Shark Tank Almost Has It Right

By Chris Russell

I’m sure most readers are familiar with ABC’s reality show, Shark Tank. The show presents entrepreneurs to a panel of potential investors (or “Sharks”). The pitch is made, the financial need established, and then the Sharks are given the chance to critique and discuss the opportunity, some more gently than others (after all, it has to be dramatic or no one would watch). The Sharks have the opportunity to get in on the deal if they are interested in the product or business.

Offering a royalty deal is now starting to become quite popular on Shark Tank. You’ll see deals where an investor will offer to invest $x for an ongoing royalty of $x per product sold. The reason the investor counters with this proposal in lieu of an equity investment ($x for x% of the company) is because they see minimal chances for a liquidity event (an exit). It’s mutually beneficial for the investor and entrepreneur to use a royalty or revenue share investment structure in that scenario. This is also a nice structure for the entrepreneur and founding team because there’s no equity dilution (a main selling point that Kevin O’Leary likes to mention) or battle over nailing down a valuation. Plus it offers flexibility, the business isn’t tied to fixed re-payment schedule. For example, if zero products are sold, zero royalty payment is due that month.

But (you knew it was coming), here’s the catch. Generally the royalty they are proposing has infinite duration. This has the potential to make the financing VERY expensive for the business. That’s where we’re different. Our Revenue-Based Financing (RBF) investment structure is designed with a cap on your payback obligation. Once that amount is paid we’re out of the picture. You have a clear expectation of the cost of capital from the get-go.

Because Shark Tank is a TV show designed for drama it’s not a true representation of the entire investing process (surprise!). There is little to no attention given to understanding if the proposed royalty is healthy and can be supported by the business. That’s all done off camera after the pitch has been accepted. Here at GSD Capital, we spend a great deal of time analyzing a company’s financials and forecasts before proposing a revenue share percentage.

Shark Tank is a great way to see the basics of the pre-term sheet stage of investment. It also highlights some of the different directions funding can take. The recent trend in royalty deals on the show highlights several of the pros, but the structure shown on the show can bite the entrepreneur in the butt. By contrast, our founder-friendly RBF structure has similar positive attributes, but none of the bite.