Season 4 of week 10 of Shark Tank was interesting because two of the pitches were for internet businesses that I could imagine seeing in my day job as a Silicon Valley Venture Capitalist. I cover one of them, for Nearly Newlyweds, over at Entrepreneur.com.
The other one was for a company that describes itself as Netflix for neckties. The two founders are attorneys in Mobile, Alabama, who found themselves wearing the same ties over and over again, and wanted to find a way to expand their wardrobe. They allow subscribers to rent an unlimited number of ties, but no more than two at a time, for $15.99/mth. Most of their ties retail at the $80-90 range.
The company launched six months ago and so far has grown to 110 subscribers, with all customer acquisition coming from PR and referrals. They are seeing an 85% monthly renewal rate. The founders did not have many good answers about how they would grow the subscriber base. They talked about a referral program, as well as direct sales. They believed that they could get customer acquisition costs to the $10-12 range, but as Cuban points out, that was just hope, they had no evidence to back this up.
Kevin O’Leary liked what he saw, and said that he was willing to invest $50,000 on terms that any other shark could set if they were willing to do the other $50,000. Unfortunately, none of the other sharks took the bait. Barbara liked the idea of a gift to yourself with a fresh new tie, and that ties are easy to ship. But she said that it was too early for her. Daymond noted a lack of passion for fashion as his reason for passing. The others all passed as well.
All e-commerce businesses should be examined through the lens of customer acquisition cost and lifetime value. The company charges $16/mth. It’s tough to calculate contribution margin without knowing more about the frequency with which ties are exchanged and the price of the ties, but lets make some guesses. I speculate that a tie lasts two years under this model before you have to replace it, and there are perhaps 4 exchanges per month. That would put the cost of the ties at around 2x $85/24 = $7/mth. The cost of shipping and handling is at least 4 x $2= $8/mth. Adding these up gives $15/mth. That leaves only a dollar of margin per month in contribution. With a 15% churn rate, that suggests about $7 in lifetime value. There is no way that customer acquisition can happen below $7. I would speculate more like $40 at scale. This business can’t work.
The next two entrepreneurs run a wine tasting cruise business. They own a boat and run 12 cruises a week. Each 90 minute cruise takes six guests out on the water to taste four wines and eat appetizers. The company did $250,000 in sales last year and is profitable.
The two founders sought $105,000 for 25% of their company. They had three stages to their plan. The first was to franchise their model, selling a captain a $35,000 boat and a business plan to replicate Corks Away for $175,000. The second, which they quickly backed away from, was to build out their Pesto Torte appetizer into a consumer packaged goods food business. The third was to build an indoor dinner ride and wine tasting cruise in Vegas.
All the sharks quickly sensed the scattershot approach to growing the company and passed. As Kevin pointed out, the business is not investable, but it isn’t horrible. They are having a great time and making money, but there isn’t an opportunity for growth and hence a return for a new investor.
Ruck Pack makes a peak performance nutrition shot, designed and tested by members of the Marine Special Forces. The founder, Major Rob Dyer, was a former Special Ops Marine, and is now an accounting professor at the US Naval Academy, with another two and a half years to go in his enlistment. He was pretty impressive. He developed the product out of necessity. His special forces teams all relied on supplemental energy shots when out in the field, and none of them worked well enough. They boosted you up, but then crashed you down. And those energy shots with caffeine gave snipers the jitters, which was not acceptable in that job.
The company has previously raised $240,000 from friends and family and put it all into R&D, building a website, and buying 95,000 units of inventory. The first 15,000 units sold out in six weeks in specialty retailers that distributed it in the Quantico area, and another 80,000 are being made now. The company sought $75,000 for 10% of the company in order to buy more inventory and scale up manufacturing. Currently it costs the company 80-85c to make a shot, but at scale this could be reduced to 50c. The shots retail online for $2.19 and wholesale for $1.65. Filling existing orders is the biggest problem that the company faces.
The founder was very focused on his proprietary ingredients, some of which need to be publicly disclosed, but others of which do not. But the sharks disagreed. It isn’t the formulation that is the barrier to entry, but rather the marketing positioning of an energy drink designed by, and made for Marines Special Forces.
Daymond had invested in a competitive business previously, so he bowed out. Barbara thought that the company should be further along for $240,000 already invested, and didn’t like that the founder only owned 43% and would be diluted by a further 10% in this round, so she passed. Neither of these reasons make any sense to me. Much of the money went into buying inventory, and a founder with around 40% owernship is still highly motivated to see the company succeed. 40% is on the high side of ownership for most of the companies that I see.
Cuban loved both the idea and the entrepreneur. But he was troubled by the fact that the founder coud not focus full time on the company for another two and a half years, given his day job at Annapolis. This is a legitimate concern. As Cuban says, business can’t only happen after 4pm.
Kevin, in a surprise move given his history, offered to meet the founders terms. Robert suggested that instead of taking $75,000 for 10%, the founder instead take $150,000 for 20%, half each from him and Kevin. Kevin agreed to this, as did the founder, and a deal was struck.
Interestingly, this new deal actually lowered the pre money valuation for the company. $75,000 for 10% implies a $675,000 pre money valuation. $150,00 for 20% implies a $600,000 pre money valuation. I think the founder was smart to take more money as this company will require substantial capital to grow due to investments required in inventory. But I think that given the demand, he could have held firm on valuation and either given up slightly less equity or taken in slightly more money for the same dilution.
Cuban is right that the biggest issue is going to be founder attention. But given that the development has been done, the growth of the company comes down to distribution and marketing. Both of these are things that the company can hire experts out of the beverage industry to do. I think this company has real potential because of the appeal of the story.
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