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Think Big. Move Fast.

I’ve been writing up reviews of this season’s Shark Tank pitches from a silicon valley VCs perspective. Week three’s breakdown covered topics like how hard momentum is to turn around, and how participating preferred stock works. This time I’ll break down week four of this season.

BACK 9 DIPS

The first company started as a BBQ catering business, and eventually focused in on their most popular product, a dip made of blended up chicken plus various sauces.  Kevin described it as a “chicken slurpy” and brought himself to tears of laughter. The founders were very sympathetic;  a man, laid off from his job, and his very pregnant wife, who sold their house and investing $150k into the business and are working hard to make a go of it.

The company has done $400k in sales in less than two years and had an early test deal with a local supermarket chain that they were massively overperforming on. They are seeking $150k for 15% of the company.

At first, Lori, Cuban, Kevin and Robert all passed. While they were very complimentary of the team and product, they all gave versions of the “I’m not the right guy to help, so I’m out” pass. This was polite of them, but they’ve all invested in businesses outside their areas of expertise before. I suspect that the core issue is that specialty foods is a very tough business, with low barriers to entry, and it’s hard to see how Back 9 Dips can be a big businesss.

Daymond was trending to a pass as well when Lori came back in. She clearly was being swayed more by emotion than reason, and offered to invest $150k for 25% of the company if Daymond would split it with her.  At this point, the very pregnant cofounder was weeping. Daymond was sympathetic because he had been given a chance early in his career, but ultimately be passed. But in the end Robert came back in to join Lori. Daymond offered to be an advisor. The company took the deal.

This deal encapsulates why most individual investors don’t make money. Lori and Robert’s decision to invest was  more charitable than rationale, they both admitted that. Their returns are likely to be similar to those of charitable giving, where they will be paid back by knowing that they made a difference in peoples lives, but not in a cash-on-cash return.

LIFTER HAMPER

The second company was founded by an ex NFL played with a bad back. The company makes a laundry hamper built with bungee cords so that it always brings the laundry up to waist level, meaning that users don’t have to bend over. The cofounder was charismatic and persuasive and asking for $85k for 12% of the company. He had been at it for 6 months and had no sales or distribution lined up yet.

Lori quickly pointed out some problems with the product; it will be hard to move down stairs and it doesn’t wheel easily.

All the angels passed, citing a variety of reasons ranging from inability to help, to price, to the company being too early. They were right to do so. This isn’t a company yet, it’s an idea, and the founder could do a lot more on his own to validate product-market fit before raising capital. He has not done so, and that is not a good sign.

BAG BOWL

The third company makes a concertinaed silicon cylinder that provides an exoskeleton for pastic bags, so that they can sit upright on their own and function like a bowl. The two founders invested $40k in the business, and plan to license it rather than manufacture it because manufacturing seems too hard. They won a design award at a trade show, but have no revenue and no orders. They are seeking $40k for a 33% stake and want investors who can provide introductions for distribution and licensing on their behalf.

Kevin questioned the use case since bowls are ubiquitous. As he said, “Great innovations solve problems or reduce costs. This does neither, so I’m out”.

Cuban said, “I see you guys not as entrepreneurs but as wantrepreneurs”. I agree with him. The two founders had really not done much beyond coming up with the idea and building a prototype and filing for a patent. They don’t want to do the work. In this way, they remind me  of the Lifter Hamper entrepreneur. I think that Kevin and Cuban were right.

Robert said that he would be willing to invest $40k for 45%. He said that he could easily make some calls to see if the company would fly. In the real world, he would make those calls BEFORE investing, not after. Doing the research to form your own view of a company’s prospects is called due diligence. This includes calling current and prospective customers, understanding technology and manufacturing, doing reference calls on the founders and key executives, verifying financial and legal information and often other items specific to the company. On Shark Tank, where investment decisions get “made” quickly. In the real world a fund raising process takes 90 days on average to get to a termsheet, where deal terms are agreed, and another 30-45 days of legal and financial diligence before the legal documents are finalized and the money is wired.

Lori believed that the company should make the product themselves, instead of licensing it. She things that it could sell well on QVC, and was willing to accept their terms of $40k for 33%. One of the founders asked for a minute to consider the deal. She said that if they wanted a minute she would pull the deal, so they said yes. Fair enough too. If someone hits your bid, you don’t really have any moral standing to delay, you have to accept right away. That’s why most entrepreneurs do not make a specific ask on valuation, but wait to hear offers from investors.

ZOMM

The last company was a bit of a puzzler. The company makes a dongle for keychain that connects via bluetooth to your phone and has several features:

  1. Alerts you if you’ve left your phone behind.
  2. Finds your keys using an app on your phone
  3. Provides an emergency one touch dialer.

The entrepreneur launched Zomm in late 2010 and did $700k in sales that year. He did $5M in 2011 sales and is projected $7.2m in 2012 sales and $2M in income. He was seeking $2M for 10% of the company.

Upon questioning, it came out that the entrepreneur had invested $4M of his own money into the company and then sold 17% of the company to another investor for $5M. He either did not know, or was deliberately evasive, about how much he had spent on R&D.

None of the sharks could understand what happened to the $9M that had been invested so far, and why this seemingly successful company needed to raise more money. Some partial answers came up, including spending on a new version of the product with additional features, and excessively high inventories relative to actual sales in holiday 2011. The company still had $2M in inventory on the books.

The entrepreneur was clearly desperate. As Cuban pointed out, this is a “down round”. Zomm is seeking $2M for 10% of the company, implying an $18M pre money valuation today. But the company had previously raised $5M for 17% of the company, implying a post money valuation after that investment of $29.4M. So the entrepreneur was willing to accept a valuation more than $10M lower than a previous valuation. That usually indicated that things have not gone to plan. Furthermore, the entrepreneur offered control to Kevin to try to keep him interested in the deal (by offering a majority of the seats on the board), which does not gel with selling only 10% of the company

All the sharks passed, and they were right to do so. Something smells fishy, and the entrepreneur was desperate, and not upfront about the issues in the company. That combination almost always doesn’t end well.

This section was clearly heavily edited, so it is virtually impossible to understand why this reportedly profitable company needs to raise money. I speculate that the company lost a lot of money in 2010 and 2011 on marketing and R&D, and that it is still unprofitable today, with limited ability to move its inventory through discounting. So the R&D spend was likely well in excess of $1M. Zomm is probably counting on a big Q4 holiday bump to hit its 2012 sales and profitability projections.  This is, of course, hard to predict, especially since they missed their holiday projections last year. So the $2M in 2012 profitability is far from in -the-bag. The company likely will run out of money well before it hits its projected Q4 sales ramp, which is why it needs an emergency financing today.

WRAP UP

I thought that this weeks pitches were the weakest set of companies to present so far. But I’d love your thoughts and comments. Also, see the week 5 breakdown now up.

If you like this, follow us on twitter at @lightspeedvp.com and subscribe to our blog at http://lsvp.com/blog/ to get the rest of the seasons’ breakdown

 

 

 

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