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Think Big. Move Fast.

Although Sharktank has been running reruns on Fridays the last few weeks, the show ran a Sharktank 2012 Holiday special on Tuesday night.

The most interesting company to present was The Coop, a modern, design-focused, indoor-outdoor children’s playspace in Los Angeles. The two founders, Lucinda Lent and Juliet Bodystun wanted to raise $150,000 in return for 15% of the company in order to franchise their concept nationwide.

 

By all accounts, the Coop is quite successful. Revenue is driven by children’s parties, which cost $600-$4,000 for a two hour party for 15 kids, which apparently is the market price for kids parties in LA. The space can host 6-9 parties per weekend, and they generated $350,000 in revenue last year. Even after paying the two founders $100,000 collectively in salary, the business still made a profit in the $125,000 to $150,000 range.

To build the Coop the two founders took a $125,000 small business loan.  As the Coop is a labor intensive business that reflects a lot of their own personality, they would prefer to build a franchise model than build a chain of Coop locations themselves.

Kevin O’Leary was the first shark to pass. He said that he loved the numbers but thought that they should build more locations themselves before attempting to franchise. He didn’t believe it was investable right now. The founders replied that O’Leary would get his money back in two years if he invested, and that they wanted business expertise, not just money.

Three of the other sharks quickly passed as well, also noting that the founders should build more locations on their own. Mark Cuban added that he thought that the price points were too high for middle-America, and that a business that reflected so much of the founders personality would be hard to scale. I agree with them that the near term opportunity is to simply build more centers on their own.

Barbara Corcoran seized on a comment from the founders that an investor would get their money back within two years. She said that she would give the founders $150k for 15%, but wanted a personal guarantee to repay the money in two years. As O’Leary said, this isn’t an equity investment. This is a loan with a 15% warrant attached at a zero strike price. Astonishingly, the entrepreneurs took the deal.

This was a crazy deal for the entrepreneurs to take. It is incredibly expensive money, and as O’Leary said, it is a confirmation that many banks are not currently lending to small business in America. If a business throwing off $125,00-$150,000 in annual profit can’t get a $150,000 loan, there is something wrong. But given that the Coop is throwing off as much money in annual profit as it needed to open the first center, it probably doesn’t need to take investment capital at all. They could fund expansion from cash flow.

The entrepreneurs did say that they wanted the business expertise of one of the sharks. But there are other ways that they could have gotten business expertise to complement their own skills. The most obvious one would be to hire somebody. They could have either paid someone a healthy salary out of the profits that they are making, or they could have given someone a much smaller equity stake in the company to attract an experienced business person.

In the venture-backed startup world, there are a couple of types of firm that will lend to a startup, even a startup that is still losing money. Some banks, including Silicon Valley Bank and Comerica, specialize in funding startups and will lend against inventory, infrastructure or for general corporate purposes. They often do get warrants attached to their loans, but for nowhere near 15% of the company;  usually an order of magnitude less. Banks often have operating covenants for their loans that require the company to be hitting plan, or close to it.

Another source of loans is Venture Debt firms, including TriplepointPinnacleWTI and many others. These firms typically charge more than banks and have higher warrant coverage, but have fewer restrictions on the use of capital, no covenants, and will often lend more than a bank will.

In both these cases, the lenders often like to see venture capital invested recently into the company that sits under the debt in the capital structure and provides some level of security to the debt. This is largely a relationship driven business, with the relationship between the venture investor and the lender being crucial to debt being made available to a portfolio company.

Debt is often a very interesting way to help finance a startup and extend its runway or facilitate expansion, but it is usually a lot cheaper than what Corcoran offered the Coop.

Fat Ass Fudge

Donna McCue was trying to raise $250k for 5% of her company, which makes delicious, lactose-free, gluten-free fudge using goat milk. She was selling her product at farmers markets and had made only $60,000 in sales over the last 12 months as a sole proprietor, although she had recently secured distribution in two local Whole Foods stores.

