Ep 580: How Fan Bi Revives DTC Brands with 30 Days of Cash Left

0:00Fan Bi:Today on the D2C podcast, we're getting into the real math behind D2C exits. I'm joined by Fan Bi, founder of The Hedgehog Company, who steps in when brands have 30 days left of cash and no clear path forward. He's bought and turned around dozens of distressed D2C brands, and he's got the receipts on what actually makes a brand sellable in this market, and what kills deals dead. We'll talk valuation myths, bridge rounds that go nowhere, how to tell if your brand's even worth selling, and the difference between product market fit and product channel fit, especially when Meta is the main driver.

0:31Fan Bi:If you're a founder thinking about an exit or just trying to survive the plateau, this one's for you. I hope you enjoy it and on with the show. I grew up in the D2C generation of Dollar Shave Club and Bonobos. There was this idea that you could be a D2C business, be valued at three to five times revenue, and very importantly, not profitable. Growing, but not profitable. Being bought for three to five times revenue when you're not profitable, that doesn't exist anymore. We've been humbled by how challenging the current environment is. The threshold for, hey, are we going to be able to turn this around?

1:10Are we going to be able to do something differently and specifically better than the smart people that we're buying it from? That bar has continued to increase.

1:26Fan Bi:This episode is brought to you by Contentful. Marketers, you know that feeling when your creative clicks, when that social post sends engagement through the roof, when your outside-of-the-box campaign hits ROI positive, when a personalized homepage turns prospects into customers? It's utter marketing bliss. Contentful helps you create tailored omni-channel experiences without working overtime. No stress, no limits, only possibilities. Get the feels at contentful.com. Welcome Fan Buy. What's the number one thing that DTC founders get wrong about how M &A actually works? Yeah, I think that, look, I grew up in the DTC generation of Dollar Shave Club and Bonobos.

2:12and there was that kind of initial burst probably 2013 to maybe 2018 where there was this idea that you know you could be a d2c business be valued at three to five times revenue the early signal was that investors are willing to value the companies on this and then it was further validated kind of importantly by a couple of these large exits walmart buying bonobos for kind of three times revenue. Unilever buying Dollar Shave Club for, I think, around seven times revenue. And very importantly, not profitable and growing, but not profitable. And so I think the big thing that's changed is that that doesn't exist anymore.

2:59Being bought for three to five times revenue when you're not profitable is extremely, extremely rare. It was rare back then, but it's even more right now. And second of all, strategics have moved up market. So those deals were kind of nine figure deals, but more so now acquirers are doing 10 figure deals. That's, you know, what were the kind of half a dozen transactions that have been, um, well, half a dozen to dozen transactions that we've seen are largely one to 2 billion or half a billion dollar deals. So incumbents themselves are dropping some of their smaller brands. They're only looking to buy larger brands, which makes it really tough for the median D2C business.

3:44Fan Bi:Obviously, profitability is the name of the game. Describe to me just the state of the market we're in right now. I see a lot of things on D2C Twitter where seasoned founders are really giving up and coming founders a reality check about the possibility of creating a lifestyle business or a really profitable business in this market and really laying down the things that you have to have, you know, strong organic following, you know, all of these things. How do you see the sort of like ecosystem right now in terms of like, is it a good time? Is it still the best time to have built a DTC brand? I think, you know, from a financial lens, you're looking at two things.

4:24One, which is like how much net income can a DTC business generate through its kind of ordinary operations? And then second of all, like, can it exit for an exciting premium? and from an operating standpoint this is being well stated but acquisition remains more challenging than ever and increasingly challenging. In an actually auction-based marketplace of meta there's just increasing there's more demand for impressions than there is supply. So yeah, it's harder and more expensive to acquire customers than it was three years ago, five years ago, seven years ago. Somehow Shopify is still doing an incredible job growing GMV, but all it's doing is introducing more competitors for each, you know, of its merchants.

5:08And so, yes, it's more expensive to acquire a customer. And then B, you know, if there's no switching costs between one apparel business to another apparel business, you know, retention becomes harder. And if there are fewer acquirers and they're moving upmarket, you know, it becomes harder to sell the business for an exciting premium. We didn't call, this podcast isn't called the anti-DTC business, right?

