advice

Why You Shouldn’t Look to Shark Tank for Startup Financing Education

Last night while I was watching Shark Tank, Kevin O’Leary insulted an entrepreneur for the umpteenth time about the presumptuousness of her valuation. In case you haven’t seen Shark Tank, entrepreneurs pitch their startups to a panel of investors. The problem is that these entrepreneurs almost never articulate valuations– they simply name the amount of money that they want to raise and what percentage of their business they are willing to exchange for that cash.

I’m sure that Kevin O’Leary knows how to calculate the valuation of a business, but for some reason, he consistently does it wrong on the show. For example, if an entrepreneur asks for $100,000 for a 25% stake in their business, O’Leary or one of the other judges will berate them and say that their business isn’t worth $400,000 (25% of $400,000). But as any finance person would tell you, if an entrepreneur is asking for $100,000 in return for 25% of their business, then they’re valuing the business at $300,000, not $400,000. This is the difference between a pre-money valuation and a post-money valuation. The pre-money valuation is what the business is worth prior to the $100,000 investment. The post-money valuation is the pre-money valuation cash plus the money that was just invested.

So why do Shark Tank’s producers allow the judges to consistently misrepresent the calculation of the startup’s valuation? I imagine they’re dumbing down the math for their audience. It would be confusing to say that a $100,000 investment represents 25% of a company currently valued at $300,000, although you could also say that $100,000 will represent 25% of the company after the investment.

What’s even more interesting is that the “deals” reached on Shark Tank are apparently “offers” for the judge to perform due diligence and structure an investment over a much longer period of time. One contestant said it can take 6 to 9 months post-show to structure an investment. Other terms part of these offers make a still bigger joke of the entire investment process on Shark Tank. I’ve heard several judges make offers where they acknowledge that the capital they’re providing is insufficient to build the business, but they’ll provide additional “non-dilutive capital” in the future. Does this mean that they’re offering free cash or debt in the future? And if it’s debt, what are the terms under which it’s repaid? What constitutes a default? Under which circumstances can debt be worse than dilution?

Shark Tank makes for great entertainment in so much as you’re watching judges analyze a bunch of startups. But their simplification of startup financing is so abbreviated as to make the process a bit of a joke. I’m not sure what would make for better television, but entrepreneurs certainly shouldn’t look to shows like this one for any sort of financing education.

The Takeaway:

  • No one should conflate pre-money and post-money valuations– they are two entirely different financial concepts.

– Andrew

Why You Shouldn't Look to Shark Tank for Startup Financing Education

Last night while I was watching Shark Tank, Kevin O’Leary insulted an entrepreneur for the umpteenth time about the presumptuousness of her valuation. In case you haven’t seen Shark Tank, entrepreneurs pitch their startups to a panel of investors. The problem is that these entrepreneurs almost never articulate valuations– they simply name the amount of money that they want to raise and what percentage of their business they are willing to exchange for that cash.

I’m sure that Kevin O’Leary knows how to calculate the valuation of a business, but for some reason, he consistently does it wrong on the show. For example, if an entrepreneur asks for $100,000 for a 25% stake in their business, O’Leary or one of the other judges will berate them and say that their business isn’t worth $400,000 (25% of $400,000). But as any finance person would tell you, if an entrepreneur is asking for $100,000 in return for 25% of their business, then they’re valuing the business at $300,000, not $400,000. This is the difference between a pre-money valuation and a post-money valuation. The pre-money valuation is what the business is worth prior to the $100,000 investment. The post-money valuation is the pre-money valuation cash plus the money that was just invested.

So why do Shark Tank’s producers allow the judges to consistently misrepresent the calculation of the startup’s valuation? I imagine they’re dumbing down the math for their audience. It would be confusing to say that a $100,000 investment represents 25% of a company currently valued at $300,000, although you could also say that $100,000 will represent 25% of the company after the investment.

What’s even more interesting is that the “deals” reached on Shark Tank are apparently “offers” for the judge to perform due diligence and structure an investment over a much longer period of time. One contestant said it can take 6 to 9 months post-show to structure an investment. Other terms part of these offers make a still bigger joke of the entire investment process on Shark Tank. I’ve heard several judges make offers where they acknowledge that the capital they’re providing is insufficient to build the business, but they’ll provide additional “non-dilutive capital” in the future. Does this mean that they’re offering free cash or debt in the future? And if it’s debt, what are the terms under which it’s repaid? What constitutes a default? Under which circumstances can debt be worse than dilution?

