Startup Inequality on Shark Tank
Don’t confuse your Shark Tank startup for a high growth startup
For two decades I’ve been focused on building high growth startups — companies that have a chance to become billion dollar companies. The way high growth startups are funded and operated is very different than the way most companies you see on Shark Tank or The Profit are funded and operated. Far too often I’ll talk to an entrepreneur whose objective is to build a sustainable business — that will eventually be worth $10M, $50M or $100M company (which is admirable and smart) and yet they want to get funded like a high growth startup in the Valley. Paul Graham from YC has a great post on the difference between the two where he explains,
“A startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of “exit.” The only essential thing is growth. Everything else we associate with startups follows from growth.
If you want to start one it’s important to understand that. Startups are so hard that you can’t be pointed off to the side and hope to succeed. You have to know that growth is what you’re after. The good news is, if you get growth, everything else tends to fall into place. Which means you can use growth like a compass to make almost every decision you face.”
The typical high growth startup will raise money several times throughout it’s life — starting with a seed round between $250K and $1M usually done as a convertible note ($5M valuation cap with a 20% discount). If things progress well the company will raise a Series A between $5M and $10M giving up around 30% of the company’s equity (the convertible note will convert into this round). Investors will encourage the startup to spend the money as fast as possible in furtherance of the company’s objectives — if the company is successful the investors WANT to invest more money. Most high growth startups will either achieve success or failure with this capital — the successful companies will raise Series B, C, D… leading to an IPO. The failures will either sell, shutter, or operate as a zombie startup indefinitely. The outcomes for high growth startups are very binary — you either win big or lose your shirt.
On the other hand, the ‘typical startup’ you see on Shark Tank or on The Profit will only raise capital once and they’ll be hyper-focused on making sure they achieve breakeven BEFORE they run out of capital. If you watch Shark Tank you know that a LOT of the deals are non-standard. In cases where the “Shark” doesn’t take a control position they’ll often ask for “non-standard” terms like royalties, contingencies, and lines of credit. For example, more than 34% of Mark Cuban’s Shark Tank investments include these sort of non-standard terms (Barbara Corcoran — 40%, Daymond John — 34%, Kevin O’Leary — 43%, Lori Greiner — 28%, Robert Herjavec — 30%). These non-standard terms are the NORM in the world of typical startups (i.e. the ones that aren’t being run like high growth startups). Investors in typical startups need a mechanism to get their money out of the company sooner than later.
Investors in high growth startups know they’re invested for the longterm — typically around a decade these days. They’ve bought a lottery ticket and they realize the price is patience. In my experience you’ve got to make around 100 of these bets to find a unicorn — most of your deals are going to zero and that is just part of the game. Investing in typical startups is a different game entirely. Protection of principle is paramount. Investors look to assets and guarantees to protect their investments and as a result they don’t expect the sort of insane returns they do from high growth startups. Typical startups that eventually repay your investment and are able to grow at least 5% a year provide a great lifestyle to their founders and a nice return for investors — investors aren’t getting rich on these deals, but they are a lot of fun.
The problem I see is that too many startups attempt to raise capital like a high growth startup but run their company like a typical startup. Out of the last 100 deals I’ve looked at here in Texas only 10 of them have been legitimate high growth startups — despite that 100% of them were raising money like high growth startups. I don’t bother to make Shark Tank or Profit non-standard offers anymore because I don’t want to offend anyone. The truth is when the economy is booming (it is booming here in Texas right now) they’ll likely find someone to give them the money on high growth startup terms and when the company fails no one will be the wiser. So the point of this post? I’m not entirely sure — keep calm and carry on.
About The Author
Alexander Muse is a serial entrepreneur, author of the StartupMuse, contributor to Forbes and managing partner of Sumo. Check out his podcast on iTunes. You can connect with him on Twitter, Facebook, LinkedIn and Instagram.