“I’m Out. Take it behind the barn and shoot it”, says Kevin O’Leary, aka Mr. Wonderful. In its nine years running, Shark Tank has attracted followers not limited to aspiring entrepreneurs. The personality clashes between the sharks, their famous quotes, and the occasional pitches that make the audience grasp, all make Shark Tank a thrilling show to watch. With that said, regardless of whether one watches Shark Tank for the drama or the products, there’s no denial that the show offers practical insights into the making and building of a business. Without further ado, let’s decode all those fancy words that bubble around the tank.
Every pitch starts with an entrepreneur offering a piece of their business, saying something along the line of “I am asking for 100,000 dollars in exchange for 10% percent equity”. 10% ownership of the business for 100,000 dollars give the business a valuation of 1 million dollars, the math is straightforward. The drama begins, however, when sharks object to an unrealistically high valuation, which they would usually determine based on the size of the market–how many people consume this products, the ability of businesses to scale–can the business grow quickly at a cost-effective manner, and most importantly, sales. High sales indicate a more established product and a stronger proof of concept, which ultimately equal lower risks. But of course, there are other factors that appeal.
First off, sharks frequently ask for gross product margin, which is gross profit divided by revenue. This number shows whether a product is efficiently manufactured. For example, a product that costs $15 to make and sells for $20 does not scream profitability. Low profit margins might mean that a company is not operating efficiently, or perhaps there are other competition in the market that drives the price equilibrium down. In which case, Mr. Wonderful opts for the question, “Do you have a patent, or what is so proprietary about your product?” In simple terms, a patent protects other competitors from copying and producing a business’s invention at a cheaper cost. Similarly, when a product is proprietary, it has a distinctive feature that sets itself apart from others of its kind, and prevents the big corporations from “crushing you like the cockroach that you are” (Thank you Mr. Wonderful for your imagery). While calculating whether a business is appealing, customer acquisition cost can assert a big role, as whether through coupons or social media, money spent on getting consumers shall not come close to exceeding customer lifetime value, which is the business’ ability to monetize those customers in their future relationships.
Next stop, which is Mark Cuban’s favorite–numbers and finance. He usually starts off with asking how much money the business has raised, as well as the valuation of the company during the last round. If the company is a startup, Mark would then be interested in their burn rate, which is the amount of money spent on supporting operating costs. A major portion the burn rate goes into building inventory. A lot of the times, a new business has yet to reach break-even, which is the point where they make zero profit. Liquidity is part of the equation, as it determines how quickly a company can convert its current assets into cash. Burn rate, liquidity, and the potential break-even point, altogether reflect the cash flow. This financial performance indicator speaks volume about the profitability of a business, namely, the ability to sustain and expand operations. Upon hearing the projection of a company, or its plans moving forward with or without an investment from the shark, investors on the show can then decide whether the business is viable.
If the business seems promising to the sharks, pitchers can expect to hear their offers. In the case one is lucky enough to entertain Robert and Lori, their offers will be structured as initially requested. Daymond, on the other hand, would likely be interested in licensing the product, which means granting another company the right to proprietary information for a limited period of time in exchange for a fee. Barbara is known for her franchising deals. Similar to licensing, it involves letting another party implement the company’s business model (how a company utilizes resources to generate profits) and use its brand name to sell its products or services.
Out of the six sharks, Kevin tends to be the most ‘creative’ in his offers. A royalty deal is a prime example. This ongoing payment is made to the investor every time a product is sold. For example, if a pair of headphones sells for $15, Kevin would ask for $3 until he recoups a certain amount of the money invested. After which, he becomes a shareholder, owning a percentage of the company. In rare cases where sharks believe that a product might be disruptive in nature, they would fight even if that means lowering their desired equity to become a partner of the company. A disruptive product is one that creates a new market while displacing the existing one, such as Netflix, Uber, or Airbnb. Many pitches like to refer to their products as disruptive in order to justify a superior valuation, only to be met with condemnation from the sharks.
After rounds of negotiations where counter-offers are made, business owners and shark tanks decide whether to move forward together. Some business owners walk out of the tank with a deal, some do not. In the long run, it is the business that speaks for itself.