I recently watched an episode of the Andrew Faris podcast where he interviews Fan Bi. Fan has looked at 400 deals over the past 2 years and presents a realist’s take on the state of DTC companies whereas Andrew by experience and maybe by nature presents a much more optimistic take.
These two states play out within founders. I think we often alternate between grim determination and hopeful expectation and between despair and optimism. So to hear these states personified and debated is fascinating.
There certainly is selection bias. Fan is going to see a lot of struggling or failing brands. If a brand is kicking ass, they are less likely to come to him. And maybe Andrew sees more successful brands on the whole. But selection bias aside, it’s hard to argue with the data. 400 companies is a lot of reps. So, what does Fan see?
Fan breaks the companies into 3 buckets.
“What is the asset you are really building?”
50% are margin challenged. Their post fulfillment contribution profit is less than 50% and often less than 40%. There simply isn’t enough margin to play with. Their repeat dynamics aren’t great so as a result they have high marketing costs to drive sales.
Andrew and Fan debate how to fix these businesses, but Fan’s experience is that the fixes like better supply chain and increased marketing efficiency take a lot of time and effort and often deliver improvements well below expectations. New product development is expensive in people and inventory, takes time and requires layering in the new products with the old products to a customer base that may not even notice. Raising prices is hard because brands at this point have usually trained their customer base around a promo and discounting schedule.
He asks a simple question of these businesses, ‘what is the asset you are really building?’
Balance Sheet impaired
25% of the companies have balance sheet issues which is usually too much MCA or short term debt. This group often has growth aspirations which are too aggressive and sometimes are poorly run. While fatal if unfixed, these issues can be fixed and if fixed, the businesses could be good assets over time. Unstated, but real is that while the BS issues can be fixed, it’s the governance and management that often needs changing if the fixes are to be permanent.
Top quartile
And the last 25% are pretty good companies with good unit economics, good repeat mechanics, good free cash flow generation and healthy balance sheets.
Realistic valuations
Another point that Fan makes is that founders often have unrealistic valuation expectations. A sub $2 million or $3 million EBIT business is going to trade between 2.5X and 4X EBIT if you can even find a buyer. So, if you have a brand with $6 million in sales and 5% EBIT margin meaning $300,000 in EBIT, you will be valued at $750K to $1.2 million. ‘Is this a business even worth owning?’ he asks.
I encourage founders and brand leaders to watch this episode and debate between realism and optimism and then answer the questions Fan poses. Your time is your most valuable asset, so are you investing it in something worthwhile?
Links
Andrew Faris podcast
The Andrew Faris Podcast 50% Of Shopify Businesses Are Worth $0 (With Fan Bi)
Andrew Faris X @andrewjfaris
Fan Bi The hedgehog Company
Fan Bi X @lifeofbi
Fan Bi In the Money podcast