February 13, 2012, 5:00 am

Dragon’s Den & Venture Capital

by: The Financial Blogger    Category: Business,Make Money Online
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dragon's denI don’t know if you watch this show, but I got hooked on Dragon’s Den last fall. I don’t really like reality shows so I never took a look at this show before this season. On a boring Wednesday night when I was flipping channels faster than eating my Doritos, I stopped on this show where 5 multi-millionaire entrepreneurs listen to people who are looking for a business partner.

 

The participants can have an existing product with a real business setup or just a prototype. It can be of any form and it doesn’t have to be a physical product either; it can be a service as well. I’m currently watching the Canadian version of the show but I know that there tons of versions around the world so you might be able to find one that fits where you live.  I really like this show for 2 reasons:

a)      I laugh my evil laugh when Kevin eats dreamers and poor entrepreneurs alive

b)      It pushes me to see my online sideline as a business and structure it accordingly

For example, I know that my site valuation model is good for my industry but worth crap for the Dragons or for other venture capital firms. Why? Because my model is not based on net profit.

 

I like this show because these 5 “dragons” know what they are doing and they bring people down to earth pretty fast. Most entrepreneurs think that their great idea is worth millions (or at least a few hundred thousands). But the reality is that your idea is worth absolutely nothing if you cannot materialize it and make money from it. If you lack of time, resources or money to generate sales; it simply means that someone else with the same idea will find the missing ingredients and make the soup before you even get into your own kitchen to make it.

 

Potential? This is the magic word to make the Dragons blow a gasket (especially Kevin!). Why? Because if it has so much potential; where are the sales??? According to them, all excuses (or explanations if you prefer) justifying the fact that there is no profit yet are unacceptable. And I can’t blame them; if you are about to invest in a company, all you care about should be how much it’s making. This is why investors look at Price / Earnings Ratio and Earnings per share. Because earnings matter!

 

How much is my company worth according to this mentality?

I often thought of seeking for private investments in our company so we can grow faster. With more money, I would obviously make more and my company would run faster than a rabbit on speed. But I realize after watching this show that I’m talking about potential and not about the real numbers. It was time I was brought back to reality!

 

This year, I should be making roughly $5K to $6K profit per month. This would total between $60K to $72K of profit for the year. My last share valuation stands at $98K so the company is worth roughly $196K according to our existing valuation model. If someone would like to buy shares of our company, we would pay between 2.72 – 3.27 times the profit. Wow, that’s cool isn’t? According to me, it’s darn good deal!

 

That’s probably where most people would stop and be proud of themselves. However, there are 2 other factors you need to consider before you claim yourself to be a rich entrepreneur: Taxes and your time!

 

The first thing you need to consider is your time. What if you would have to pay yourself for all the hours to put into your sideline? I work about 4-6 hours a week and so does my partner. To make round numbers, let’s say that we each work 10 hours a week at $35/hour. This is a salary of $36,400 that we have to take off from our “profit”. This leads us to a bracket of before tax profit of $23.6K – $35.6K. Not as appealing right? But wait… there is more…

 

All right, if I take off taxes from my profit (19%), I get an after tax profit of $19.1K – $28.8K. So an investor would be paying between 6.80 and 10.3 times our company’s net profit. The 6.80 times is not too bad but the 10.3 times is definitely too much for any realistic investor.

 

Then, what’s the point of selling 25% of our shares for a mediocre 50K?

 

If we were to sell 25% of our shares, we would barely get 50K for it. Even worse than that, there are company expenses that would be not tolerated by additional partners. For example, I doubt that any private investors would tolerate that my partner and I have our Blackberry and internet for free. They wouldn’t tolerate that we change our laptops and computers every 2 years because we like technology. In other words; having investment partners means also that you have someone breathing down your neck when you want to dispose of your company’s income.

 

Do I want to go through all this just for a meagre 25K each? Hell no! If I ever sell my company, it will be for millions… not for thousands of dollars!

 

Think twice before seeking investors, there are others ways to get money for your company

 

If you need money to grow your business, I wouldn’t advocate seeking venture capital or an investor angel. I think that if you are at an early stage, you will be giving a lot to receive less. As much as I would love to partner up with a Dragon, I think I would be getting a lot more from their experience not just their cash. And they would eat me alive asking for 50% of my company! This is why I’ve pursued other ways of financing.

 

Believe it or not, the bank was the first place where we got a loan. We cautioned a 15k line of credit for the company at a 10% interest rate. The interest rate sucks and the amount available is small but at least, we have access to liquidityJ.  The problem with banks is that if you don’t have money invested in your company, they won’t be the ones taking the risk alone. This is why they asked us to personally guarantee the line of credit. With our day jobs and assets, it was approved in a heartbeat. But remember: first put money in your company, if you are not willing to drop cash into it, they are not the clowns that will put their money on the table.

 

A little bit more than a year ago, we wanted to grow faster and were looking for a bigger amount. This is when we looked for a private lender. We didn’t want anybody telling us what to do in our business so this is why we wanted a loan and not an investment in exchange for shares. So we now have our private loan for a little bit more than a year and it is going very well. The loan is not cheap (10%) but it’s not the end of the world considering we are making a 28% return on our investment so far.

 

The third place where we got financing was to borrow on our houses. I do not suggest that anyone does this. This is very risky and you put your whole family on the line. But I like risk and my partner and I never borrowed more than 10% of the value of our homes to invest in our company. We use this technique when we have a very specific project in mind and we know how much we will gain from our investment. We also make sure that we are getting paid within a year. We have done it 3 times so far and it has worked very well. It’s a bit more stressful than having a line of credit from the bank or owing money to a private lender but it is still another way to help our business grow.

 

Our goal is still to grow our gross income and not our profits yet. This is why we are reinvesting most of our money in the company and it won’t change in 2012. However, if I was going to present my financial statements in order to sell shares of my company; I would definitely make a good clean up of our financial situation prior to showing them off!

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Comments

I believe the same show is called Shark Tank here in the US (or if not, it sounds like the same concept), but I love the show as well. The valuations on that show are a little crazy, but then again, those guys are professionals and they obviously know what they are doing. It’s some great advice for anyone looking to get funding for their business, or to sell their business outright. I watch it religiously!

How did you come up with the investor payment (before Tax: 2.72 – 3.27 times the profit and after tax:6.80 and 10.3 times our company’s net profit)? and on what share precentage?

I am intested to know your math…

I swear, your posts on investing/websites come out at the very best times for me lol.

I do not watch this show that often but I have seen some very cool episodes. Keep in mind, that none of the VC investors actually put their money down just from talking to these people on the show. They do meetings with them after the show. Also, yes there are other ways to get money for your business but venture capitalist entrepreneurs or angel investors have the experience to help you make your business successful and will push you towards success because your success means their success.

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