Shark Tank: The 3 worst startup mistakes made on TV’s best reality show

Posted: May 21st, 2013 | Author: | Filed under: Startups | 3 Comments »

This article first ran as a guest post in Geekwire.

For a long time I’ve felt like I must be either the first or last entrepreneur to discover the ABC series Shark Tank.  For the uninitiated, it’s pure startup voyeurism: a company stands in front of a panel of 5 plutocrats, pitches, and either gets an investment or gets laughed off the stage.  It wasn’t until Jeremy Liew’s great review of the latest episode that I realized I wasn’t alone.

But watching Shark Tank, I find myself grimacing repeatedly.  It’s like nobody pitching has ever read a half-decent book on negotiation. I keep seeing the same mistakes, over and over again.  Here are the three worst.

Negotiate

By far the most embarrassing mistake any of these poor companies make is actually failing to negotiate.  They show up and make their pitch.  They get asked some questions.  Suddenly, the sharks are piling on about what’s wrong with the deal. The entrepreneur is visibly flustered.

Suddenly, one of the sharks floats an offer.  Maybe a second one joins in.

You can see the look of gratitude and relief on the entrepreneurs face.  How gracious of them to offer to invest in their flawed child!  How generous of them to help.

Pshaw.  None of these folks are chumps or charity cases.  Do you know why they trash your business before making an offer?  So you’ll take the offer.  It’s not one of the nicest negotiation techniques, but it’s plenty effective.

Here’s the simple rule.  If someone makes you an offer, it’s because they’re interested.  If they’re interested, you should negotiate.  Not accept; negotiate.

Of course, there are right ways to do this and wrong ways to do this.  You’ve seen plenty of entrepreneurs on the show (and in life) start grandstanding about company value, only to have the Shark shake their head and declare themself “Out”. Don’t do that. Don’t be ridiculous.

Instead, make a reasonable and polite counteroffer.   “I’m really excited by the prospect of working with you.  How about 20%?”  Even if they appear to be tottering on the edge of leaving the deal (and remember that they have every interest in making you think they’re about to bail for maximum negotiating leverage), a polite response like that won’t hurt anything.  The worst you’ll get is a “no”, and now they know that you’re not a total pushover.

And of course, if you’re a hot item – if more than one shark is interested – make them bid!  Get them each to give you numbers, and don’t let them collude to drive your price down.  With multiple offers, use a line like this.  “Each of you would be a huge asset here, but my goal here is one fully-committed partner and the best deal for my shareholders.”

Know what you want

You’re going to come in with something clean and simple, like “$50,000 for 10% of the company”.  They’re going to counter (because unlike the contestants, the Sharks always negotiate) with something like “$100,000 for 8% and a 5% royalty”.

When this happens, people get this funny look on their face, like Mr. Wonderful just sprouted wings and started handing out gumdrops.  There’s no excuse for that.  The Sharks have a limited array of tricks up their sleeve, and you should have considered all of them before setting foot in that room.  Here’s the exhaustive list (please comment if I’ve missed one):

Stake size: The most obvious.  They’ll offer the same money in exchange for more of the company.  This is easy to plan for by deciding ahead of time on the worst case dilution you would accept.

Controlling interest: If the ownership is 50%, then no major decisions can happen without both you and the Sharks agreeing. If it’s 51%, then they can fire you the next day and liquidate the company if they think that’s a good idea.  And don’t fool yourself – if things are going sideways, they probably will.  Decide what you can live with.  If it’s 51%, remember the words of Mr. Wonderful: “I can fix you, but you probably wouldn’t like how I would do it.”

Number of Sharks: Most entrepreneurs get giddy over multiple investors (or, as they’re known in the startup parlance, “party rounds“).  Truth is, if you have more than one or two Sharks in the deal, you’re getting a lousy deal.  First, because each of them has a comparatively small stake, and therefore a small incentive to help.  Second, because if you’re in a bind, each of them reasonably expect one of the others to help out (the Bystander Effect).  Third, because the alternative to being in the same deal is offering competing deals – since that didn’t happen, you almost certainly took it in the shorts on valuation.  There’s only one situation where multiple sharks in the offer is good: when they are getting a 50% or greater interest.  That’s because while one person with 51% runs the company, two people who split the round are each just 25.5% owners.   If I was giving up 51% of my company, I’d want that stake split between as many Sharks as I could get – since my vote, plus any one of theirs, would constitute a majority.