The entrepreneur was definitely a big personality and hilarious, but all the sharks quickly passed. As Barbara Corcoran said, “I see a wily enthusiastic lady who likes to make fudge. It doesn’t have anything to do with the money. You just want to get out there and meet people and share your chocolate. But you’re doing that already, so I’m out.”

Not all passion projects are meant to be big businesses.

The Living Christmas Company

Scott Martin, or Scottie Claus as he preferred, pitched the Living Christmas Company. Whereas most Christmas Tree vendors sell dead trees, the Living Christmas Company instead rents live trees and delivers them to local customers in Southern California. The company has grown from about 100 trees rented in 2008 to 1,300 trees rented in 2011, charging $100-200 each. Note that this is more expensive than buying a tree.

The company did about $150k in revenue over its two month season last year and realized $33k in profit, before any owners’ salary. Scottie wanted to raise $150k for 30% of his company in order to build out a nursery and infrastructure to handle growth.

Most of the sharks passed quickly, citing the difficulties in scaling the business, and the competitive landscape (more expensive than a real tree, and plastic trees are equally convenient and don’t contribute to deforestation).

In a surprise move, Cuban agreed to invest the $150k for 40% after hearing about Scottie talking about how he was creating meaningful jobs for dozens of people, mostly veterans, over the holidays. The job creation really seemed to strike a chord with Cuban. He said that he believed in the proposition of convenience with a conscience, but still thought that the company had a price problem. But he was willing to work with Scottie because, as he said, “Money is easy, doing the right thing is hard.” This tells you that his reasons for investing were not entirely driven by expected returns, and likely were not even primarily driven by expected returns.

Partie Poche

Partie Poche is a small pouch that straps to a woman’s thigh for her to store her phones, money and ID so that she doesn’t have to carry a purse when she goes out. The two founders, both students at Loyola Marymount University, sought $100k for 20% of the company.

The company had only sold 200 units on their website, for prices ranging from $17-$39, relative to a cost of goods of $4. They talked a bit game, projecting 100-200k unit sales in their first year, and touting a conversation with Nordstrom and various connections through their investors as likely to drive big purchase orders.

Through further conversation it turned out that the 200 units were sold 6 months ago and the company had not sold anything since. They had raised an additional $50k for 40% of the company from new investors a month ago and were now seeking a big markup in valuation from the sharks.

Almost all of the sharks got indignant about valuation. But they also identified other reasons for passing, notably the little that the founders had done to advance the business and the fact that they did not appear to listen to the sharks, but rather wanted to try to bulldoze over them by making the same, mostly theoretical or projected points, over and over again. As Robert said, “You’ve done everything except get dirty. Go do some work.”

Cuban was the most patient of the Sharks. He said, “You guys remind me of me when I was 21, trying to win every battle, that is what being competitive is about”. But under questioning from him it became even clearer that the founders had not done the basic work or research to move their business forward. All they had done was make some assumtpions and run an excel model. He passed as well.

Unfortunately, this “wantrepreneur” attitude is not uncommon among business students who want to start a company. Many of them are happy to do the planning, modeling, strategy and even take some fun meetings, but they don’t want to do the dirty, boring, difficult, nitty gritty work that it takes to actually make progress. Partie Poche doesn’t even have a real website up today, just a parked, free Wix page. They knew for 6 months that they had a product that could sell, but they didn’t take action on it. They should take Robert’s advice, go do some work.

The other thing to learn from Partie Poche’s failure on shark tank is that they thought that they could change the shark’s minds by arguing with them. A pitch is not a debate that you can win. There is no judge scoring you for points.  You can never change a potential investors mind by arguing with them about projections or plans. You can only change their minds with facts and progress.

Trying to argue is futile, and damages the opportunity to come back again in the future when things have changed. While it is frustrating to have someone refuse to invest in your business, your best option is to take the rejection gracefully, accept whatever feedback you think is useful (versus trying to refute everything) and come back later when you have real proof that your assumptions were right.

 

Follow us on Twitter @lightspeedvp.

 

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