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Legal Eagles & the Dragons Den - Why face value is no measure of a good investment

Welcome to our weekly Dragons Den blog where a member of Harper Macleod's entrepreneurial team will share their view of the latest episode, give some hints and tips and also explain how we could have helped … and hopefully have a bit of fun along the way. Following Paula Skinner's blog on Why the devil is always in the detail of a deal, this week's blog is by Jo Nisbet, a Partner in our entrepreneurial team who works extensively with Scottish companies through their entire life cycle – from inception to exit. She's part of a team that has completed more than 90 equity deals in the last three years.

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Week two of Dragon's Den was another week of business-to-consumer companies all seeking to secure investment from the Dragons.

What exactly am I investing in?

First into the Den was Sean with his product Showergem, a shower products organiser. Sean was looking for £100,000 and was offering the Dragons 10% equity in his business. After some negotiation, he did well to secure the money from three Dragons but gave up 24% of the equity.

The conversation between the Dragons and Sean raised interesting questions about what is being invested in. Currently, the business is only one product so the Dragons were interested in his future plans and what exactly they were investing in.

After negotiation Sean accepted the Dragons were investing in future products for the home and not just the current product, however, having to tease out what is being invested in left Peter Jones feeling he had been misled.

What a business owns and what the investors are investing in is a critical point and when we are speaking to clients we always ensure that the structure and future plans are well considered so that it is clear from the outset what the company owns, what is on offer and what is the intention going forward.

Are your figures fact or fiction?

Second into the Den was Martin with an app, yboo, which he has developed to track mobile phone deals. After a confident pitch, things began to unwind quite quickly when it came to the Q&A. As we have seen many times before in the Den, finances were the undoing of Martin.

He had valued his business at £10 million on the basis that one year earlier he had received an offer which put the valuation at £5m. However, when the Dragons reviewed the offer letter they quickly saw that the actual valuation was significantly less than £5 million. From thereon in, conversations then focused on whether Martin had misled the Dragons on purpose or whether he was naïve and didn’t understand what the letter said. However, regardless of Martin's intentions, the result was the same – the Dragons had lost confidence in him.

Martin's problem is one we see frequently – founders misunderstanding what is in the documentation. If anyone puts an offer letter to you, it is critically important that you know what the letter actually means, not just your understanding of it, and we always advise companies to go and get advice to make sure they establish what is being put in front of them to avoid any costly mistakes or misrepresentation.

A problem shared

Ruth and Oliver from Churchill Gowns were next into the Den. Churchill Gowns is an eco-friendly graduation gown business which is trying to disrupt a well-established market. Ruth and Oliver delivered a confident pitch, however, the Q&A revealed an all too common problem, bad deals at an early stage!

The company had taken in two rounds of equity investment already and even though the rounds were fairly small they had the effect of the investors holding 72% of the company. Having investors as the majority shareholders in a business at an early stage is an issue, as it leaves the founders so diluted that effectively it is no longer their business and they don’t have sufficient economic interest in it.

We always recommend that companies produce a share capital table and play around with different numbers so they can see the effect of investment on their shareholding. It is one thing to have a small slice of a large pie but quite another to have a small slice of a small pie.

Three's a crowd

Finally into the Den were Matt and Jacqueline from the Great British Porridge Company. They described themselves as partners in the business however it transpired that Matt's wife is also involved. Having a structure whereby you think you are in partnership but the other side of the partnership is actually two people should be considered carefully as you can quickly find yourself in a two versus one situation and be continually outvoted.

When setting up your company you need to be sure to get advice on the structure and documents regulating the relationships among the parties.

Get in touch

Please get in touch if any of the issues discussed above are things that you might need to take advice on.

Click here to view corporate solicitor Anisha Kaura views on episode 3.

Useful links 

BUSINESS  LAW & CONTRACTS

CROWDFUNDING

CORPORATE LAW

ENTREPRENEURS, GROWTH & INVESTMENT 

CATCH UP - DRAGONS DEN EP 2 SERIES 17