Al Nelson went on the third season of ABC’s Shark Tank seeking a $150,000 investment in his Miami-based technology business, EZ VIP. A kind of combination Expedia and OpenTable for nightlife, EZ VIP bypasses the proverbial velvet rope by allowing anyone to go to its website and pre-purchase admission, a VIP table, and bottle service at the hottest and hardest-to-get-into nightlife events. “We provide access and convenience,†says the 27-year-old Nelson.
After submitting three audition tapes, filling out a 50-plus-page application, and presenting his business to producers, Nelson was ready to pitch his business to the panel of five private investors–aka the Sharks: real estate mogul Barbara Corcoran; billionaire Mark Cuban, owner and chairman of HDNet and the NBA’s Dallas Mavericks; technology innovator Robert Herjavec; branding expert Daymond John, founder and CEO of FUBU; and venture capitalist Kevin O’Leary.
The Sharks have a clear goal–to own a piece of the next big idea, sometimes for as much as a 50% ownership stake. Nelson, having netted $90,000 on $250,000 gross in revenues, caused a feeding frenzy as the Sharks made offers and counteroffers back and forth. He had intended to give up a 15% equity stake, but clinched a deal with Cuban and John to receive $150,000 in exchange for 30% of the company. Nelson went with the duo because of the brand value they could bring.
Having a business idea or product that resonates with a potential investor is key to raising capital, says John. “Mark [Cuban] and I were at one of the hottest night clubs in Miami when the Mavericks won the championship. I had clients who were there. They booked a table with EZ VIP two weeks beforehand.â€
Like Nelson, other early-stage entrepreneurs seek out angel investors–private high net worth individuals or groups of individuals–to invest in their companies, typically in exchange for equity ownership of anywhere from 5% to 25%. But it’s not just an infusion of cash they want: Business owners also want angels to bring experience and contacts that will accelerate their companies’ growth.
In today’s tight economic climate, angel financing fills the gap in startup capital and early stage financing. About 42% of angel investments were in seed capital last year, reports the Center for Venture Research. In contrast, there was a 48% decrease in seed money among venture capital firms (VCs), according to the PricewaterhouseCoopers/National Venture Capital Association MoneyTree Report. John and his fellow Sharks are part of a larger pool of more than 300,000 angels active in the U.S., funding more than 66,000 companies and investing about $22 billion in total last year. Angel investment
activity rose in total investments, up 12.1%, and deal size, up 4.7%, from 2010 to 2011. Deals can range from $150,000 to $1 million, but the average angel deal is about $400,000. By comparison, VCs invested $29.1 billion in more than 3,700 deals, a 5.2% increase in deals from 2010. Last year, venture capitalists invested, on average, $7.8 million per deal.(Continued on next page)
The Sharks are reflective of the overall private investor community. They have backed about 41% of the 147 entrepreneurs that have appeared on the show. Using their own money, the Sharks have made deals totaling about $15 million in the show’s three seasons. John and Corcoran have reportedly offered the most money and invested in the greatest number of companies.
Many small business owners find angels, often retired executives or entrepreneurs, through word of mouth. But several business groups have created networks of private investors, such as the Minority Angel Investor Network, Angel Capital Association, Angel Venture Forum, and Private Investors Forum. And, like Nelson, more entrepreneurs are seeking creative ways to pitch to private investors.
“Investors are hungry for deals,†says Tim Reese, co-founder of the Minority Angel Investment Network and managing partner at Forge Intellectual Capital. There is a lot of money on the sidelines, because investors have been selective the last three years or so, he notes. “That money is now in play.†Individual angel investors are even collaborating with private equity and debt lenders, he adds.
Top 5 Ways to Bait Sharks
Capital-seeking entrepreneurs ought to be armed with such pitching tools as a business plan that includes a well-defined marketing strategy and solid financial statements that indicate high growth potential. Also, first impressions count. Corcoran says you need to look the part. John says, “Don’t turn off a potential investor before you even open your mouth. When you are pitching, you are presenting yourself as the brand.â€
When you speak, avoid rambling. Clearly and succinctly explain how your product or service solves a problem or fills a need, who is your market and consumer base, what distinguishes you from your competitors, where you will spend the money, why you will be a financial success, and when the investor will get his or her money back.
The Sharks share other tidbits about how to get equity investors hooked on your business.
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Passion: Bring your product or service to life with your energy. In sizing up an entrepreneur, Corcoran looks at how much genuine enthusiasm the person has for the product. But John notes that fast talking should not be confused with
passion. “Let investors see that you are doing what you love.†Cuban likes to home in on a unique quality about the company and the person running it: “I want to invest in both.†Also, adds Corcoran, “Does this person have the personality to sell the product and the endurance to weather insults and rejection?â€Knowledge: One of the biggest mistakes a business owner can make is “not knowing the company and its numbers inside out,†says Cuban. An investor will reject a business idea if the owner “is not prepared and is not realistic about their business or industry.†Be prepared to answer questions, advises Corcoran. For instance, what are your sales? Did you generate revenues? Have or will you turn a profit? What are the margins for your industry? John adds, “Investors want to see that all line items are being addressed, such as are you paying yourself a salary.â€
Vision: Prove that there is market demand. Besides making a PowerPoint presentation, showing a prototype, or handing out product samples, provide results from research or knowledge you’ve acquired from surveys, focus groups, and product tests. An entrepreneur in residence at Babson College, John has M.B.A. students analyzing businesses in which he invests, including those from Shark Tank. The students assisted with EZ VIP’s expansion plans into Las Vegas, New York, and Los Angeles. They also provided feedback on the company’s website redesign, social media strategy, and marketing to women. Some helped with creating sales pitches for corporate partners, concierges, and general sponsors.
