Angel investors fund young small businesses with a promising future. Contacting a potential investor can be a daunting task because they don’t respond to unsolicited emails.
Additionally, you must be ready to pitch to them whenever you get to meet them as shown in the ABC reality show Shark Tank.
The panelists of seasoned investors is made up of Mark Cuban, Daymond John, Robert Herjavec, Kevin O’Leary, Barbara Corcoran and Lori Greiner. Aside from being are judges they are famous angel investors and venture capitalists (VC).
The show is popular because there are many startup founders seeking funding and so the competition is very high. However, a snappy pitch has helped many contestants to stand out. Additionally, the majority of business angels such as Mark Cuban and other sharks want to invest in startups with a bright future and in the same industry that they have invested in before.
The show has some degree of showmanship and dramatization as a result of extensive staging, and editing. However, there is a lot that you can learn from the way the judges evaluate every pitch and the way participants make their presentation
Here are the lessons that you can learn from these angel investors.
1. The Business
Shark Tank judges are first all investors. Some of them are into entertainment, construction machinery playgrounds, elf sweaters and more. As a result of that these investors are interested in sales.
It’s common to see sharks laughing at some pitches and business ideas. However, they keenly listen to business ideas that have generated significant sales. Actually, they even sober up and begin to negotiate a deal with such founders.
It’s important for entrepreneurs to realize that sometimes it’s hard to predict consumers’ reactions. So, the only foolproof strategy is to put the product on the market. Indeed most of the previously laughable ideas turned out to be the present-day unicorns.
Also, attractive products should be protected with some sort of patent. It’s actually easy for hot selling products to be knocked out of shelves. Therefore, shark judges will ask you how you plan to protect your protect especially in law-abiding markets such as the US.
Still, sharks reveal that the majority of investors prefers products to services. They want to deal with items sitting on a shelf or a website waiting to be picked or ordered by a buyer rather than a service that one human being provides to another. The reason is that maintaining quality and scaling up service is much harder compared to products. The process of hiring, training and managing human resources in a service-based business is more tricky compared to rolling out products in the market.
2. Market Size
An angel investor is interested in your business potential and its valuation. Seasoned business persons and entrepreneurs understand that even in a big or attractive market, execution is the key to taking a bite out of it.
To do that the founder and founding team should have strong and diverse abilities which are influenced by their background and the business traction.
Sharks are not impressed by how big the market is but your ability to tap it. They also want to strike a deal if the business opportunity is a great fit for their existing portfolio. Take for example Kevin O’Leary whose one of his platform targets weddings and young couples. Therefore this investor is keen on business opportunities that can push a new product or service along that line. In the end, both parties will win.
On the other hand, sharks are looking to invest in businesses that have a huge customer base. They are looking for niches that can grow with time although they look small at the moment. But, investors shun businesses in markets that remain small forever.
3. The Valuation
In the show, you will see founders asking for $100,000 in exchange for a 10% stake in the company valued at $1 million.
With that in mind, the judges will then ask the selling price of one unit of the product plus the cost of making it. The goal is to determine the profit margin. Therefore, a product retailing at $10 and whose production cost is $5 has a 50% margin.
If the company generated $100,000 as revenue in the previous year, out of it 50% or $50,000 is profit. So asking for $100,000 means that this investment is 10 times the revenue that your company generated or 20 times its profit.
Based on these numbers, an angel investor who accepts a 10% stack in your company in exchange for $100,000 funding will receive $5,000 profits every year. That means it will take them 20 years to recoup their investment back if everything remains constant.
However, this might shorten by 5 – 7 years or more if the business hopefully grows and the revenue continues to rise. However, the sharks can help the founders with guidance, support, industry connections or other abilities to help it grow. Unfortunately, these investors can’t touch any business opportunity that takes more than 7 years to recover their entire investment. Similarly, venture capitalists and private equity prefer investments that take 3-4 years but not beyond 10 years.
Still, these investors are concerned about the debt that the company has in addition to the founders’ shareholding percentage in the company. This is particularly important in a company that had previously sold equity in exchange for funds.
In view of that, companies with high debt levels tend to be unattractive and so angel investors opt to stay away from such companies. They also don’t want to sign a deal with a founder(s) that has lost the majority share in their companies. The reason beyond this is that such investors have reduced motivation and control over their business’s fate since they’re no longer the major shareholders.
4. The People
Both angel investors and venture capitalists choose startups based on the people running them, particularly their founders. While sharks might be excited to fund young founders in their teens or those in elementary schools, they don’t touch businesses that are not run full-time by adults.
In addition to a full-time commitment to running your company, sharks want to back entrepreneurs with proven success and experience in the industry or space they are pitching in.
Sharks will buy into the story or the cause when they individually like the founder. Otherwise, the show is edited to capture its viewers’ interest.
“What do you have that I can’t just do myself?” is one of the several questions sharks ask founders. In other words, they are asking them whether they understand the competition, They also want to know whether this business idea is so unique such that it can’t be blown away by its rivals.
Actually, an angel investor can take this idea since they have the money, hire top talent and become a competitor. But because the founder is the only one who knows the secret, his products and services will be unique and will stand out regardless of the competition.
Defensibility varies from business to business. One of the ways is having a strong patent. Businesses have trade secrets, secret ingredients, secret formulas, relationships with distribution channels, progress made in branding and more. A business opportunity tends to be unattractive without defensibility. For instance, it’s easy to duplicate an idea of a doorbell that is linked to smartphones
6. Industry Bias
As mentioned earlier, sharks are looking for businesses and industries that match their previous investments and experience. For instance, Daymond John is into the retail industry and particularly clothing businesses, Lorie Grenier is interested in businesses that fit well with the QVC channel while others are into high tech businesses.
Like other angel investors, sharks will only invest in business types they know. Similarly, the majority of participants wants to work with investors who have good experience as well as strong connection in their industry.
Additionally, some angel investors are keen to invest in companies led by women. For instance, the female Shark Tank judges Barbara Corcoran and Lori Greiner will tend to pick female-led companies while the other male sharks such as Robert Herjavec sign deals with companies run by men.
7. Leverage or Scalability
This is more applicable in products than in services and so a product-based business is scalable. Still, there are a few service businesses that one can scale such as web services.
The reason why it’s hard to scale a service business is that it’s done by humans and so growing it means adding your payroll, and other fixed costs. So it’s hard to scale service and so there are very few Shark Tank participants selling services. Actually, the owner-operator stands to benefit more than an investor
The Shark Tank show helps the public understand what angel investors are and what they do. The show also helps startup founders to understand what angel investors and venture capital look for in any business opportunity.
Investors are looking for businesses in growing markets, and founders with the ability to take a bite out of such a market. They want to invest where it will take just a few years to recoup back their investments, and businesses with experienced founders although it’s expected that they will bring in knowledge and industry connections to bolster sales.
Further, they want to work with founders that are able to protect their products through patents, businesses that are scalable and most importantly in familiar industries.
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