Dragons' Den: a TV phenomenon versus legal reality

Answer

This article was originally published on 28 November 2023. 

Most, if not all, of us have watched the British TV phenomenon Dragons' Den. We put ourselves in the shoes of the investors and critique the deal we’d strike with the presenting entrepreneur if we were a ‘Dragon’. We know what the structure of the show entails (ie, the entrepreneurs offer a percentage of equity in their company in return for a cash investment) but most of us don’t know what that means in reality and what happens after the cameras stop filming. Dragons' Den describes the Dragons as 'venture capitalists'; although, 'angel investors' may be the more appropriate designation, but what’s the difference between the two?

Venture capital

Venture capital is a form of private equity that funds early-stage developing companies that have little to no operating history but have significant potential for growth. Companies seeking funding, like the contestants on Dragons' Den, sell ownership stakes to venture capital investors in return for investor financing, support and expertise. Venture capital investors support companies by offering their resources, knowledge and guidance in order to maximise the company's success. The aim for a venture capital investor is to invest at an early stage, in the hope to profitably exit, usually within four to seven years. It’s important to note that although some venture capital investments may be high reward, they also carry a high-risk element due to the uncertainty of the company's success. Venture capital investments will be managed by a fund made up of contributions from wealthy individuals or companies (ie, the fund uses other people's money). Venture capital investments support the growth of the British economy and according to British Private Equity and Venture Capital Association (BVCA), £27.5 billion was invested into UK companies from private equity and venture capital in 2022.

Angel investors

In contrast, angel investors are high-net-worth individuals who invest their own funds in company start-ups by providing companies with initial seed money in exchange for equity. Angel investors are often personal connections to an entrepreneur and are likely to deploy their capital in industries that they’re already familiar with. Angel investors (as investing their own funds) will typically invest less than an institution would, therefore reducing the size of a funding round. That being said, angel investors support many businesses in the UK and according to the BVCA, angel investment totals an estimated £1.5 billion a year in the UK. Like venture capital, angel investment comes with high risk; however, it can be said that angel investors have an even greater risk exposure as they invest at a very early stage.

Due diligence

The first thing we’re not shown on Dragons’ Den is the due diligence process, which takes place prior to the entrepreneur being selected to appear on the show. Due diligence is one of the most crucial steps in any investment and no investor should miss this step. Due diligence offers the investor the opportunity to investigate the target company by reviewing their legal, financial and commercial information. Through the due diligence process, the investor can establish whether the company valuation is correct and whether there are any issues that will require a renegotiation of the investment amount (eg, potential or current litigation facing the company). It’s important to note that the investor also has the option to pull out of the investment if they discover something they don’t like during the due diligence process.

The TV show portrays to the viewers that once the terms of the investment have been agreed and the entrepreneur and investor shake hands, a deal has been struck. However, following the filming the investor will conduct their own due diligence in order to confirm that they’re not making a bad investment and that the information they’ve been provided by the entrepreneur during their pitch is accurate. What isn’t aired on the show is that a portion of the agreed investments are abandoned following the due diligence process.

Legal documents

Once the due diligence process is complete and the investor is content with their findings, the next step is to focus on the legal documentation to complete the investment.  One of the key documents of the transaction is a subscription agreement, also known as the investment agreement. This agreement is the principal legal document, which sets out the terms and conditions of the investment and will include the investment figure, completion conditions, warranties and exit provisions. Additional documents, which are also important, include the company's articles of association and a shareholder agreement. The articles are a constitutional document of the company, which is legally required and publicly available (can be viewed at Companies House) and sets out rules for how the company will operate internally –it’ll usually cover board meetings, voting rights and share classes, for example. The shareholders agreement is a private document, which sets out how the company will be governed and how decisions will be made (including provisions relating to the issue and transfer of shares, shareholder obligations and shareholder consents).

Conclusion

Dragons' Den certainly has its purpose and isn’t only entertaining, but also demonstrates a business funding avenue that many of us, otherwise, may not have been aware of. It also shines a light on what makes a good pitch and what’s the crucial information in determining whether a business has the potential to succeed. However, the show doesn’t explain to its audience what venture capital is and what happens following striking a deal and the celebrations. As discussed in this Commercial Question, the real work starts after the initial deal is struck, where legal advisors play their part in the transaction and deal with the lengthy due diligence process and the drafting of extensive documents to solidify the deal in line with what’s been agreed between the parties involved.

Marta Borowicz is a second-year trainee at DWF Group Plc.