrepreneur’s business. Instead, the alliance should enable an entrepreneur to secure his or her first projects or to create the initial products necessary to launch or grow a business. As a source of funding, the goal of a strategic alliance is to facilitate new opportunities, to improve the probability of cash flow, or in the case of a startup, to get a business off the ground. Finding and aligning with the strategic partner might be the first step to securing the funding needed for long-term success.

 

Reference

Hsu, D. (2007). Venture Capitalists and Cooperative Start-up Commercialization Strategy. Management Science, 52(2), 204-219.

Ozmel, U., Robinson, D., & Stuart, T. (2012). Strategic alliances, venture capital, and exit decisions in early-stage high-tech firms. Journal of Financial Economics, 107(3), 655-670. doi:10.1016/j.fineco.2012.09.009

____

Featured Image Source: Getty Images/Jose Luis Peleaz Inc.

David Harkins is a business strategist, speaker, and teacher.

He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below: