This is, hopefully, one of many deals I’ll be posting publicly.
I have the founder’s permission to post this, and I’ve scrubbed identifying information because posting the inner workings of a company for the competition to examine isn’t a great idea.
Anyways, why am I doing this?
The “me” reason is that I want as much critique as possible to improve my investment decision making process. It also helps me reflect better and learn from mistakes.
Before we jump into this, keep in mind, I’m an angel focused on maximizing returns through value creation, and have no problem holding companies purely for dividends…which is something VCs and most angels are not OK with as they tend to look for binary outcomes. My approach generates immediate cash flow, which can then be used to fund more deals.
Anyways, let’s get started…
For the purpose of this article, let’s call the company in question Company X. Company X is currently sitting at approximately $4,500,000 in revenue, with $540,000 in EBITDA, and was looking to raise $600,000 at a $4,400,000 valuation.
Other funding sources are not getting involved because:
Company X is an eCommerce retailer in an industry with traditionally low valuation multiples. VCs (and most angels) buy into companies with the intention of going to a billion or bust as they need one winner to bring back their entire portfolio and more. This specific company is not going to be able to do that, purely due to the nature of the products they sell and the valuation multiple assigned to companies in their industry.
Suppliers, others in the industry, etc… won’t get involved because the company’s business model is foreign to them. Things like low capex and payroll terrify them.
Lenders like banks and the SBA won’t lend to them due to a lack of hard assets and the industry they are in.
The company is geographically located where raising equity and debt is very, very hard. Investors in the area are accustomed to oil & gas deals, not an eCommerce retailer that barely carries inventory on their books.
Small deal size. This immediately throws most PE firms and growth oriented investors out of play.
Big risks involved in this deal include…
Marketing channel risk. The company will spend $2,000,000+ on ads in 2018 through one channel alone. They make a little bit of profit per sale brought in by those ads, then make money on repeat customers. As things currently stand, if the effectiveness of this marketing channel decreased even slightly, the company would crash and burn. The company is legally restricted from advertising via any channel other than AdWords. Increased competition bidding on the same keywords could drive prices high enough to make this channel unfeasible for Company X if they don’t find a way to increase margins or average order value.
Low profits as a percentage of revenue mean little/no room for error. After running for approximately 5 years, the company has roughly 12% in EBITDA on $4,500,000 in revenue. This is lower than most are comfortable with, because a few small errors could eat up the company’s capital which increases holding period and the likelihood of failure.
Capital hog. Despite being built to be as lean as possible, the company still requires a large sum of working capital relative to other companies in my portfolio. Securing the working capital the company needs will be difficult due to industry they are in.
Retail is a terrible business model…and they’re a retailer! Retail is currently a race to the bottom and isn’t sustainable long term because more and more companies are electing to sell direct to consumer. Platforms like Amazon make doing the process of selling direct to consumer so easy that just about any brand can list on Amazon and dramatically increase margins. Things are even worse here because the company is drop shipping the majority of their products, which reduces the incentive for brands to keep using them.
Yikes, that looks pretty bad right?
The good news is that, in my opinion, there are great things about this company and room for improvement that could yield huge returns. Most of the problems the company has right now are easy for us to solve.
Here’s what I like about the company as is…
Strong, proven, founders. The founding team has bootstrapped this to $4,500,000 in revenue per year already. The most fundamentally difficult part of launching any business is behind them. I noticed that they seem passionate about self-learning as well, which ensures they should “scale” nicely as the company grows. This is important because a different skill set is required to run a company doing $100,000 a year than a company doing $2,500,000 a year, or $10,000,000 a year. If the founders in a company can’t keep up, then it creates issues down the road as the company grows.
My favorite thing about this team is their respect for process and using data-driven decision making. When a company makes decisions using data there’s little to no room for disagreement on anything other than the validity of that data.
No need for babysitting! The founders of Company X have never gone out and blown through money on anything objectively stupid. By “objectively stupid”, I don’t mean missteps…I’m talking about doing things like buying $28,800 in Herman Miller furniture or pointlessly inflating payroll. As an investor, these means I don’t need to worry about watching how the company is managed too closely. All I need to do is sit down and focus on helping them grow as much as possible. This is a lot more enjoyable for everyone involved.
Amazing systems! When a business requires management/founders to be involved in the day-to-day operations, it prevents the company from scaling effectively. The easiest way to prevent management from getting stuck working “in” the business instead of “on” the business is by implementing fool-proof systems. For the most part, this company has created beautiful systems; even better than some $100M+ companies I’ve worked with in the past.
