A good friend of mine, Farzad, is a fan of shark tank. After a discussion with him I decided to start watching shark tank. Frankly, it is painful. Having worked at two VCs, shark tank is, ehhh, borderline idiotic. But there is a something that really bothers me about the deal -- besides valuation.
Kevin Oleary's royalty deals are basically loan sharking! Here how it goes.
I give you the money you want -- say $100K (on $1Mil post money). But I don't want any equity. Instead, you give me $2.50 on each item you sell for $10, until I am fully paid. Then the royalty goes down to $1.25 per item after that forever!
Here are just a few problems with that deal. Lets say your product has a 50% profit margin. you need to sell 40K units to give O'Leary his money back, so far no problem. But in effect O'Leary now owns 50% of your business while he is getting paid back! People who take equity are entitled to sharing the profits and not the revenue; and that is after the debts are paid. With the royalty deal, everything is suddenly debt. Even if not, the initial $2.50 royalty out of the $5 profit amounts to 50% equity. The later $1.25 royalty will be 25% of the company long term.
Doing a quick math, the initial post money is only $200K, and later it is $400K in valuation!
But what is worse is that the royalty stops anyone from doing an M&A! Anyone who wants to buy the company will now have to pay the royalty, a complete deal killer. The royalty holder can take the company hostage and demand any percentage of the deal they want.