5:27Fan Bi:No, no, no, we're pro-DTC here, but we understand, where we want to deal with in the reality as much as possible yeah and i think that like you know it's you know you asked about the state of the market it's it's very much a tale of two cities you know we have friends you have friends that the top three percent of businesses they're still getting you know zero to a hundred and two and a half years with all the promise of the scalability of the internet and reaching customers in all corners of you know the continent let alone the world, finding people that can come back on a monthly or quarterly basis.

6:07We're still seeing, you know, winners for sure. But I think for the other 97%, it's tough.

6:14Fan Bi:I think of my friends like Bart Sanuski, who's running, you know, Dad Gang, or my friend Brock Mameser, who's running Frostbuddy. And they're still like, they're not solopreneurs, they have teams, but they're still shooting all their content. They're still living the DTC dream in a lot of ways where they're, it's like they have these small teams. They make a lot of their own content themselves. That's what's driving the business forward. Frostbuddy just had insane numbers on TikTok shops, you know, this sort of like, but they're few and far between, as you're sort of saying, these people that are running these really lean, really high growth teams.

6:51Fan Bi:What do you look for? Like, obviously, those are going to be harder brands for you to acquire. You're more interested, I guess, in acquiring brands that have strong fundamentals but are weak in specific areas. Like, what's your criteria in this day and age for looking to acquire a brand? Yeah, strong fundamentals, I'd say 20 % plus post-marketing contribution is a very strong metric that we look at. Usually that has bled into it some pretty strong repeat behavior. and maybe they're not the kind of one person plus small team shop. They've expanded their team to be... It often kind of correlates to a venture-backed business that is heavy on G &A and OPEX and the team is maybe a little bit too big for the business.

7:37Sometimes it means that it's had a few years of negative EBITDA or negative net income that's bled onto the balance sheet and so the balance sheet kind of has started to crack a little bit. But they're the kinds of things that we can fix. What we can't fix is that there's no product market fit or there's no customer affinity or there's no kind of product channel fit with Meta.

7:56Fan Bi:I don't know if you can give me an anecdote, a specific story, but talk to me about maybe your favorite example of a brand that you kind of turned around. Yeah, I mean, I think maybe one of our better known brands is a backpack business called Baboon to the Moon had raised a bunch of equity, built this really cool brand. And it's maybe a Gen Z focus, like Neon, Callaways, Travel First, Adventure. Yeah, I had a reasonably strong contribution margin. But again, because it had built team and infrastructures ready to scale for growth, it never quite got there. There was maybe some excess. And so we were able to take a team down from maybe high teens to less than a handful of people.

8:40continue to invest in the content strategy that had been working for them. So, you know, organics are a big part of the reach. Continue to invest in wholesale, specifically Urban and Nordstrom, which has continued to perform well. We've been able to benefit from having it being pretty successful within the corporate channel. So B2B, logo for Nike, et cetera. That'd be an example of something in the portfolio that we've been proud of.

9:06Fan Bi:And then do you hold it? you build the portfolio and hold it or do you look to flip it or sell it up market? We're usually looking to sell the businesses. Some of the pieces from the intro that I gave earlier, I think, you know, naturally we're concerned about the longer term trends of DTC businesses. So we think that there are a ton of great operators out in the market and for ones that are really focused and naturally we run a portfolio strategy. and someone that's really focused on a specific D2C business can maybe do a better job with it than we can. So yeah, our hold periods are pretty short.

9:41We're looking to come in, fix it up, fix up the income statement, fix up the balance sheet, get it profitable, get it stabilized, and then leave kind of the upside for a new owner.

9:51Fan Bi:You mentioned a lot of the big, the institutional players are moving up market. So they're looking for bigger deals. What sort of size deal are you looking for? Yeah, we're typically looking revenue of kind of 10 to 30 million. Describe maybe the tranches or like the landscape of like exits in this day and age. So you've got people in that range, maybe they're in that distressed category a little bit, and that becomes an opportunity for you. What are the other sort of major tranches that brands find themselves in where they might be thinking about an acquisition? Like what when you say moving up market, these institutional players, what size of deal are they looking for?

10:26Fan Bi:And then are there any tranches like in between that are, that are attractive? Yeah. So if you look at the median Shopify plus business, that's probably something in the like maybe three to$10 million range. And so maybe we'll, to answer your question, let's talk about tranches. So maybe there's the like nascent seller, the one to$3 million business. Even if you're profitable, it's really, really hard to sell that business for anywhere near kind of what you think it might be worth. I think most of these transactions happen for, you know, a million dollars or less. So for the people out there that are running a$3 million business thinking that they're going to sell for$10 million, I think that's tough.

