hat are a few pieces of advice that accountants and financial professionals should give to entrepreneurs specifically who are starting up a business?
First, start off with a small investment. This is my theory of activating “The Power of Broke”. A lot of people believe that when it comes to start up investment, the bigger of the investment that you put in, the better a chance you have launching a company. But that is not true. It is not important to have a big investment to start.
The important part is to see how much you can do with little to no funding, which requires you to put the numbers into the right place. You start off with a smaller investment to create an initial amount of revenue and you do the best you can. Don’t invest in a website for $20,000.00. Instead, you can start off with a Facebook page, and you do a couple of Facebook ads, and/or have someone who can help understand pay-per-click and things like that. Rather than taking a big lease in a space, open up something like a co-share or maybe even operate from home. For many start-ups, they acquire large amounts of debt early on and they don’t recover from that.
Second, entrepreneurs should begin with sound accounting and legal advice to up front. Starting with a legal business formation and an accurate accounting set up and process creates a structure for the entrepreneur to begin searching for that initial small investment we just talked about. That investment should be used to create a proof of concept at a smaller scale, which can then be used later to apply for a loan or to approach investors.
I really like what you said about seeking the advice of a lawyer, and the best accountants in my opinion are those that are partnered with attorneys, and they take a teamed approach. Businesses that aren’t built on a stable foundation, from the way they incorporate to the way they manage their contracts, may be profitable, but they will fracture under the weight of their own existence.
I've noticed several times on Shark Tank episodes, somebody's come in with a great idea, fantastic business model, solid revenues, and then you guys ask a question like, "But is this invention patented?" And there are just blank stares. The entrepreneur looks like a deer in the headlights. And that completely ties your hands as an investor; there's not much you can do with that.
This is correct. That goes to not having good advice in the beginning. And I agree completely that if the structure of the company is weak, you're going to be crushed under it. Hiring good accountants and good attorneys from the beginning is critical. And you brought up a good point. The accountant and attorney need to talk to each other. Compare this to your own company. If the sales team doesn’t talk with production, everybody will do their own thing. And somewhere down the line you are going to find out that there isn’t any margin there.
Whether you are talking about building a building or building a company, it's all about the foundation that you build it on.
What other types of research do you and your colleagues on Shark Tank do before you consider investing in a candidate?: If an entrepreneur is looking for an investor, what type of things will that investor be looking for?
Daymond: We absolutely look at the entrepreneur’s legal structure and the accuracy of their financials. We look at how the company was initially funded, because depending on initial funding, we might need to create a new company. Do you have the ability to take in partners? Do you even have the legal structure to take in funding? Were proper trademarks and patents acquired? Are trademarks in the proper categories?
We examine sales, but not just sales. We examine the full picture from gross sales to what is sitting on the balance sheet in terms of inventory. And we also look at how the entrepreneur go to market. What was the acquisition cost per customer?
Joe: There's a concept that comes up sometimes on the episodes related to funding that I would like you to elaborate on. Sometimes somebody will approach you guys for an investment, and you classify their request as gold digging. Can you explain what that means?
Daymond: On the show, we come across some people who fit in one of two categories. First, they don't really want a deal. They are so obnoxious in their requests, because they feel that just being on Shark Tank will give them the platform to become well-known and they won’t need to share profits. Second, they over-value their company because they have fallen so in love with the brand, product, or concept, that they believe that it is worth way more than what the market will pay for it. We may try to bring these entrepreneurs back to reality, but that is a good indication that the entrepreneur will always be challenging.
Joe: I'm glad you broke that down. It's great to understand what you mean by the term on the show, but also I think sometimes small businesses approach banks, venture capital funding, or even private investors with that same mentality. They are too emotionally connected. Because they’ve described an emotional value component, they're deflated when they go to a banker and the banker is making it all about the numbers.
The big takeaway is that an investor, regardless of where they are from, will invest because they want a return on the investment. If there is not evidence of a return on investment, then the entrepreneur is not going to get money. It is the accountant’s or bookkeeper’s role to be able to connect the value proposition of the business in a financial way to the person that wants to lend our client the money.
Daymond: Correct. There are two type of buyers or investors out in the market. There are people that want to make an investment to scale the company. These investors see an opportunity which accountants and bookkeepers clearly can convey.
The other investor is someone looking for a strategic value. One great example of this was Apple Computer who went out and acquired Dr. Dre's Beats, the headphone company, and Dre's music catalog. This allowed Apple to bring in the millennials. Apple didn’t need to create a new pair of headphones. They needed a strategic acquisition to increase market share, so they paid a pretty big valuation for that.
In either case, the accountant has two jobs. First, the accountant needs to provide accurate financials. That is obviously their number one job. The other job is to give the entrepreneur the advice of a realistic approach which includes basing negotiation tactics on realistic numbers. The accountant gives their client the insight and ammunition they need to walk in the room.
Part two of this two-part series will be published on May 5, 2021.