At my favourite beach, there is a siren that goes off if sharks are around – and for good reason. Sharks are professional hunters, who, given half a chance, will take a bite out of you. But you can’t blame the sharks for this; it’s just their nature.
Channel 10’s hit show Shark Tank features a panel of professional startup investors, the Sharks. The fact that they’re called this should be warning enough for startup founders to be very careful if you’re going to step into the water.
A lot of startup founders I’ve met believe that if they can raise money from professional early stage investors, like the Sharks or a venture capital (VC) fund, then they’re guaranteed success, a large exit, and early retirement. But this is dangerous thinking. These investors (for ease, let’s just call them all “Sharks”) are almost always only investing in you for one reason – they believe they can make money out of what you’re doing. They’re definitely not interested in your early retirement.
It’s unlikely you’d marry someone just because they’re interested in you, so apply the same logic to a Shark.
The investment process isn’t like Bondi (my favourite beach). There’s no siren to warn you about Sharks and their real agenda, meaning you’ve got to have your wits about you.
So what are the telltale signs that you need to watch out for when Sharks are interested in investing?
Firstly, there’s a good chance any investor who spends too much time talking about what they can “bring to the table” (other than their financial investment), is almost certainly trying to draw your attention away from some other part of the deal which is less attractive. For example, it could be a low valuation, small investment or bad term sheet. Don’t fall for this. Unless they’re willing to sign an agreement holding them to their non-financial investment, be very wary.
At Found, in the early days, we once had a prominent VC tell us to reject a significantly better deal from another party to take theirs – despite them offering a lower valuation, smaller investment and much worse term sheet. This was because they were “smart money” who could “help us along the way”, however when questioned about where they had done this in the past, they failed to provide any concrete examples or references. No, thanks.
Secondly, as they say, “the devil is in the detail”. For early startups, this really means, “the devil is in the term sheets” (the legal document which sets out what the investor is contributing, and what rights they get in return).
In normal business, working out who controls and owns a business is pretty straightforward – it’s whoever has the most shares. This is far from the truth for “early stage” deals, though. Any founder who believes that they’re still in charge because an incoming Shark only owns a small fraction of their company needs to be very cautious.
It’s relatively common for Sharks to introduce terms, such as founder vesting (you “earn” shares in your own startup over time); ratchets (if the business doesn’t go well, the Sharks get more shares for free); ad leaver (if you leave on bad terms with the Shark, they force you to sell them your shares at a low valuation); or drag and tag (where they can force you to sell your own startup). The VC who we spoke to wanted all of these, which would have left them in effective control of our company, despite contributing only a fraction of the total investment into the business. Again, no thanks.
Finally, be aware that any relationship with a Shark is going to run for many years, and is much closer to a marriage than dating.
It’s unlikely you’d marry someone just because they’re interested in you, so apply the same logic to a Shark. If the first few dates with a potential partner or investor include a lot of unhelpful suggestions, criticisms of what you’ve done in the past, or a one-sided conversation where you’re forced to listen to an “expert”, it’s unlikely that you’d go beyond the first couple of dinner dates – and you certainly wouldn’t put a ring on it. Don’t take the money if you’re not comfortable working with the individual people over a long period of time. I’ve seen it happen, and it rarely ends well; founders get burnt-out, investors become frustrated, and ultimately, it’s the business that suffers.
Despite the upfront challenges and sometimes-dangers of working with the Sharks, there can also be significant upside if you’re able to find a great group of investors to partner with to grow your business. Globally and within Australia, there are plenty of examples where amazing companies have been built with the help of professional investors. Sharks are typically well-connected, and have achieved success in growing and scaling businesses over time, and this can be invaluable with the right structure and circumstances.
So just like the beach, feel free to jump in the water – just watch out for what’s lurking below.