On Friday night's episode of Shark Tank, the two founders of Kodiak Cakes company approached the sharks in hopes of landing an investor for $500,000 in exchange for a 10 percent share in their company. Though the sharks were immediately impressed with the initial sales of the whole-wheat flapjack and waffle mix, they voiced some concerns from the start.
Nearly all of the sharks asked the founders why they weren't borrowing against their receivables or rolling over their profits in order to not have to take on an investor. This was the smartest and most honest beginning to an investor pitch I've seen on the show in a long time.
The Sharks Get It Right
I'm usually not a fan of Shark Tank, because I would like all business owners to thoroughly explore any and all financing options before giving away valuable equity in their companies. Debt financing is oftentimes a much better solution than equity financing, but many entrepreneurs give in to the allure of having an investor interested in their idea or service and the relatively easy money that comes from having an investor versus taking out a hefty business loan. I encourage all business owners to consider that taking on an investor is permanent, while a loan is temporary.
This is why it was refreshing to me to hear a few of the sharks on Shark Tank advise the Kodiak Cakes founders to seriously consider debt financing over equity financing.
With the $500,000 investment, the founders would spend a large majority of the cash on slotting fees--that is, the upfront fee paid to stores in order to be on the shelves with the major competitors in the space. Though the sharks agreed that the slotting fees are a necessary evil in the food industry, Mr. Wonderful was the first to speak up about the company's valuation and counter with a 50 percent share offer, and Robert Herjavec offered $500,000 at 30 percent equity. Barbara Corcoran came up with a partial offer of $250,000 for 25 percent equity, and Mr. Wonderful joined in at $250,000 for another 25 percent (making their joint ownership 50 percent).
Obviously, the Kodiak Cakes founders were a little stunned with these reduced valuations. They turned down both offers, and Mark Cuban praised the founders for their decision, remarking, "I think you guys are smart," as they exited the tank.
I often disagree with Cuban, and I think that he has, at times, done a disservice to entrepreneurs by opposing small-business loans to start companies, but I found myself happily agreeing with Cuban on Friday night. By agreeing with the Kodiak Cakes founders' decision not to take on an investor, advising them to borrow against their receivables and fund their own growth, Cuban helped to educate entrepreneurs across the country.
Bringing in an investor is, in my opinion, often a misguided step in expanding and financing a small business. Instead of giving away valuable equity to a partner that you'll be stuck with well into the future, consider debt financing as a way to maintain your ownership of the company with a temporary small-business loan. Cuban might finally agree with me on this point, or at least be willing to concede that starting a business with borrowed money isn't always a terrible idea.