If you run a business and have time to watch television, your favorite reality show is likely Shark Tank. The show provides lovers of entrepreneurship with a candy-like fix by showcasing interesting business ideas that may or may not catch the attention of the “shark” investors. While I love the show’s entertainment value and admit that many budding companies get a great promotional boost from it, as a financier, it drives me crazy that entrepreneurs routinely give up large equity stakes when they often would be better served by financing with debt capital.
For those who have never seen it, Shark Tank enables entrepreneurs to pitch their startups to a panel of well-known investors, including Dallas Mavericks owner and billionaire Mark Cuban, fashion magnate Daymond John, QVC maven Lori Greiner and others. The business owners present their businesses and seek an investment from the sharks in return for an equity stake in the company.
A recent article in The Hustle detailed an analysis of every deal made on the show since 2009. It showed that the average deal amount is $286,000, and the average equity given up is 27%. Small business owners with great ideas are routinely giving up more than a quarter of their business when they may have been better served with an infusion of growth capital provided by other sources.
Again, I’m a fan of the show, but I can offer many reasons why taking a deal from a shark takes too big of a chunk of precious equity. Banks, credit unions, non-bank lenders and the U.S. Small Business Administration (SBA) can often provide better deals with debt capital.
For example, SBA 7(a) loans can be used for many business purposes, such as expanding or starting a business, buying real estate, refinancing existing debt, and purchasing equipment and inventory. All these are typically on the wish list of Shark Tank contestants. And rates are currently in the 5%-8% range.
My contention is that a working capital loan for $286,000 at roughly 8% is more attractive than giving up 27% of your company. Here are a few other reasons why a loan may be better than a deal on Shark Tank.
The deals the sharks really love likely qualify for loans.
If you have sales and a track record, you will likely draw the attention of the sharks. If you have an idea and a prototype but no sales, the sharks aren’t going to pick you — and neither will a conventional lender. However, if you have a good idea, have proved your concept and have sales, the sharks will be circling. But remember, a solid income statement and a burgeoning track record also look good to some lenders.
You can use a loan for stuff that makes the sharks cringe.
Watch the show, and you quickly learn what the sharks hate. For example, they frequently cringe when entrepreneurs want to hire marketing people. With a loan, you don’t need the blessing of a millionaire to do what you think is right for your business.
‘I don’t understand your business; therefore, I’m out.’
If the sharks are outside their comfort zone, they typically drop out of the bidding. Conventional lenders are more agnostic and have experience financing businesses across many sectors. Shark money is contingent on the stars having experience in your business.
Sometimes, sharks just want to lend.
Every deal is different, but on many occasions, the sharks fall back to offering loans or lines of credit to small business owners. It’s a great deal for them: They get above-market returns on money you likely could have gotten cheaper somewhere else, plus they get a small equity stake.
You are on the launching pad. Don’t give up equity now.
Most businesses that go on Shark Tank are at an inflection point. They are positioned for tremendous growth, and the business owners can taste it. They have built up their company and know what to do. All they need is cash. Why give up a big equity stake when you are on the edge of greatness? Consider financing the growth instead, so you can keep the long-term wealth for yourself. According to Harvard Business Review, debt is generally cheaper than equity.
Sharks have their place in the financing food chain.
While I am a proponent of debt capital, I also believe that giving up equity does have advantages for some businesses. You usually don’t pay interest on equity capital that you raise, so you may have more cash available to build your business. If your business fails for some reason, you also may not have to pay back your investors the same way you would to a conventional lender. Lastly, the right type of investors, like the sharks, can often offer great advice and connections that can help build your business in other ways.
Every small business is a bit different, and each contestant on Shark Tank has unique attributes. While some sharks recognize that entrepreneurs shouldn’t hastily give up equity, the premise of the show is that sharks buy into businesses. However, many business owners are better served with debt financing. Shark Tank makes for great entertainment, but it’s not necessarily based in the best business reality.