11:02Then you get to that median Shopify Plus business,$3 to$10 million. If you're growing and you're bullish and you're focused, my advice would be to keep going. But if for whatever reason you can't, you really sold on a profitability multiple. So maybe you're a$10 million business doing a million in EBIT. You're probably selling for$4 to$5 million. Once you get to kind of mid-market size, maybe$10 to$50 million in revenue, they're probably still not the strategic buyers, but you might get other PE firms or other trade buyers, like a manufacturer or a distributor, maybe a boutique licensing firm.

11:43you start to get a little bit what's called multiple expansions. So rather than kind of three to five times EBIT, you might be looking at four to eight times EBIT. So even double your size, that$10 million business doing a million, a million and a half of EBIT, selling it four times. You could be a$20 million business doing$3 million EBIT, maybe selling it six to eight times. And so there can be quite a bit of a jump, but then very category specific and not necessarily D2C, but still kind of consumer brands, once you're in that kind of$100 million plus revenue and you're printing kind of 15 to 20 % EBIT, there's much more multiple expansion.

12:23Obviously, we've seen a handful of huge food and bed deals. We haven't really seen anything material in apparel for a number of years now. We've seen a good number of personal care deals. So it's very category dependent because naturally, it's based on the kind of corporate development strategy of some of these legacy brands on, you know, how well that they're doing and what their balance sheets look like.

12:45Fan Bi:And D2C, like the other thing too, I guess, as opposed to the early days is D2C is not usually a standalone effective path to one of these deals. I'm looking at some of the brands that you're highlighting. You got to go find, you got to find Fan, I'll link to him on LinkedIn here, but you're posting all the time about interesting deals that you find in the space. And the one thing I'm seeing is a lot of them are, you know, they're the omni-channel, they're retail, they have these big customer bases, they're consumable repeat purchases. I'm just looking at your post on Laird here. What made Laird Superfood such an interesting acquisition to call attention to?

13:23I think there's a few things interesting about Laird. One, which is they decided to go public even as a kind of smallish brand. They wanted to tap, I think it was kind of peak Zirp era. So a few companies did this. They're one of the few that have kind of survived in the public markets. Saying, yeah, the fact that they're a small, like at a microcap is always interesting. They've never really been profitable and yet kind of surviving in the public markets. And then, yeah, it looks like they're trying to do a multi-brand platform, which has been tried a lot in the last five years. So I think that's interesting.

13:56Fan Bi:And then you have another post here about the most interesting capital move in beauty isn't growth, it's repair. What do you mean? Is that sort of like a skin service or skin repair, essentially? It's financial repair, not product repair. So yes, the founder of this beauty business put in$200 million of her own money, so she exited, I think, had a maybe$600 million exit to a PE firm. Didn't go well. PE firm took on a bunch of debt. She's now recapping the business to$200 million of her own money from the exit to come back, take control. And kind of the point of the post is more that I think we'll see some more of these founder takebacks, whether it's selling back to the founder or the founder investing at kind of a steeply low valuation to recap the business.

14:44They're one of the same. And yeah, I just think we'll see a little bit more of that as investors try to move on from some of the stuff that isn't working.

14:52Fan Bi:When you look to engage on a D2C deal, what are some of the things that can kind of kill that deal the fastest when it comes to those situations? Yeah, maybe not the fastest, but the first thing that jumped into my mind, because we're kind of on a couple of these right now, and one of them is moving particularly slowly. People say that speed kills all deals, and I think when one of the two parties, even just one of the two parties, the level of both parties, replying to each other, instead of talking a couple of times a day, it's talking a couple of times every few days, or talking once every few days, deals need momentum.

15:32So if you're really slow moving, really hard to get a deal done. I think the order of information is sometimes interesting. This is getting really tactical, but some people share a lot of information before the first LOI gate or the letter of intent gate, just to make sure everyone's got information and you can make a really thoughtful offer. The opposite is also true of, hey, we'll give really skinny information, try to get a lot of offers hopefully get kind of a non-normalized offer outside of the band something way above like whatever else is because there's limited information get that under a contract what we often see is that a lot of those processes end up getting broken because the top bidder is like oh actually now that i've dug into it more so that's always interesting um you know how people decide to run run their m &a process i think a bad version is like hey let's just have like a couple of conversations this week.

16:28Oh, nothing kind of came of it. Let's have a few more conversations next month. Nothing, you know, you kind of really need to collapse it all and run kind of a very rigorous sale process.

