With ABC’s television series Shark Tank came a surge of everyday people interested in investing in startups. While Shark Tank is certainly a unique syndicated show, with its talk of equity, valuations, and debt, how well does the show portray venture capital investing off screen?
Each episode, the five “sharks” – the show’s name for its venture capitalists/angel investors – hear three to four pitches from entrepreneurs and ask questions about the entrepreneur’s business model and potential success thus far. The sharks can then either offer an investment in return for an equity stake in the company (or licensing/royalty deals, as is common with shark Kevin O’Leary) or withdraw. Based on that feedback, the entrepreneur can either accept, make a counter offer, or leave empty handed.
So how does Shark Tank measure up?
In the real world, the first thing that differs widely from this model is the pitch itself. Unlike the show’s 10-15 minute segments, startup pitches for investors are typically much longer and are only given to one potential VC (or VC firm) at a time. On Shark Tank, the sharks will make a deal first and then conduct due diligence, whereas typical VCs will have already reviewed the startups’ financials prior to the pitch—meaning there shouldn’t be a “gut reaction” when it comes to actually making a deal.
A key factor in the sharks’ decision-making process is usually the company’s sales figures and profitability. A number of the sharks will outright refuse a deal if the company hasn’t already been making sales or reached profitability. However, an early-stage company typically hasn’t reached profitability and would either need long-term bootstrapping or a large equity investment to help bolster sales. Investors would most likely see a potential return on investment after a liquidity event such as an IPO or, more likely, an acquisition, not based on sales or profits.
While startups may think offering 5-10% of their equity makes sense in all cases, it may only serve to lessen the founders’ hold on the company without giving the startup the valuable business advice and mentorship of an angel investor. On Shark Tank, a certain equity stake makes sense, as entrepreneurs gain the valuable contacts and celebrity status associated with their shark investor. But often, the sharks will negotiate for a larger equity stake, one that may significantly dilute the ownership of the entrepreneur.
As an added note, it’s common to see a “shark tank effect,” where even companies that didn’t receive a deal from one of the sharks still see an uptick in sales – something startups wouldn’t see with a typical VC.
The types of companies featured on Shark Tank can also vary quite a bit from the startups the average VC encounters. The companies on Shark Tank are often mass-market consumer products more suited for TV audiences and unlike Big Data, IoT, or social media companies that typical VCs may see. Many companies featured on TV might not have made it through the strict screening process required by typical VC or equity crowdfunding firms like MicroVentures and are featured instead for the entertainment value.
In addition, Shark Tank deals tend to be with small businesses rather than future “unicorns,” or privately held companies valued at over $1 billion, meaning these investments are less risky and less capital intensive.