The Future of DTC: Funding Strategies and Using AI

0:00Now you have very qualified investors, in my opinion, canvassing this category and making investments, which ultimately will benefit consumers long-term. because more better brands are going to get funded. Hey everyone, welcome to Shopify Masters, your companion for starting and building a business. I'm your host, Shuang Esther Shan. Financing for direct-to-consumer businesses has changed a lot in the last few years. Venture capital is harder to come by and consumer acquisition costs have gone up. But our guest today has some ideas about alternative financing options. Matthew Scanlon is the founder of Nautam, a sustainable cashmere clothing company, and they have been around for over 10 years.

0:47It all started with a loan and 32 plastic bags of cash in the middle of Mongolia. We'll let him tell that story. Matthew, thank you so much for being here. Thanks for having me. Excited to be here. Yeah. Nautam started in such an interesting way, and I don't say that lightly. So you've got to tell us a story how you ended up in Mongolia and wanted to get into the cashmere business. I very honestly expected to be doing something totally different. And as the story goes, I had taken some time from work about 12 years ago. So I was going to take a vacation, so to speak, and travel around Asia. And didn't really plan it all the way through, I'm 23 years old, so it was kind of like a sowing the wild oats type of trip.

1:38But I plotted it out, and I knew I wanted to start in Mongolia. Ended up in Ulaanbaatar as my first stop with my now business partner and college roommate, Diedrich. Ulaanbaatar is the capital of Mongolia. So I'm going to back up for a second and give you a couple important details. Mongolia is a population of about 3 million people, and half of the population, 1.5 million people, are nomadic, which means they don't own homes, they don't own land, they subsist off of animal husbandry primarily, meaning they raise animals and either sell the meat or fur, whatever it might be. And that is the culture.

2:13All of Mongolia is built around this culture. That's how it was for thousands of years. And it's a really beautiful, beautiful way of life. And it's something we'd heard about and wanted to experience, but didn't think we'd experienced it in the way that we ended up experiencing it. So we arrive, we meet a couple guys at a bar who invite us out on a day trip, so we think, to the countryside. Now for me, a countryside trip is like going upstate from New York City or something. So we meet them the next morning after maybe drinking a little bit too much and not really understanding what we signed up for.

2:48And we don't bring anything, we leave everything we have at the hostel because we think we're coming back that night. and we begin a road trip, we spend something like 20, 21 hours in the car making casual stops here, there, experiencing the countryside and the culture. And we think we're doing a big loop coming back to the city at the end of the night. Turns out that's not the case. We get to a tiny gare after some engine difficulties with the car in the middle of the night. And this is like a a year. So it's a tented structure. Think of like a tent with felt on the inside. And this is where Nomadic Herder lives.

3:27Long story short, we end up spending a month living with this family of Nomadic Herders in the middle of the Gobi Desert. The beautiful thing is they took care of us. They fed us, they clothed us, didn't ask for anything. And we more or less were ingratiated in the culture. But that's kind of the simplified version of what really happened on this trip. The real trip is I was scared to death. The real trip is I was 24 years old and had never really traveled outside of the United States before. And here I was in the most remote part of planet Earth with no cell phone, no food, no water, and didn't speak the language, didn't know anything about the culture.

4:07And I was overwhelmed and scared and spent most of the first two weeks there thinking about all the ways I was different than the people I was with. I'd never been in a place where I wasn't with people like me, right? And I think this is a commonality for people where when you're in a foreign place, you spend your time focused on all the ways you're different than other people, right? And so in any event, there's a day that we're asked to take the goats out to pasture. So we're herding the goats. And I let the goats mingle with another group of goats. And that's not allowed. And the way I find out is a herder comes running out and he's on horseback and he's screaming, he's yelling at me.

4:51And it was in that moment, it was the first time I had felt comfortable the entire time because I knew what was going on. I was getting yelled at. I was in trouble. This was something I'd experienced previously. You didn't need language to know what was happening. And it occurred to me right then that everyone I had been around in this kind of very foreign atmosphere was exactly the same as me. They cried when they were sad. They laughed when they were happy. They yelled when they were angry, when you did something wrong. And it became clear that those are universalities of the human condition.