Shark Tank makes for great entertainment in so much as you’re watching judges analyze a bunch of startups. But their simplification of startup financing is so abbreviated as to make the process a bit of a joke. I’m not sure what would make for better television, but entrepreneurs certainly shouldn’t look to shows like this one for any sort of financing education.

The Takeaway:

  • No one should conflate pre-money and post-money valuations– they are two entirely different financial concepts.

– Andrew

Are You Too Old to Launch a Startup? Part 2

An Alternative to Starting from Scratch

The other day, I wrote about mitigating risk as an older entrepreneur launching a startup. My suggestion was to focus on an opportunity where you develop skills and relationships that will be helpful in garnering future employment opportunities in case your startup fails. But even in the best circumstances, the cash flow that you can personally generate is likely limited to 10% of the total capital you raise. And the likely scenario for most startups fortunate enough to raise capital is an initial “friends and family” round of less than $1 million. If the CEO’s salary is 10% of the total capital raised, then you’re likely to be making $100,000 or less per year.

How else can you undertake an entrepreneurial venture while still generating a significant amount of capital? You might consider buying a business.

If you’re apprehensive about starting a business because you don’t have much in savings, the prospect of buying a business may seem scarier still. But buying a business doesn’t necessarily require putting up your own capital. There are plenty of institutions and high-net worth individuals who would finance the right acquisition. Just as importantly, there are many businesses that make sense to acquire and grow.

Types of Businesses to Consider

Of the millions of apps and websites in existence today, the overwhelming majority will run out of cash and eventually close their doors. Most of their founders will be receptive to opportunities to sell, but that doesn’t mean that these companies are right for you to acquire. An app with no revenue and a small user base usually has no value. The business may also cost a significant sum of money just to maintain.

There are also instances of sites or apps with significant traffic where the owners haven’t figured out how to monetize the traffic, usually because it’s too small to command sponsorship deals. Others have found success aggregating media properties to achieve the scale necessary to generate advertising dollars, but that type of strategy– usually referred to as a “rollup”– is a more complicated proposition than what I’m focusing on here.

There are two types of businesses that I would suggest looking into: offline businesses with huge online potential and online service-based businesses.

1. Offline Businesses with Online Potential

There are plenty of offline businesses that successfully sell local products, whether it’s a company selling crafts, local foods, or even specialized machinery. The owner might be making a comfortable living and is unfamiliar with the opportunities afforded by digital marketing and national or international distribution. Either that or they may be unaware of effective strategies that they could use to transition their companies to sell online.

If you can identify a business like this and then construct a business plan that contemplates massive expansion through Internet marketing, you might be onto a great opportunity. The risk proposition associated with introducing a new product into market will be largely reduced, as the owner should have already validated consumer interest in their product. Therefore, you can focus on profitably acquiring new customers through paid digital marketing channels.

2. Online Service-based Businesses

In the offline business example, you’re looking for an opportunity where you can apply new marketing channels to a successful business.

The online service-based business opportunity is often about applying new sales muscle to an existing digital business. There are many talented design firms, app development shops, and even SEO and SEM companies that never scale beyond a relatively small size. Why? Because while their owners are talented at their crafts, they have virtually no management experience and no knowledge of how to build a sales funnel. The result: while the gross billings may be high, virtually nothing drops to the bottom line and the business is constantly treading water in terms of its financial position.

What’s the Upside of Acquisition?

Acquiring a business requires you to create a business plan, similar to how you’d create a business plan for a new startup. If anything, you need to substantially sharpen your pencil when it comes to projecting an acquisition’s cash flow and detailing your marketing and sales efforts. Often, your fundamental thesis is that subtle tinkering can have a profound impact on scaling the business.

Who Will Invest?

In a near zero interest rate climate, there are many investors looking to diversify their capital where their returns can be substantially higher than if they were putting money into savings accounts. For a small acquisition (less than $1mm), you’re likely approaching the same friends and family investors who you would otherwise be approaching if you were financing a startup. For a larger acquisition, you’re likely approaching a private equity firm that is in the business of financing similar types of deals.

