As a mergers and acquisitions advisor, I find the Shark Tank show fascinating like a football coach would, watching next week’s opponent’s game film. The show distills what is often a 6 to 8 month process down to a very intense eight minute vignette of the deal. Prior to the Shark’s grilling, the contestants prepare their investment business case (the equivalent of the offering memorandum) and market their opportunity to the show’s producers to earn the right to pitch the Sharks.
The culinary ninja with his Paleo Ice Age Meals had an attractive product in a hot area with lots of potential. He used a little showmanship and delivered his pitch as a poem after presenting his ask at a company valuation of $10 million, with limited current sales. Every one of the Sharks was turned off and several delivered a poem response that conveyed the message that his valuation was off the charts high and how can he possibly justify that. He had essentially lost them and tried to recover with his very recent development of a potential partnership with Cross Fit. That information was interesting to the Sharks, but he had already lost them.
With the caveat that I was not standing up there in the glare of the bright lights with 5 seasoned deal- makers in attack mode, I am going to deliver some arm chair quarterbacking. In our business, we are often approached by companies with great potential or the best technology, who just need the buyer with the brand, the customer base, and the resources to take the product to the next level. Where the reality gap comes in is that they want to be paid for all of this future performance with a lofty valuation not supported by current financial metrics and they want it all in cash at closing. That is what the Ice Age Meals guy did and he got justifiably bloodied by the Sharks.
How could he have changed his outcome, gotten his investor partner, while creating the possibility that his valuation would be realized? Well, he could have withdrawn his deal and waited until he closed the partnership with Cross Fit, and then come back later with the same valuation expectations. That is not a good idea because getting this audience with the Sharks is too important to pass up and may never return. The approach this arm chair quarterback would have been to preface his value expectations by first presenting the Cross Fit potential partnership . Next he should have acknowledged that it was not a sure thing so he was willing to do a deal with a significantly lower valuation at deal closing with a contingent future valuation based on post closing performance.
So his valuation proposal would be comprised of both value and structure. For example, he may ask for a closing valuation of $250,000 for a 10% ownership stake. The second component would be a potential $750,000 additional valuation which could be based on 6%, 5%, and 4% respectively of sales during the next three years of operations. So if sales were $3 million, $4 million and $5 million during the next 3 years, he would capture $180 K, $200 K, and $200 K of additional contingent transaction value. In the mergers and acquisition world, this contingent transaction value is referred to as an earnout.
Buyers are more than willing to pay for potential once that potential is realized and they love it when the Seller shares in the risk and puts their money where their mouth is. By using this approach the Paleo ninja would not have immediately turned off the Sharks and been dismissed as an unrealistic seller. He would have been viewed as a more resourceful partner and someone willing to work with the buyers. Here is the sad part of blowing this opportunity. The deal with Cross Fit has a lot of hurdles to clear before any money changes hands. The odds are against a fledgling start-up trying to do business with a much larger established company. The biggest reason is that a great deal of buyer resources are expended in order to roll out a partnership and they do not want to risk that their new partner goes out of business and wastes the investment and potentially damages their brand.
An investment from a Shark is a self-fulfilling prophesy. The little company will survive and thrive. Taking this information of the Shark’s investment back to Cross Fit immediately removes the largest impediment to getting the partnership deal closed. The odds of the partnership deal improve dramatically which in turn improves the future sales potential for the Paleo meals resulting in realizing the full potential of the contingent portion of the transaction value.
It is a shame a deal did not get done with a potentially very good product with some serious upside potential. A small tweak in deal structure could have resulted in a much more accepting deal environment between the Paleo ninja and the Sharks. Investors and business buyers set up evaluation gates that the target must pass through. Don’t allow them to eliminate you early by not passing the reasonable seller gate.