The popular reality TV show Shark Tank allows hopeful entrepreneurs to pitch their businesses to a panel of business executives and investors.  The show has everything I look for in entertainment: the American dream, witty puns, and some valuable lessons in business and entrepreneurship.

Plenty of articles have attempted to develop a list of business lessons one can glean from the show, though few have put it into an easily digestible framework for how investors assess a potential investment and what that means for how an entrepreneur should pitch.  It essentially boils down to a three part screen that investors follow when assessing their potential involvement:

  • Is it a good business idea with real potential?
  • Are the deal terms realistic?
  • Would the investor want to work with the people?
Let’s look at each of these three screens in more detail.

Good business idea with real potential

This is the screen where most entrepreneurs fail.  It is the most intensive screen of the three, requiring either clear proof of success in the marketplace or strong potential based on the problem it solves and its differentiation.  The criteria have some subjective components, allowing investors to often disagree about the potential for an idea’s future success.

Solves a problem – Investors want businesses where the customers of the product or service have a clear pain point that the business clearly solves.  They are not keen to invest in seasonal, novelty, or extremely niche opportunities (with the exception of when the business has shown an impressive track record of success).

Differentiation – It is often not enough to have a business that solves a real problem; the product or service needs to be differentiated from other offerings in the marketplace, and be able to maintain competitive advantage.  The most preferable differentiation is through intellectual property, though sometimes through the founders’ story, or occasionally through first mover advantage, though this is rarely a long-term competitive advantage.

Proof – It must be more than just an idea; it must be an operating business.  That means there must be a functioning business model with a fully developed product or service, a healthy base of customers, and good numbers.  With enough customers and revenue, the need for the business to solve a problem and be differentiated can matter less.  On the other hand, an idea could be considered investable without sales if it solves a big enough problem with clear differentiation.  Either way: know your customer, the market size, and have a clear plan for customer acquisition.

Realistic deal terms

For a business to be investment worthy, the investors need to see a clear path to a return on their investment.  That means it must have a realistic valuation based on where the business currently stands, allow them enough stake to be worth their time and investment, and have a clear plan for growth that would allow them to recover their investment within a reasonable timeframe.

Valuation – Many people value their company way too high.  They assume an optimistic scenario of what the company could be worth in the future, without recognizing that the valuation should be done based on current risk-weighted assessment of potential scenarios.  There are a couple key ways to develop a valuation: using a multiplier common for that industry, or a discounted cash flow.  Realistically value your company.

Equity offering – Strategic investors are rarely interested in businesses that offer an extremely low equity stake (5-10%), often seeing it as an insult.  It needs to be enough equity that it is worth their time as well as their money.  That said, if they have full confidence that the business will essentially run itself (that the business owner does not need coaching, advice, or resources from them), then they can be willing to go for small equity amounts.

Purpose of the money – Acceptable and preferable uses for the investment money are production to meet overwhelming demand or automating production to reduce costs to keep up with demand.  The investors rarely look favorably upon the money being used for research and development of the product or for marketing, since this is typically an indication of a company that does not yet have a proven business model, or does not have a clear path towards growth.

Good people

Finally, the investor must want to work with the entrepreneur.  They recognize that their role as an investor is typically not limited to the money, but that they will act as a strategic partner to help guide the entrepreneur.  Therefore, they need to feel assured that there will not need to be excessive handholding, the entrepreneur is willing to learn, and also has good intuition.

Knowledgeable – The entrepreneur should display experience, resources, passion, and confidence in the field of their business.  Any faltering in the knowledge of the product, market, rationale for the business model, or economics calls into question the person’s credibility as the leader of the company.

Candor – Investors don’t like being jerked around.  If they sense any dishonesty like changing from the original deal terms, discovering history of the business that was being covered up, or the entrepreneur skirting around the answer to a straightforward question, the investors can become concerned about potential dishonesties in the future that could keep them from wanting to work with the entrepreneur.

Open-minded – During the Q&A portion of the pitch, the entrepreneur must show humility and a willingness to listen and learn, or the investors could deem the person stubborn or difficult to work with.  People who talk over the investors or respond defensively to all of their questions tend to rub them the wrong way and end up not getting funded.

Intuition – The entrepreneur needs to have a certain gut instinct about the business that the investors can sense, as well as be tuned into the mood of the investors to be able to negotiate appropriately.  Some entrepreneurs get too pushy during the Q&A or negotiation, unable to read the situation well, ultimately losing them the deal.

What does all of this mean for you as a potential entrepreneur pitching to investors someday?

Make sure you are pitching a good idea at the appropriate time for the type of investor you are approaching.  Get feedback early and often (before your pitch) to make sure you are solving a real need, make sure it’s something that people really want, and find a way to keep yourself differentiated from the rest of the market.  Prepare for any and all questions about your product, market, profitability, and plans for growth.

Value your business realistically and have a strong rationale for why your business is worth that much at this point in time, besides just “potential”.  This means the timing of when you ask for money is very important.  Also, go into the negotiation with not just your asking price, but your walk away price, and a decision on how to respond if other scenarios such as royalty structures or selling the company entirely should arise.  Remember, your walk away price should consider the difference in value of you growing the company on your own versus with the help of the investor and their money.

Although you cannot change who you are as a person, you can display the best side of yourself.  Remember, the pitch is an opportunity to share your love and passion for what you do, while also getting valuable feedback from experts at growing successful businesses.  Know that you should be the expert on the numbers and customers of your business, but that you should have some humility with regards to their expertise in some areas of marketing, distribution, and sourcing.

Also keep this in mind when watching the show – Shark Tank is not how the real world works.  Your first pitch will not be an ask for money in exchange for equity.  So take from it the lessons and not the expectations of how meetings will be run.

And let me know if you have any additional lessons to add!  Thank you and good luck pitching.

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