How Much Money Can You Make?

In the startup scenario, your salary is capped because the business isn’t making any money while you’re trying to get it off the ground. It looks unseemly for you to take a large salary when you’re starting with 100% of the business and you’re asking others to follow your entrepreneurial dream.

In the acquisition scenario, it may be that the majority of the business is owned by your investors. More importantly, you’re likely looking for a business where your salary is coming from the cash flow of the business instead of from the capital that you’re taking from investors. Based on the size of the acquisition, you could make substantially more money– a salary potentially competitive with what you could have earned at a job. The difference is that you’re the CEO and as a much of an entrepreneur as the person who started their company from the ground up.

The Takeaway:

  • For older entrepreneurs who are risk-averse, acquiring a company may be a better option than launching a startup from scratch.
  • 2 good options for acquisition: offline businesses with online potential & online service-based businesses with growth potential.

– Andrew

Read part I here.

Want help weighing entrepreneurial options? Sign up for a free Founders’ Hours session.

Are You Too Old to Launch a Startup? Part 1

An Optimism Tempered by Fear

The hallmark of the entrepreneur is usually unqualified optimism. “We will disrupt this space” is a common refrain. You expect to hear that every idea is a “billion dollar opportunity.”

But lately, in several private conversations, I’ve been hearing from entrepreneurs who speak in a much humbler tone. They ask me, “Am I too old to start a business?” One guy said: “I can get over the fact that every venture-backed startup seems to be led by a CEO right out of school. I can even get over the fact that there’s probably some age discrimination at play when it comes to financing startups. I think I can afford to launch a company. But I’m not sure I can afford to fail. Am I too old for a startup?”

It’s easy to tell someone that you’re never too old to start over. Or you’re never too old to start up. Or you’re never too old to dream of doing something big. But is it true? At what point does the fear of failure become a self-fulfilling prophecy for those embarking on the path of entrepreneurship?

Older people arguably have more to worry about than younger people. Older people are more likely to have families or they may be gearing up to start them. Older people may be taking care of aging parents or considering how their own retirement is approaching. An older person’s desire for stability may trump their search for new experiences as they consider their finances, obligations, and time required to start anew if their venture were to fail. So an older person may have a great business idea and huge ambition, but if their savings aren’t very large, it’s understandable they would be afraid of the possibility that they might find themselves looking for work and depleted of savings with nothing to show for their failed startup.

If that outcome sounds bad, it’s not the worst prospect. It’s a fact that most businesses don’t succeed, but they often don’t fail right away either. Instead, they may churn along for 5 or 6 years before they finally fade away. Worse than being 45 with no salary or savings is being 50 with no salary or savings.

“Can I really afford to take that risk?” they ask me. To put it simply, there is no easy answer.

Is Entrepreneurship Less Risky than the Alternatives?

There exists the notion of launching a startup not as fulfilling a dream, but as pursuing an alternative. For example, most people considering starting businesses are unhappy with their current situations. In New York, I’ve met many people who have recently left high paying jobs in finance and are now considering becoming entrepreneurs. They evaluate the tiny salary they might earn with a startup against the much larger salary they were earning at a bank, struggling with the huge differential. But, the comparison is often a false choice.

When the banks downsized a few years ago, they laid off many people in their 30’s and 40’s. And the unfortunate truth for many of these people is that as the banks begin rehiring, they’re replacing their mid-level managers with upstarts in their 20’s. The same is true for other professions where older, more expensive workers are replaced with younger, cheaper workers. For any person who once believed that their career was a lifelong decision, they may now be a third to half-way through their life, faced with the reality that they must learn new skills necessary to transition their careers to an increasingly digital world.

A Startup as a Tool for Developing New Skills & a New Rolodex

Sometimes, the ability to recognize how bad the alternatives are makes starting a new business easier. When you realize that the old opportunities no longer exist or that you’re missing the skills to get the new jobs you want, or worse yet, you’re just miserable with the established way of doing things, the prospect of launching a startup is less about seeking new possibilities and more about fulfilling an imperative.