5:24And regardless of where you are, what you do, that's a constant. And so we eventually left this experience. But that moment stuck with me because I felt like something profound had happened. It personally transformed my perspective. So I left feeling like I need to share that message with other people. I wanted to share my experience and I wanted to find the biggest platform possible. How did you arrive at the fact that starting a business would create great impact for the community? So the first thing we thought to do was build kind of a nonprofit and invest in some work that could support this community because we learned a bit about what would be helpful for them.

6:01Turns out it wasn't very successful because we failed to understand a key dynamic of the microeconomic circumstances that dictate how these communities subsist, how they make money. They, for the most part, are goats. Those goats produce cashmere. That cashmere is sold to traders that sell to brokers who then sell it to mills, who sell it to manufacturers, and so on and so forth. What happens in these remote areas, we find out, is that oftentimes pricing of the raw material is fixed because it's so remote. Only a couple people come out, so they dictate the pricing. And no matter how healthy your animal is and how good or how valuable the material is, pricing is going to stay the same.

6:43and in so doing the middlemen are the ones that are taking all the margin so we came to the conclusion that the best thing to do would be to disintermediate this supply chain go there ourselves push out these traders and brokers that were coming oftentimes from abroad to these communities who didn't care about the people the way that we did and buy the material directly from them and then cut out a bunch of steps in this stakeholder chain and then find a way to sell the material. We knew nothing about cashmere. I think we just recently figured out what cashmere was. We had no idea what we were doing.

7:19It sounds like you need a lot of investments to get this idea off the ground. How did you get the money to get started? We came back to the United States with no idea what we were going to do, but knowing what we wanted to do was buy the material directly from these communities and resell it someplace further down the line. So we did. We took a loan for about$2.5 million. It was a hard money loan. It had 12 months and very high interest. It was guaranteed by a set of assets that we were lucky enough to get access to as collateral. And we wired all the money to a bank account in Mongolia. I showed up at the bank in Ulaanbaatar and we walked out with$2.5 million in cash.

8:00It was 32 plastic shopping bags, 65 pounds of money. It filled the entire backseat of a Land Cruiser. And we drove what took us 24 hours in the middle the Gobi Desert. And over the course of three weeks, we bought 60 tons of raw cashmere, filled 16 tractor trailers with raw material, which we then trucked back to Ulaanbaatar to begin processing. That's how we got into this business. Yeah. I mean, so much to unpack here because I think a lot of people will have some sort of life-changing moment while they travel, while they interact with people who are quite simply the same as them, but they realize that only through traveling.

8:42But your story is so unique because you went above and beyond to start something completely new. Let's start with the loan part because a lot of people might have had ideas. They would have turned back when they heard I need to secure a$2.5 million loan. So how did you go about convincing a bank to take a shot at you when you were in your early 20s? And how do you even manage that when you're with a bunch of raw materials and trying to figure out how to start? Yeah. So we didn't go to a bank because a bank would never underwrite this. It was an individual. We found an individual who understood of commodities trading in Asia.

9:27So I had some awareness of how the raw material commodity was traded and understood the risk of what they were lending against. But it was collateralized by essentially a second mortgage that my parents helped us out with. So it was not a risk that I took. It was not only a risk I took. It was a risk that my family took as well. And it's been so much time since this happened that I don't think I appreciate how crazy all of this was, that this was even agreed to in the first place, because we didn't know what we were doing. And as evidence, when we got back to Ulaanbaatar, the capital of Mongolia, with 60 tons of material, we didn't know that it needed to be washed and de-haired as the first step of processing the material, and that in that process, you lost 50 % of what you purchased.

10:15So we ended up with 30 tons of material that could be turned into yarn. And we didn't know anything about pricing it or selling it. We learned that as we went. We had to get it. We didn't know we had to get it out of Mongolia the second we purchased it. We had to bring it into China to be processed and then out to Italy to be spun into yarn. It was a very unique learning experience. Let me put it that way. Yeah. Yeah. Well, thank you for being so transparent about that. But even then, right, as someone in your early 20s trying to convince your parents, trying to convince someone who is in commodities trading, that is a tough feat, I guess.

