I was watching an episode of Shark Tank last night and started to wonder how the show would be different with different “Sharks”.

Last night I was trying to imagine knowing what I know about Buffett, most of which comes from his biographies and shareholder letters, how he would react to the business pitches. Buffet has three main principles he applies to investment. One of his first principles is stay inside your circle of competence, I imagine he would be passing on the vast majority of the proposals. Some of the Sharks seem to be willing to take a swing at almost any pitch, except for the truly ridiculous. The problem with this is that there are unforeseen problems with the various businesses that you will have no way to anticipate if you are unfamiliar. You can see this in how some of the sharks will pass on businesses that they would have previously invested in, because of past negative experiences (i.e they lost money). One way to avoid losing money is to refuse to participate in investments where you do not have a deep understanding of the risks and how the company makes money.

In particular on the shows I have seen, most of the sharks seem to love the branded consumables (chips,pretzels, cookies, peanuts, peanut-butter etc.) The problem with these businesses is that they truly have very little competitive advantage (another Buffet principle), which is sometimes mentioned on the show, but infrequently. What I mean in this case by lack of competitive advantage is that basically anyone can create another branded consumable and market it. The problem with not having a competitive advantage is that, in financial speak your returns will equal your cost of capital over time (the returns you have to promise or are expected to entice investment). What that means is that every dollar you invest or someone else invests into the business will increase the value of the business 1$, so you are not really getting anything for those extra dollars over time. The reason for this is competition and unless you are investing on terms which greatly undervalue the business your better off spending the money elsewhere.

The last Buffett principle is buy with a margin of safety and it’s hard to tell if the Sharks are doing this or not, because many of these businesses have not earned a profit. The margin of safety principle states that you want a buffer between what you pay and the value of the business. This is to protect against unforeseen business downturns or various problems and hopefully limit or eliminate the chance of major loss. It’s difficult to value a business that has not yet earned a profit, or that has only been in business for a few years. The range of possibilities is so large that even assuming Buffett found a company on the show that met the first two tests, this last one would probably kill the deal. This is because to invest where the range of possibilities includes losing all of your money(if you were willing to take that risk) means a very large discount upfront, probably one that most entrepreneurs would be uncomfortable with.

In summary the three principles that Buffett often talks about are 1. Circle of competence (staying inside it) 2. Durable competitive advantage and 3. Buying with a margin of safety. If he were on Shark Tank I think there would be much less activity and probably hundreds of pitches before he swung as it’s difficult to pass all three tests. This would be more profitable for him, but not make for such great T.V.