When you’re older, you’ll need to consider different issues than you would if you were younger while embarking on a startup. You should be aware of the resources you’re lacking as well as the skills and expertise that you’ll need to scale. For example: if you were to launch a social networking app, you would need to develop an understanding of product design and development, and you’d also need to learn what it means to construct a funnel for acquiring customers and how online paid acquisition works. It’s crucial that recognize your weak points and plan ahead.

Recently, I spoke with a 40-something entrepreneur who was evaluating the future of his enterprise software business that he’d been selling to some of the largest retailers in the world. He wanted to know what I thought about his prospects if he were to discontinue the business. I pointed out to him that his rolodex of senior executives at these retailers was second to none. He had perfected the sales process akin to something of an artform.

If his startup didn’t succeed, it wouldn’t be because he couldn’t sell, but because there were macro changes afoot concerning the software being used in his industry. He could feel safe pursuing his business, knowing that every day he was learning and building more for himself, regardless of whether or not his business succeeded. If he ever needed to find another job, the relationships and skills he’d been developing would prove invaluable for another software firm targeting these same clients.

I find that every entrepreneur is afraid of failure. But the sine qua non for the successful entrepreneur is to operate in a way where the fear of failure doesn’t cripple your ambition or cloud your strategic decision-making skills. The culture of entrepreneurship is predicated on the notion that failure is expected on the path to success, so much so that entrepreneurs who have failed are generally viewed as more financeable than aspiring entrepreneurs who have never tried to start businesses.

As an older first-time entrepreneur, you’ll need to convince yourself prior to starting that failure is likely. If it happens, it will be part of your journey, rather than the end of the road.

Mitigate Risks by Choosing the Right Business & Planning Ahead

More responsibilities means that older entrepreneurs need to be much more granular in planning than younger entrepreneurs. This is especially true when managing the personal cash flow. Whereas you once might have been comfortable with unknowns and living off of credit card debt, you’ll now need to understand the exact cash requirements of your new venture before you start.

I tell people who are starting businesses that they should plan to go 6 to 9 months with no salary. At the end of that period, if you’re able to raise capital from friends and family, your annual salary probably won’t be more than 10% of the total money raised– a number that is likely to be less than what you’d be earning at a day job. Your strategy for dealing with the salary issue is to develop a clear understanding of what you will realistically make and how much of your savings you’ll likely deplete before you can expect to earn a more competitive salary. Whereas younger entrepreneurs might not contemplate devising a personal “breakpoint,” you’ll need to figure out early on at what point you won’t be able to afford to continue your business.

If the “breakpoint” is a year out and you’ve selected a business where you’re acquiring skills that would also be useful on the hunt for a new job, then you should be able to come to terms with the prospect of failure. Recognize that a new venture will shape you and your trajectory regardless of its ultimate outcome.

The Takeaway:

  • It’s normal to have fears, but don’t let them cloud your judgment.
  • Analyze your situation objectively to figure out whether or not a startup would provide you with more long-term opportunities than your current career path.
  • If you decide to launch a startup, create a realistic personal cash flow and choose a “breakpoint” before you start.

– Andrew

Read part II here.

Still have questions about entrepreneurship? Sign up for a free Founders’ Hours session.

Should You Build 2 Products at Once?

This past week, an entrepreneur shared with me his mobile app and a very clear description of the business proposition that his app would address. When he was done, and after I had absorbed his business opportunity, he paused. Then, he said: “The best part of my story is that this exact functionality can be used as the basis of a second business. All I have to do is change some copy and graphics within the app.” This, he said, was a case of “build once and receive twice.”

If I was half-way excited by the first part of our discussion, my excitement level fell to zero after hearing about the new opportunity. His sentiment about adapting a piece of his app’s functionality to solve numerous business problems is a not a phenomenon unique to this entrepreneur. While in the trenches, every entrepreneur sees new opportunities that they couldn’t have imagined prior to commencing their product’s build.

The new idea is often appropriate as a product extension. Other times, you might come to the conclusion that you’ve stumbled upon two ideas that can serve as separate, compelling businesses. I’ve heard entrepreneurs go so far as to rationalize this process of building two unrelated products by referencing Google. They say, “Google offers search as well as work productivity software. If Google can do it, why can’t I?”

This is my response: 1) Google won search first before building Google Docs or any of their other products; 2) You’re not Google (yet).