10:50Like, what do you think about your process of sharing the story or quote unquote pitching that really convinced people to actually take a shot? I think it's really simple, actually. And I've thought about it probably since then to now in different forms as we've built a brand and sold product, et cetera. I think the fundamental component that has driven value from that moment to now is that we had a reason why we were doing it. Notam specifically was really never a cashmere brand or clothing brand. We were a set of values around why we believed we should do things. And that is what we went out with.

11:36When we raised equity, when we raised debt at later stages, as we built the brand, that has been the commonality, right? When we acquire a customer, we don't oftentimes talk about the how and what of the product, how we make it or what it is. We routinely go back to why it is we're doing this in the first place. And, you know, I think that in of itself is a pretty meaningful component of this. It wasn't just to help this community. what we sought to do was establish this commonality between people to show people that the things you buy come from a place and those two things are a lot closer than you think that they are furthermore doing the right thing creating equity in a supply chain shouldn't be a novel business concept.

12:28And that we believe that if you can make a good product, a better product, but do it by helping other people doing the right thing, I think in the simplest format, in so doing makes doing the right thing accessible to people. Right? So we always wanted to pass the value of how we purchased our material to the consumer. We always wanted to price it in a way that it was broadly accessible to everybody so that we could show people that this is where we started. This is why we did it and that you can all access the set of values that led us to this conclusion essentially. And anything we do going forward is motivated by the same set of values.

13:12So it's been a constant for us. Yeah. Well, now in this movie timeline, we got to zoom back because now you have the loan. You realize that the materials actually shrink in half after you wash it and process it. And you also have this pressure of 12 months for repayment to start. What do you even do to start selling some of this product? So I think the thing we realized was we weren't going to have enough time to run a full conversion cycle between buying the raw material and selling it as knitwear. We didn't know anything about the distribution. around we didn't know anything about e-commerce specifically and we didn't know how to make products we didn't know how to make a sweater um so the the fastest path towards repayment was to turn it into yarn which is kind of the first step after you wash and dehair the material you get spun into kind of spools of yarn that get fed into machines and turn it in it where um so we partnered with a facility in northern italy in biela um and we certified the first cradle to cradle, sustainable, 100 % cashmere that we then took to trade shows and sold as yarn.

14:26That was the first year of business. We were left over with some yarn and we turned that yarn into some knitwear finally. And that's how we launched the brand that people know today. But initially, yeah, to make that cash conversion cycle work, we had to turn it into yarn because we're going to take us too long to figure out how to sell it as an end product. So we aren't in the arm business anymore. But we kept that up for the first three years or so we were selling arm. That's how we built up scale and could go back and continue to buy large sums of raw material because we had multiple channels that we were always using outside of just our direct consumer or wholesale arms.

15:01And actually, before we sold anything online, we were selling to retailers because we didn't know enough about e-commerce yet. And we hadn't figured out the pricing strategy and products strategy for e-commerce. So I literally packed a bag of sweaters and I drove up and down the East coast with a leather bag filled with men's sweaters. And every men's boutique I saw, I walked into and I sold them sweaters. And that's how we got our first orders till towards the end of our first year of business. Well, that sounds like being very agile. And it's so interesting because when you start out in wholesale, that had the speed of giving you access for inventory turnaround, but then you also grew vertically to make sure that you're more integrated into the direct-to-consumer space.

15:47When you're managing all those channels, how do you know when is the right time to invest in something new, take a chance on direct-to-consumer per se or retail relationships? When did you know to make those pivots? Yeah, I'd say for the first couple of years, it was really necessity driven. It was not as strategic as I'd like it to sound. It was a sell down strategy. And we knew the end goal was again, the platform, right? How do we get into this? We wanted to tell our story. We didn't know what platform we would be able to tell that story on. We knew having a direct relationship with a customer.

16:27And this is like 2014, so a decade or more ago, the tools used to build e-commerce businesses, specifically in apparel, were very limited. It was a major transition period between the retailers and the advent of e-commerce as a major distribution channel. And I think things were majorly in flux. You had the advent of Facebook, now Meta, becoming a digital marketing tool that could scale. But But in its early days, we didn't really know how to use it that well. The programmatic tools weren't in place when we first started. So we were investigating and then investing in tools we thought would give us the biggest platform to then tell the best version of our story.

