When to tell that wonderful investor, ‘Thanks, but no thanks’
Viewers of the popular investment/entertainment television program Shark Tank are very familiar with Kevin O’Leary, a Canadian businessman, investor, writer, and the show’s “Mr. Wonderful.” The reality program’s premise is simple: Entrepreneurs make a brief presentation to investors in hopes of earning a capital investment. O’Leary is one of five sharks/investors on the panel — the one who routinely wants the royalty deal, the “give me more equity for less investment” or the “loan interest into perpetuity” deal. He’s the one you want most to impress, perhaps, but he’s also the shark who takes the biggest bite.
An O’Leary offer seldom feels “too good to be true.” More often, the fledging entrepreneur finds the investment terms suddenly spiked higher than anticipated. Even the other shark investors have been known to point out the folly of doing business with O’Leary, but to take his or her business to the next level, a startup hopeful needs an immediate capital investment, and it’s hard to turn down O’Leary’s check and connections — and hard to shrug off his criticism or his bottom-line prediction of your business failure without him.
When should you exit, stage right?
But when is a deal not a deal? After airing your financials, past failings, and optimistic hopes of glory and riches to attract an investor, when should you swim as fast as possible toward safer investment waters?
- When an investor wants too much equity for the infusion of capital. You can’t afford to give up control of your company. Be very cognizant of future equity needs, even when you seek early funding. Remember that a second investment round will dilute your position another 20%-30%. You need to retain at least 51% of your company now, and holding closer to 80% will put you in better position moving forward to retain control.
- When an investor expects too much sweat equity and not enough salary. It’s an unrealistic expectation that you will not take a fair-market salary or that you’ll work 80 hours a week. If you WANT to do that, and many business owners do that to move the company ahead faster, that is your prerogative. But don’t make it a condition of bringing aboard an investor, or you’ll have an uphill battle to pay yourself later or to hire more help when you burn out from working too many hours yourself.
- When investment terms seem unreasonable. Most often, an investor will want to discount your business valuation to best leverage the value of his or her cash infusion. A lower valuation paves the way for more aggressive loan terms, since your “Mr. Wonderful” pushes the perception of absorbing a greater risk to invest in your business. While you might trade some equity position for an investment in your company (you do this when the investment actually is at risk, and you are not asking for a straightforward loan), you haven’t traded control for less than 51% equity. Beware of clauses that demand the investor must preapprove adding other investors, and be on the lookout for other “controlling interest” terms that could critically affect future cash flow or business management. You must retain the ability to immediately respond to new opportunities to run a business.
- When you can attract two sharks instead of one. In the excitement of pitching a deal on national television within a three-minute time span, too many entrepreneurs hope for a single response rather than suggesting that two investors come in on the deal. A co-sponsored deal suggestion usually comes from one of the sharks rather than from a participant. Why? Think of your own business; rather than bringing in one investor at 30% equity for $200,000, wouldn’t it be better and easier to bring in two investors at 15% equity each, for $100,000 each? You’ve watered down their individual control of your company, made the entry point more palatable, reduced their individual risk, and better served your company (and all investors) by tapping into their expertise and connections.
- When the investor gives you a “now or never” decision deadline. When they suspect another shark’s interest in a deal, television sharks Robert Herjavec and Mark Cuban are quick to make an offer followed by the caveat “you must accept my offer in the next 20 seconds or I’m out,” meaning do it now or that shark is heading off into the sunset in search of better morsels. Too often, the investment terms would likely have been better if allowed to simmer in the tank a little longer. Ultimatums from either party serve no higher purpose and, in fact, arouse suspicion that the deal shouldn’t be scrutinized too closely. Take the time to think every deal through and negotiate the best outcome for both sides.
Very seldom does a business self-fund its enterprise 100%, for 100% of the time. It’s common to need the occasional line of credit, a business expansion loan, or (third choice) an investor. While terms are standard for the first two options, involving another individual’s cash in your business is always risky business for both of you.
Knowing the true value of your business, and bringing an optimistic but reasonable vision of expected future success, is important, but knowing when a deal is a deal and not a predatory offer made by a bull shark in a business suit is critical.
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