Most entrepreneurs find it extremely hard to do one thing well. Only with a herculean amount of effort can you apply the requisite discipline and focus necessary to succeed at one venture. When you’re just starting out, it’s next to impossible to do two things well simultaneously.

Here’s what I told the entrepreneur: if he liked his new app idea better than the first idea, he should abandon the first one. Although he claimed that creating two ventures would double the size of the addressable market opportunity, he would likely fail at executing both of them. By embarking on two separate ventures, he would almost certainly turn off any investors and advisors who might otherwise be willing to help him.

The Takeaway:

Focus on doing one thing well. If you succeed, the next opportunity will present itself in time. When it does, it will be easier for you to accomplish than the first one.

– Andrew

What Happens When You Run out of Blog Content?

When we first launched the Roadmap course in May, we debated for a long time about whether or not we should start a company blog. In my past ventures, blogs ended up as exercises in futility. They inevitably died when we lost steam on our posting frequency and then we eventually stopped writing them altogether, leaving behind a graveyard of content and dreams of a large readership.

When actively maintained and frequented by an engaged user-base, a blog is an amazing asset for any company to have. So the question we posed to ourselves was: how can we create a blog that is likely to remain sustainable over time, avoiding the burnout that so frequently follows blog creation?

Our first conclusion was that my prior burnouts weren’t associated with the actual writing, but rather with the process of selecting topics to write about. Our second conclusion was that the principal focus couldn’t be simply opining on industry stories. The blog’s focus needed to center around content that we were already engaging with on a consistent basis.

So what would this tactic look like, practically speaking?

On a regular basis, I receive many questions and invitations for meetings from startup founders. In the past, I would do my best to respond to each person individually and schedule time to speak with them. My motivation for connecting with first-time entrepreneurs was threefold:

  • It kept me sharp. The best way to learn about what the future holds is to be speaking to as many people you can about the future that they are creating;
  • I believe in the principal of ‘paying it forward.’ In the past, many people were there to help me. It’s good karma for me to help others; and
  • I’m interested in bringing founders into the Roadmap boot camp where I can provide the most comprehensive entrepreneurial information I’ve gathered and scale the educational platform that we’re building.

In the past month, we created Founders’ Hours— weekly 20-minute sessions that entrepreneurs could schedule in order to ask me any questions they have about building startups or relating to the weekend course that we offer. Right now, we’re using the free minimalistic service Calendly for meeting scheduling.

While each founder’s case is fairly specific, the advice that I offer is, more often than not, broadly applicable to a wide range of entrepreneurs. This means that it makes sense to try and memorialize each session’s content in the form of a blog post. Using Founders’ Hours as a content creation vehicle would accomplish:

  • Educating entrepreneurs on business questions asked by real startup founders;
  • Drawing dedicated, quality entrepreneurs to upcoming events; and
  • Generating sustainable and shareable blog content.

By institutionalizing these question-and-answer sessions on a weekly basis, we’re guaranteeing that we’ll continually generate blog content. Publishing these findings would also satisfy our company’s over-arching vision, which is providing guidance and inspiration to entrepreneurs so that they can build stronger businesses.

At the outset, we’re instating the following basic guidelines for our blog, just to keep the content uniform and flowing smoothly:

  • Each post is based on a Founders’ Hours session;
  • Content is anonymized and generalized so that no individual can be identified and so that it will aid the larger entrepreneurial community.

As we launch this blog, we view it as an experiment, not a fixed device. For the time being, we hope we’ve solved the problem of offering content that isn’t duplicative, irrelevant, or merely self-promotional. We’ll continue adapting our guidelines as we go along, making sure to focus on content generation tactics that can be enacted with the least amount of effort and the maximum potential value, which we’ll write about here.

The Takeaway:

To have a much better chance at developing a regular blogging habit, center your blogging system around content that:

  • You’re most interested in;
  • You deal with frequently (which makes you somewhat of an authority);
  • You view as having a great potential for being automated.

If this tactic has worked for you in the past, we’d like to hear about it. Leave a comment about the wonders of automation or your blogging hacks below.

Want to receive entrepreneurial advice and contribute to the greater startup community’s knowledge base? Schedule a free Founders’ Hours session with me here. (We’ll never share your personal details.)

– Andrew

AR Menu