Tuesday, October 15, 2013

Shark Tank's Equity Clause

Here is something I didn't know about Shark Tank until it is gone:
Recently Mark Cuban gave an ultimatum to the lawyers at ABC's Shark Tank: Either remove your equity clause or I'm not coming back, reports Jason Cochran.  
According to the clause, all contestants were required to give Finnmax, Shark Tank's production company, either 2 percent of their profits or 5 percent equity in their company. This rule applied regardless of the deal struck with investors, and all contestants since Season One were obliged to agree to it.  
However, last Sunday, Cuban, who went to court Monday over insider trading allegations, wrote on Facebook that the equity clause had been removed, thanks to him:  
"FYI, there is no additional equity or percentage of anything taken any longer. That was removed retroactively," he told a group of former contestants. "I told them I wouldn't come back this season if it wasn't." ABC and Sony Pictures Television declined to comment. 

Before reading this article, I thought that entrepreneurs went on Shark Tank without having to give anything up but their time and effort to put in an application.

Now, when I find out that they had (past tense) to give up 5 percent of their company, I am even more curious about how Shark Tank sustains itself.  After all, there are plenty of investors/partners out there who would hear these pitches and not charge the entrepreneurs 5 percent of their company to do it (call this other company, Guppy Tank).

The Guppy Tank could offer the same deal as Shark Tank, but without the equity clause.  This would be strictly better than Shark Tank for the entrepreneur.  So, how come the Guppy Tank doesn't put the Shark Tank out of business? In my mind, it comes down to publicity.  For some kinds of companies, the added publicity of giving your pitch on TV is worth giving up 5 percent of your business even if you don't get the deal.  Pitching your company on national television is a service that only Shark Tank provides, and that's valuable to the entrepreneur. The people at Shark Tank recognized this source of additional value, and they set the contract to capture it.  If you think about how you can capture it, you can't exactly charge the entrepreneurs money (because they're cash strapped and asking for money), so you do the next best thing, require a portion of the business.

There is a problem though.  Some types of companies won't find it worthwhile to give up 5 percent of their company in the event that a deal doesn't go through.  These companies will automatically go to the Guppy Tank over the Shark Tank, and these are the missed opportunities that Cuban wanted to try and get by removing the equity clause.

From the perspective of Shark Tank (even as just the investment group, and not the television show), I am not sure what is going to lead to better quality deals.  Eliminating the equity clause is going to increase the variety of companies (low publicity demand firms will find it optimal now), but it is also going to increase the intensity of publicity hogs who apply to the show.  Perhaps Shark Tank will screen these bad apples out in the initial round, but it will be interesting to see how the Shark Tank pitches change.

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