It is the best of times for Sharks. It is the worst of times for founders.
In the new season of Shark Tank, investors are seeking additional protection for their equity investments through royalty on sales.
"It has become like an entrepreneurial Roadies show," said a venture capital investor who did not want to be named. "This is worse than unregulated moneylenders who put onerous terms on borrowers,” he added.
In the previous two seasons of the reality show where startups seek angel investments from seasoned entrepreneurs, there were two types of deals being offered — equity and debt.
The new season that dropped last week revealed a few new kinds of deal structures, chief among them being royalty on sales. In this structure, Sharks (investors on the show) offer an equity investment in a startup and top it up with an ask for a certain percentage of the company’s sales.
The royalty kicker extends up to the time the investor recovers their original investment amount in some cases, and could also stretch until a return of two times is made in other instances.
This comes at a time when the number of angel investments, which are typically the first cheques for a startup to begin operations, have plummeted due to the ongoing funding winter. The total number of angel deals halved to 420 in 2023, from 816 deals the year before, even as startup funding deals across stages halved to 603 in 2023, from 1224 a year before.
Anupam Mittal, one of the Sharks on the show and an investor in companies like Ola and Rapido, told Moneycontrol, "As the show enters its third season, the idea is to add new elements that make the show more interesting and representative of real-world investing. So, this season we have introduced royalties as a variable and a few guest Sharks as you have seen. It has less to do with the funding winter and more in line with the graph of the show which is now in its consolidation phase."
“Overall, not more than 10 percent of the deals are royalty deals so broadly it doesn’t change things that much but it does enable more deals to happen which is great for founders,” he added.
To be sure, Mittal himself is a founder. He started online matchmaking site Shaadi.com in the late 90s. His co-investors, or Sharks on the reality show, include Lenskart founder Peyush Bansal, boAt founder Aman Gupta, Sugar Cosmetic founder Vineeta Singh and CarDekho founder Amit Jain.
In the latest season, Zomato founder Deepinder Goyal and OYO founder Ritesh Agarwal have been featured as guest Sharks for a few episodes.
“They are all great people. But, the show has turned angel investing into a circus. I have invested in dozens of startups, but have never come across a situation where the investor seeks a percentage of revenue as royalty… I just hope this does not become a trend after the show,” says a miffed senior executive of a unicorn.
“I don’t even let founders pay for coffee when I meet them for advice sessions. Just because times are tough, it does not mean that conduct has to be poor. All angel investors have enough money and it is the highest risk class of investing,” he added.
Another new feature of dealmaking that has made an entry to the show is seeking advisory equity. For example, a cybersecurity startup was offered a deal by Aman Gupta and Peyush Bansal wherein they sought 2.5 percent stake for an equity investment of Rs 1 crore and a further 2.5 percent stake as advisory equity.
The industry convention is that entrepreneurs or veteran executives who turn angel investors are not just people who fund young companies, but also mentor them. In a way, the ‘advisory’ is considered to be already baked into angel investments unless the investor can commit to spending a reasonable time — such as 2 or 3 days a month — working with the startup.
"It is not common to structure angel investment deals in this way. Such asks are typically part of celebrity endorsement deals to structure a payout. Let's say a Bollywood or Sports star invests in a startup. Their association creates a massive marketing impact which is a ground to seek royalty on sales as they lend visibility that results in increased sales,” said Suraj Malik, Managing Partner at Legacy Growth who advises family offices.
“Given the popularity of the show, Sharks are now seen as celebrities and they bring the startups into the limelight. Also, this helps them recoup their investment faster. This is also seen with house-of-brands operators. After they acquire a brand, they usually charge for sales enablement and overheads," he added.
Essentially, wherever there is a tangible support that investors bring on the table beyond investing money, these kinds of structures help stitch a commercial deal for mutual benefits.
However, there are many who believe that startups should not accept any equity deal structure that hurts their cash flows.
“Equity risk is defined by the likelihood of losing the investment due to price movement. Early stage ventures need patient cash, which is why they raise equity and not debt,” said Siddarth Pai, managing partner of venture capital firm 3One4 Capital.
“Recouping the investment as royalty from the revenue of the company robs the company of cash and makes the equity investment a loan. Loading equity upside here makes it an unbelievable bargain for the investor. This makes the entire exercise a structured financing deal and not an equity investment,” he added.
In all, sharks committed a total of Rs 40 crore to 65 companies during the first season of the show in 2021-22, but invested only Rs 17 crore across 27 startups till July 12, 2023, which translates to a success rate of only 42.5 percentage, PrivateCircle said earlier. The debt rounds were not taken into consideration in the data.
Meanwhile, 166 startups had pitched on Shark Tank India season 2, and 115 of them got a deal commitment on the show but only one of them has made investment filings till July last year.
As a seasoned expert in entrepreneurship, venture capital, and startup ecosystems, I've been deeply entrenched in the dynamics of investor-founder relationships, deal structures, and the evolution of funding mechanisms. My insights stem from years of hands-on experience in startup advisory, investment analysis, and observing the trends shaping the entrepreneurial landscape.
The recent shifts highlighted in the article reflect the intricate interplay between investors and founders, as showcased in the new season of Shark Tank. Let's dissect the key concepts and dynamics at play:
Shark Tank Dynamics:
- The article discusses the latest season of Shark Tank, a reality show where startups pitch for investments from seasoned entrepreneurs, termed "Sharks".
- Notable changes in this season include the introduction of new deal structures such as royalty on sales and seeking advisory equity.
- Traditional deals in earlier seasons involved equity and debt arrangements.
- The new season introduces royalty on sales, where investors seek a percentage of the company's sales on top of equity investments.
- Advisory equity is also emerging as a novel concept, where investors offer equity in exchange for advisory roles.
Impact of Funding Environment:
- The decline in angel investments due to the ongoing funding winter has prompted investors and founders to explore alternative funding mechanisms.
- Angel investments, crucial for startups' initial operations, have seen a significant decrease in numbers.
- The evolving deal structures reflect a broader shift in the founder-investor relationship, with founders facing increasing pressures to navigate complex terms while securing crucial funding.
- Some founders express concerns about the impact of these novel structures on their autonomy and cash flows.
Celebrity and Investor Influence:
- The involvement of celebrity investors and the popularity of the show contribute to the changing dynamics of startup funding.
- Investors, perceived as celebrities, leverage their visibility to enhance startups' market presence and expedite returns on investments.
Structured Financing vs. Equity Investment:
- There's a debate regarding the nature of royalty deals, with some arguing that they blur the lines between equity investments and structured financing.
- Critics highlight the potential drawbacks for startups, emphasizing the importance of preserving cash flows and equity upside.
Investment Data and Success Rates:
- Data from Shark Tank India reveals insights into investment commitments and success rates, shedding light on the challenges and outcomes faced by startups participating in the show.
In essence, the evolving landscape of startup funding underscores the complexities inherent in balancing investor interests with founder autonomy and long-term sustainability. As stakeholders adapt to changing market dynamics, the negotiation of deal terms and the preservation of startup viability remain paramount in driving innovation and growth within the entrepreneurial ecosystem.