Sustainability: Demonstrate how you intend to grow the company. “How is the business scalable?†asks John. “EZ VIP was successful in one small area of the country that could be replicated in other areas, so there was scalability.†Investors gauge their return on investment based on a company’s potential to achieve high growth, strong market position, and sustainable competitive advantages. Also, investors don’t want to see that the management team is too thin or inexperienced to handle the company’s expansion. The key is to focus on leveraging your strengths and to reflect the strengths of the product, says Cuban.
Honesty: Don’t try to avoid or hide any problems with the company. Just be prepared to discuss how you plan to solve them. “Don’t tell me about sales and patents only for me to learn that the patents are pending, and when I look at the books I see that you have $400,000 in loans outstanding,†cautions John. Investors give money to entrepreneurs who appear trustworthy and transparent.
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It’s also important to know your audience. “When you are
pitching, it is about what is important to the person you’re pitching to. So entrepreneurs need to know why people are investors,†says John. For example, “Cuban’s philosophy is ‘I will invest in 20 companies or more. I want all of them to succeed, but it takes just one big pop to create great returns.’ And O’Leary has a pure VC mentality: He wants to invest money and have a clear three- to five-year exit strategy.†As for John, “I like to license. I am a manufacturer and branding guru with celebrity ties, and I like leveraging relationships.â€That knowledge extends to their other investments as well. John says investors want companies that will complement and expand their existing portfolios. For example, he’s not interested in companies that are going to cannibalize earnings, such as another urban clothing line. But tech companies excite him.
3 Reasons Sharks Won’t Bite
Shawn “Chef Big Shake†Davis also entered the Shark Tank during the second season with his business, CBS Foods, which specializes in gourmet seafood dishes. Founded in 2007, the Franklin, Tennessee-based company’s flagship product is the Original Shrimp Burger in five flavors. A restaurateur and personal chef for more than 20 years, Davis was inspired by his daughter, who at the age of 10 became a pescatarian. He wanted a low-fat, high-protein alternative to hamburgers.
As with most startups, Davis’s challenge was capital. “You can have the biggest dream, but if you can’t back it up with money, then it isn’t going to happen,†says Davis. With his vision of putting his shrimp burger into every supermarket in America, Davis pitched to the Sharks asking for $200,000 for 25% of his business, valuing the company at $800,000.
Although the Sharks liked Davis, they didn’t bite at his business offer. John was among the Sharks who felt that Davis had overvalued his company. He had sold 22,000 units with sales grossing around $30,000, and he had commitments from just two major supermarkets for orders worth $87,000. Unless they’re considering a fast-growing high-tech company, investors expect entrepreneurs to value their businesses on current sales and assets, not future aspirations. Moreover, seafood is an expensive commodity because of price fluctuations and the cost of refrigeration. O’Leary was looking for margins of around 70%, while CBS Foods had gross margins of only 53%.
The Sharks give the three most common reasons why investors reject a deal.
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Overvaluation: Valuing your company for more than it’s worth is a no-no. “You can’t price your business on potential,†says Corcoran. “You might believe in it, but it’s having actual orders that makes the investors believe.â€
No Sales: Investors like to see traction, momentum, and actual sales. “No sales equals no value to an investor,†says Corcoran. But sales are just the beginning. “The No. 1 thing that shows that you’re viable is sales,†says John, “but you can have millions of dollars in sales revenues. What are your expenses? What is your net? What are your profits?â€
No Way Out: Show investors the return on their money. What’s your exit strategy? It may be going public or selling the business to another company in seven years. “You have to ask yourself why it would be worth it to an investor to give you money at that price,†says Cuban, “and how is the investor going to get their money back.â€
Not all Shark Tank contestants who receive offers seal the deal after leaving the show. The hardest part is negotiating the final terms. Nelson closed the deal with Cuban and John within three months, pretty much in keeping with the offer made on the show.
“Moving fast in providing the information the investor requires in the due diligence period is key,†says Corcoran. “Smart entrepreneurs complete the documentation within a few weeks, but other, less savvy entrepreneurs take several months. The longer an investor waits for the needed information, the less likely the deal will close.â€
On the flip side, former contestants like Davis have secured funds after being denied by the Sharks. “I didn’t realize the power of television. While the show was airing my phone was ringing.†A private investor gave Davis $500,000 for a 30% stake; Davis is currently seeking capitalization of between $5 million and $10 million from VCs.
Revenues for CBS Foods also grew more than 300%, to between $200,000 and $300,000 in 2011; revenues for 2012 are projected to reach $6 million. When Davis appeared on Shark Tank he had zero retail, one small store, and several local restaurants buying the product. By the end of the year, the Original Shrimp Burger will be sold in more than 2,200 retail stores, including Price Chopper, Giant Eagle, and BJ’s Wholesale Club. Other CBS products include a lobster slider, lobster pot pie, and lobster macaroni and cheese.
Davis even reappeared on Shark Tank in season three in a follow-up episode about his success. The biggest lesson Davis has learned from swimming with the Sharks is to be prepared when any opportunity presents itself.