A royalty:  You should know ahead of time what kind of royalty your business can support, and realize that a never-ending royalty seriously limits the long-term viability of your company by permanently lowering your margins.  And realize that once a shark gets their money back, they have a much smaller incentive to see you succeed – people are more motivated by fear of loss than opportunity for gain.

Help:  Some of the sharks have specific assets that may be useful.  Mark’s got stadiums and movie theaters, Damon’s got retail distribution, and so on.  Many of the deals are done because the entrepreneurs want access to those networks.  Do your homework before you get on so you know what help you can realistically expect from who.

Contingencies: This is the one that kills me.  If they say “I will invest contingent on X”, that’s the same as saying “I won’t invest, but might change my mind if you do X”.  A typical structure is that they will invest contingent on a valuable introduction to Their Friend Abe going well.  Well, real investors introduce their companies to Abe, and also Belinda, and Charlie, and Dolores, and a whole alphabet of partners because they’re committed.  Contingencies are just shopping around, saying “I’ll see what my friend thinks”.  Avoid offers with contingencies if you have any other options.

Don’t ever leave the room

“I’ll offer 25%.”

“I’ll offer 20%!”

“I’ll do it for just 18%!!!!… wait, could you leave the room for a minute?”

Pop quiz: when you return, your options will be:

a) 25%, 20%, and 18% because they just wanted some private time to talk about how much they liked you

b) 15%, 13%, and 11% because they’ve been negotiating against each other while you were gone

c) Just 18%, because the other two dropped out

d) 30%, but good news!  We’ll all be investing together to help you.

Don’t let Sharks collude.  There’s a reason the federal government outlaws business collusion: it drives the prices in the wrong direction.  If the Sharks try any of the “please step out for a moment” shenanigans, just let them know you’re on to their tricks.  Explain that you want one committed partner who doesn’t need to seek the approval of others, and if you walk out the doors you’re not coming back.  They only do the “step outside” when they really want a deal, so all the leverage here is in your court.

Of course, the most egregious error here is people who actually volunteer to leave the room.  Don’t call your spouse.  Don’t call your mentor. Don’t call Steve Wozniak. And for heavens’ sake, don’t go outside to talk to your cofounder who’s standing right there. Do your homework up front, know where everyone’s bottom line is, and trust your cofounder to implement the strategy you discussed without going outside and whinging about it first.  Then make the deal, or walk out with your head held high.

Life is Shark Tank

I love this show because it’s the only reality TV I’ve ever seen that feels real.  I’ve had friends sell companies for the original offering price. I’ve stared stupidly at an angel investor, finding myself totally thrown by the suggestion that we add a board member. And I’ve knowingly pitched a room full of angel investors, where the actual printed agenda  calls for me to walk out and sit quietly in the hallway where they collude on price.

If you haven’t had the pleasure, pull up a comfy chair and watch a few episodes.  Just remember when you watch Shark Tank: your role models aren’t the entrepreneurs.  They’re the Sharks.

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  • http://mightywisemedia.com/ Eric T. Wagner

    Great insight Dan.

    Given what I’ve seen from some of the totally ill-prepared entrepreneurs on the show, can you imagine what happens with the real world of entrepreneurs faced-off against vcs and angels? Not a pretty sight indeed I’m sure.

    Thanks for sharing your wisdom…

    Eric T. Wagner

  • uxemily

    Hi Dan,

    I read this on Geekwire and didn’t notice you were the author. Good stuff. I’m looking forward to reading your book.

    Emily Holmes (fellow science camper :))

  • strive4impact

    Hi Dan,

    I’ve never seen SharkTank (yet). My uncle’s
    company was asked to be on the show, but then didn’t get on because
    they “had too many tech companies”.

    Anyway, reading this and your suggestions help me understand a couple of things:

    1. I really need to get around people like you more often – even just through reading your blog. These are awesome tips.

    2. I really need to watch some episodes of SharkTank.

    Thank you for this write-up.

    Jonathan Kraft