17:16And it wasn't until I'd say 2017 when we launched a YouTube video that told the story I just told you that then made it clear to us. When it got millions and millions of views and went all over the internet, it became clear to us that e-commerce was the direction we wanted to go because we had the megaphone to tell the story the way we wanted. We could then translate those eyeballs into customers. Again, not highly strategic, so very surface level strategy, but we kind of fell into the right time, right place for how e-commerce, specifically the digital marketing tools that could scale e-commerce.

17:56That was a moment in time that was very unique. And we had a story that could be told really well on platforms that had really, really wide audience opportunities. That's how we determined our price and our product strategy kind of fit where our story was resonating and where the biggest platform could exist. It sounds like your sales channel mix was also nomadic. You know, you went where the consumers are, so it made a lot of sense. It's a nice corollary, I think. Yeah, yeah. And then also, while all of this is happening, managing all those sales channels, you were also thinking about fundraising, something you did up until 2022.

18:35too. What did you learn from speaking to different investors to ultimately find the right fit for you? So in the early days of launching Nodum, we were just our story, right? The things we've been talking about. We had a brand story we wanted to tell. And I think going through the process of meeting with early stage investors made us believe in our own story, if that makes sense, right like we know what matters to us but is this novel is this unique enough to build a business around it was in that process of raising money that we told that story enough and we dissected our business enough with folks that we saw where the nugget of value really was and how to then translate that to something much more scalable and to put it in its simplest terms we knew we could make a better more affordable product right and then by telling the story of how we did that we could translate to customers again that doing the right thing making a sustainable version of a luxury product would make it more accessible to everybody and in so doing make doing the right thing and being sustainable accessible to everyone it's with that same thesis in mind, but it was only through engaging with the investment community, getting poked and prodded by investors that kind of molded and shaped the thesis that has defined our success through to today.

20:12And just so you know, for anyone and for anybody listening that's raising money, I was told no, I'm going to guess a thousand times at least. And I still get told no today. Not an exaggeration. No. Not even a little bit. And I'll tell you what, it hurts every time. There's no, being told no still stinks. The only difference between 24-year-old Matt and 36-year-old Matt is I know that statistically speaking, there's another conversation to be had and I can just keep going. But back then when I was being told no all the time, there were a lot of times where I was like, I don't think I can do this.

21:01I don't think this is gonna work. So the perseverance is a skillset that I think defines most entrepreneurs that manage to do it over an extended period of time. It to me seems like a prerequisite. And also the funding space has changed a lot too. There's less leniency in terms of getting funding and direct-to-consumer brands feel that in a certain way. I guess like what are you experiencing nowadays when speaking to investors? I think that the entire category flipped on its head. In the very early days, let's call it 2015, 2014, venture capital was drawn to the consumer category because a unique input-output ratio was established where rapid growth could be achieved, and thus early-stage venture capital and its exit values were justified.

21:49Meaning, you could put$1,$2 to work in Facebook and Google, and you could get out$8 to$16. So you had this 8 to 15x ROAS availability that obviously changed consumer. It made a ton of sense. That was novel. That never existed. Think historically how marketing worked. You back up to the 90s or early 2000s, catalogs, billboards, calling people, stores, clienteling. You didn't have access to a digital component where you could automate and programmatically target with precision people who were traveling throughout the internet. We take this for granted today, but back then this was so novel. And so really what venture capital was investing in was, yes, great brands and good products, but also the novelty of digital marketing and the rate at which it could scale certain categories in consumer online.

22:51And so theses were created around this being a retail apocalypse. It was going to kill all other channels and e-commerce was going to be the end-all be-all for all categories, all buying and selling. And we know today that that's kind of not what happened. that in reality, consumers need multiple touch points. And some product categories specifically lend themselves to real-life transactions or multiple touch points. And others don't. But that novelty is what drew venture capital in. That disappeared. In 2021, when iOS shifted and Meta and Google could no longer track you from their platform to everywhere else via pixels on the internet, it means that the information they had on you was less qualified, which means I can't target people as well.