16:38Fan Bi:That's what I was going to ask next was just sort of what a good M &A process look like for brands under 20 million. Like how, how long should it take? Or what, or in your best examples, how long has it taken? Yeah, I'd say like the median from really from beginning to end, it's probably like maybe four and a half months, you'll find out in the first three weeks if you're going to get traction or not. The best way to get traction is to expand the top of the funnel. Everyone in your ecosystem, competitors, financial sponsors, manufacturers, distributors, anyone that's reached out to you in the past, you know, expressing interest, collapsing all of that, you know, trying to come up with a minimum 50 names and tell everyone that you're in market, reach out to all of them and be like, hey, we're running a process.

17:26Maybe we're giving you an early peek before we kind of open up to the market next week. Have like a good amount of information. And maybe not everything, but a good amount of information so people can make informed decisions. Yeah, hopefully create some heat.

17:39Fan Bi:One of the things we talked about in the pre-interview is this idea of bridge to nowhere brands and brands that are kind of maybe stuck in a attraction loop, essentially, what are some instances where a bridge round, a bridge round of funding is actually just sort of kicking the can and is maybe helping that brand sink deeper? I think most bridge rounds have the story of, we're going to, we just need to grow an extra 30 % to get to break even. That's kind of the normal bridge round. And the reality is, if it hasn't grown the 30 % previously, it's going to be like, most people aren't taking a big enough bet in that bridge round because it is supposed to be a short bridge.

18:23You know, if you really pressure tested it, it's like they're mostly underwriting, like miraculously finding some creative that's going to give them more efficiency, which again, to everything we talked about earlier, is just hard. And what probably needs to happen is that it needs to be something fundamentally changed about the business. that probably gives it the better shot rather than, Hey, let's just kind of try to iterate around the same thing, but give us six more months of cash to do it.

18:50Fan Bi:If you've got a leaky bucket, it's going to leak. Yeah. I'm just interested in the space overall, because I've been, I've been, you know, investing on in, on the side into AI companies, into microprocessors. There's so many things happening. It like, it feels like the whole U S economy right now is really being fueled by these like really high-end technology plays. And it's like, do you ever see a point in the future where CPG and D2C brands will be as attractive as they were in those early days? Like, I guess everything is cyclical, but do you see a point in the future where CPG and D2C deals will kind of return to prominence?

19:30Fan Bi:Or is this, do we live in an AI microprocessor world now? Yeah, I think when you're moving physical product, just doesn't have the natural scalability of software. And yeah, look, I think that there are going to continue to be great transactions, continue to be great brands that are worth a lot of money. And there are going to continue to be investors that make a lot of money from those. And I think the last two years have really shown that. I think the probably biggest difference is, whether it's AI or software, it's really the switching cost. you and I will probably be using our favorite LLM for the next five to 10 years in the same way that we've been using Google as our main search and you know Google's been monetizing us to the tune of hundred dollars you know hundreds of dollars per user for the last 10 plus years but just with consumer brands the switching cost is so much lower and we're constantly bombarded with new ads to try different kind of competitors so staying relevant maintaining that margin over the long term, I think it's challenging.

20:36But yeah, there'll be continue to be brands that catch lightning in a bottle and hopefully they exit at the right time.

20:42Fan Bi:Is the aggregator play mostly dead at this point? Is it mostly just funds and individuals who are buying or is there still an aggregator play active? It's very, very rare. We certainly come across multi-brand platforms, but it's, you know, one one hundredth of, you know, what it was, maybe even less so than it was in the 21 peak. Makes sense. Can you give me an example of a brand that you maybe recently passed on? You don't need to say who they were, obviously, but maybe sort of some of the reasons you did pass on them. Yeah. I'm surprised that I'm going to say this, but like maybe after doing this for a while, we've become a little bit more, even more skeptical on that.

21:21That's even, you know, the we've had to accept, you know, be humble. We've been humbled by how challenging the current environment is. and so the threshold for hey are we going to be able to turn this around are we going to be able to do something differently and specifically better than these small people that we're buying it from that bar is continuing to increase and so most of it it's just that margin of safety of do we believe commensurately even at this you know 20 contribution margin but maybe the revenue is declining or, hey, you know, it's a subscription business, but really masquerading because, you know, the trend is so high, it's really just a transactional business.

22:08Yeah, there's some of the traits of, you know, meaning that we're, yeah, moving on.