Strong technological edge. They have done an amazing job building the core platform and systems that the company needs to scale. They’ve gone as far as developing custom plugins and rebuilding plugins they use to optimize site speed…which is unusual for a company this size. Moreover they’ve done so cost-effectively.
Proven customer acquisition engine. The hardest part about building an eCommerce business is attracting customers. Company X has done a great job of building a proven machine for acquiring customers, and then ensuring they are happy customers post-purchase. Their Trust Pilot score is fast approaching 9.0.
As a value driven investor, the more positive impact I can have on a company, the more I can ensure my investment performs the way I want it to. If you can help 10x EBITDA of a company in 12 monthso or less, then the company has to mess up pretty badly for you to lose your money. Conversely, if an investor can’t add value to a deal, then their margin of safety is much lower.
Here’s what we’ll start working on immediately, in no particular order. There are more improvements but these are the biggest:
Shift away from retail and into becoming a consumer brand. Margin increases significantly, allowing more breathing room on customer acquisition costs, and of course, increases net profits. The large customer base means we have an audience to sell our own product to, and costs incurred would be insignificant if launch is executed properly. Could potentially quadruple net profit for Company X with one high quality product. Spend on doing so would be in the low 5 figures executing on this, making it a logical asymmetrical bet to make.
Improve email marketing. There’s a lot of room for improvement here as Company X is not segmenting deeply, not using trigger flow, still sending from a shared IP, no evergreen funnels driven by content exist either.
Monetize plugins. The company has developed a suite of powerful eCommerce plugins for in-house use. These can be sold by a subsidiary or packaged and licensed out to an existing plugin developer with a good reputation.
Content marketing. There’s huge potential for Company X to supercharge their organic traffic by setting up a basic content site and spending $5000 — $15,000 on targeted content.
Marketplace launch. The company isn’t utilizing Amazon or eBay right now. Both are low-risk to test, and could potentially boost top line revenues significantly, likely up to $800,000 — $2,000,000. We will integrate our marketplaces specialist with this company to launch on marketplaces. Branding rehaul. Company X has tons of room for improvement here. Basic storytelling needs to be implemented along with more consistent branding across customer touch points.
Smile & dial. Due to the nature of the products being sold, email marketing is difficult and retargeting is essentially impossible. Implementing phone calls to follow up with customers to increase satisfaction, upselling, driving reorders, etc… is logical. The framework for executing on this already exists.
Implement CRO. Company X is currently sitting at a conversion rate of around 1.2%. Even getting this number up to 2% would completely change the business as we would be able to afford to spend more to acquire customers and enhance our bottom line. Bring on A-players. Currently, one of the founders spends a lot of time managing marketing. The other angel and I have the ideal candidate to take over this, which will allow the founder to focus on growing the business.
Improve branding. There’s a lot of room to improve the branding behind Company X. Good branding doesn’t have to be expensive, nor is it overly difficult. Something as simple as integrating storytelling into all instances where the customer interacts with the brand will significantly enhance customer loyalty.
Customer satisfaction. Company X has managed to maintain very good levels of customer satisfaction, proven by their Trust Pilot reviews. This is extremely difficult to do in their industry. However, customer satisfaction could be easily improved by directing customers towards well-reviewed products that fit their needs better using basic automation.
Line up working capital. Obviously, Company X has had issues maintaining enough working capital due to restricted access to traditional financing mechanisms. Our capital injection will clear existing debt and allow them to raise $500,000 — $1,000,000 to use as working capital. Affiliates/partnerships. The company doesn’t currently have relationships with any large communities. We’re going to partner with forums to become their retailer of choice by providing their users with special discounts and deals.
Prepare subsequent financing round. We don’t expect to need it, but we may line up another round of funding and keep it on the “bench”. This round provides additional room for the company to make mistakes.
Like I said, there’s more to it, but that’s the gist of things.
I can’t dive too deeply into the term sheet we all settled on, but essentially…
Approximately $220,000 raised from myself and another angel for a healthy chunk of the company — discounted from the original valuation to account for our ability to contribute to the growth of the company. We moved quickly and decided to invest within days of meeting the founders. As an entrepreneur myself, I know how frustrating it is waiting weeks on end to hear from investors, so I always try to make a decision within a few days. Downside & dilution protection via standard mechanisms we build into most deals we do.
…that was a little longer than I expected!
If you have any comments/questions, feel free to leave them below.
Here's the original article on my blog site with better formatting: https://medium.com/@karta/deal-analysis-ecommerce-retailer-d11d1d99f49f
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