23:40And so my dollar goes less far. I need to show you more advertising to walk you through a purchase funnel than I used to have to because the platform would do it all for me. I could target a one-legged pirate living in Minnesota who likes parrots. Doesn't exist today. You can't target people like that anymore. And so it made the input-output ratio for venture capital much less valuable. And thus, the venture capital community en masse has exited investing heavily in the category, the caveat being that good brands will still gain investment. The valuations are more right-sized now. So they don't have those same tech valuations where a business doing a million in revenue can have a$30 million valuation.

24:35It doesn't exist because it's proven that that doesn't make sense. It doesn't actually validate itself at later stages. So once you have this reset of valuations, you have less capital. Now you have very qualified investors, in my opinion, canvassing this category and making investments, which ultimately I think will benefit consumers long term. because more better brands are going to get funded and less businesses are going to fight for dollars and eyeballs that don't have the same pre-qualified RAND components that needed pre-vetting from investors. So it's a good thing for consumers, but it just means that the threshold to getting into this industry, I think in the traditional sense, the way we did, specifically in apparel, is much, much harder.

25:24Now, there's a flip side to this we could talk about, which is the advent of TikTok and tools that have made it really easy for people to scale specific product categories and specific channels. But that like extreme scale of billion dollar brands being built off the back of venture capital kind of never existed. It never came to fruition, and I don't think it will ever exist. It sounds like things are leveling out and there's a touch of reality adjusting back to this leveling. And of course, we talked about the evolution of direct-to-consumer and also fundraising. What are some alternative options you think founders should think about and look at?

26:02So if I could go back in time, or let's say I was starting a brand today, given the investor dynamics and lending dynamics, I would not go take early stage venture capital. Maybe one or two early stage seed investors might be helpful, angels that could guide me, right? and give me some insight around different areas of the business that otherwise would take me a decade to learn. But that would be the only reason for taking on that capital. I think now there are more lending tools to access for early-stage businesses and consumers, specifically e-commerce, that didn't exist until two or three years ago.

26:44There's AR financing. There's AP financing. Very low threshold for acquiring that level of financing. but it's an offset to improve your cash flow, which is really part of the challenge for financing an early stage consumer business. You don't know how quickly you're going to turn product or inventory you purchase. So if you go out and buy it and it takes you six months and you plan for it to take three, it's a really easy way to go bankrupt unless you can extend your cash flow. So there are fintech tools that will lend to early stage businesses and extend your cash flow so you You can sell down your inventory, make all your payments.

27:18They can be expensive, but I think that that's a reflection of where interest rates are today. Then you have shorter term loan structures. Obviously, we know of the SBA being a good tool, but there's some risk on that. You have to give a personal guarantee, and that can be challenging if you're going to scale a business and take on investors. So I wouldn't recommend taking SBA loans that you personally guarantee if you're going to have investors around the table at any point because your incentives are never going to be aligned. unless they've agreed to pay that off and or transfer that guarantee to the entity and can guarantee it themselves.

27:52So that's a kind of a separate strategy. For apparel brands specifically, and I'd say most consumer brands, ABL structures are very interesting. So they're asset-based loans, meaning they lend to you against a percentage of your available inventory, cost of your inventory. And then there are some tools that will lend to you against your AR. And in this instance, AR could be your projected e-commerce business, but then it's a little bit more of a high-touch relationship where you need to prove to them you have a brand that can turn your e-commerce inventory that has no purchase order. So there's no guarantee behind it.

28:29It's much riskier. But those relationships work well. And then there's credit facilities, small ones for banks. And then there's private lenders that will do credit facilities and fintech partners that will do credit facilities. That's the high level. I could get way more intricate on this. But those are the building blocks of lending today that I think are pretty accessible to early stage founders. I'm talking$100 to$1 million in revenue. Yeah. And then just to clarify, accounts receivable, this is something ideally for someone with sales history, ideally maybe some Shopify data to back up last years or years before sales so that the lender is confident that the inventory can result in future sales.

29:10And I guess for Nautam today, how are you thinking about paving the runway and also building up the financial foundations today? Through a couple different things. Nautam's in a unique position. We've been on this consumer roller coaster for a decade. And my thesis is not a particularly intelligent one for how to do this. I believe that brands are built by customers over time. which means the variable to being successful in the category I'm in is time. The longer you're here, the more valuable your IP becomes, as long as you're not destroying your brand by doing really stupid stuff like over-discounting, giving away product, partnering with the wrong people, etc.