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On Sharks, Scrubbies and Why Money Isn't Everything In this new series, an investor takes a closer look at a deal for a promising scrubbing sponge business on the hit business television show.

By Jeremy Liew

Opinions expressed by Entrepreneur contributors are their own.

Editor's Note: This post is the first in a new series examining the deals presented on the popular ABC television show Shark Tank through the eyes of a venture-capital investor.

I'm a venture capitalist, a managing director at Lightspeed Venture Partners. I led our investments in LivingSocial<, Playdom, Flixster, Bonobos and ShoeDazzle, among many others. I'm also a huge fan of the ABC show Shark Tank. This season I'm analyzing the companies' pitches on Shark Tank from a Silicon Valley VC's perspective. Here's my take on Friday's show, Week 7 of Season 4

You never get just one offer to invest in your company. You either get zero, or many. The pitch either resonates, or it does not. This week's show demonstrated both sides of the equation

Scrub Daddy was the first company to present, and it is definitely a case of a story that resonated. Aaron Krause, the founder, has developed an innovative new scrubbing sponge, shaped like a smiley face, and with an innovative feature that makes the scrubbing texture firmer or softer according to the temperature of water that is used to soak it. He gave a tremendous live demo of the product.

When he came on the show he had sold $100,000 worth of product, primarily through three appearances on QVC, but also online and in four Philadelphia area supermarkets. Scrub Daddies sell at $2.80 wholesale on a cost of goods of $1/unit. Krause sought an investment of $100,000 for 10% of the company, implying a $900,000 pre-money valuation (See my analysis of week 2 of season 4 for an explanation of pre-money valuation). He wanted the money to build his own factory so that he could control his manufacturing schedule to better meet demand

The demo got three of the sharks interested. Lori Greiner and Daymond John bid the deal up from $150,000 for 25% of the company (a $450,000 pre money valuation) all the way up to Greiner's final offer of $200,000 for 20% of the company (an $800,000 pre money valuation). Greiner said that she'd get the company an infomercial deal and would be in retail distribution worldwide within weeks

Shark Kevin O'Leary initially offered to invest as well, but quickly realized that he had little to add to the company beyond money. He knew that the only way that he would win would be if he was the highest bidder on valuation, and he didn't want to have to be the highest bidder. O'Leary cleverly changed the basis of comparison, shifting his offer to a royalty deal

When you're losing an auction, complexity is your friend as it makes direct comparison more difficult. His final offer was to give the company $100,000 in return for a royalty that paid out $0.25 on each unit sold until his $100,000 was returned, and then $0.075/unit thereafter. Assuming that the company had minimal overhead and marketing costs, the gross margin of $1.80/unit should be a pretty good proxy for profitability at scale. So the royalty would amount to roughly $0.25/$1.80 = 14% of profit for the first 400,000 units sold, and just 4.2% of profit thereafter. Comparing this to giving up 20% of the company for $200,000, especially since the company only needs $100,000, O'Leary's offer is a better economic deal than the equity investment, all else equal.

But all else is not equal. Greiner, with her history and relationships with similar products, would be most able to help the company grow. O'Leary offered none of these benefits. He was smart to appeal to the entrepreneur's ego. He suggested that Greiner was treating the entrepreneur like he didn't know what he was doing and said that he trusted the entrepreneur to run the business without help. But in the end Krause made the right call and accepted Greiner's offer.

It's almost always better to own a smaller piece of a bigger pie than a bigger piece of a smaller pie. Smart entrepreneurs like Krause will weigh heavily the value that an investor can add, beyond just the money.

See a breakdown of the rest of the companies to pitch, including two companies that got no bids, on the Lightspeed blog and analysis of the first six weeks' episodes. I'd love to hear what you think.

Jeremy Liew is a managing director at Lightspeed Venture Partners where he invests primarily in the Internet and mobile sectors. He writes about small business, startups and financing on the Lightspeed blog.Follow Lightspeed on Twitter at @lightspeedvp.

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