Acquisitions Anonymous - #1 for business buying, selling and operating - Make Bank buying a bankrupt business | With Mehtab Bhogal - Acquisitions Anonymous Episode 89

Episode Date: April 26, 2022

Bill D’Alessandro (@BillDA) is joined by Mehtab Bhogal (LinkedIn link) DTC eCommerce specialist to talk about distressed acquisitions & turnarounds, operations, capital structures, downsizing for quality, finding a business partner on Reddit, why makeup brands suck, and much more.We discuss a Bankruptcy deal, BH Cosmetics, linked below.-----Thanks to our sponsors! CloudBookkeeping offers adaptable solutions to businesses that want to focus on growth with a “client service first” approach. They offer a full suite of accounting services, including sophisticated reporting, QuickBooks software solutions, and full-service payroll options.-----* Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel.* Do you enjoy our content? Rate our show!* Follow us on Twitter @acquanon Learnings about small business acquisitions and operations.-----Acquisitions Anonymous Episode 89Show Notes:(0:00) Intro(1:00) Cloudbookkeeping.com(2:09) Mehtab's introduction(4:23) Why do you buy a business to downsize it? [Episode clip for wednesday](6:14) What is your general path after acquiring a business?(7:21) What does the cap structure look like pre vs. post-close?(10:23) How do you handle the Equity?(15:39) Let's jump to the Deal: BH Cosmetics.(18:14) Revenue trajectory(21:19) What is a 363 auction?(23:16) What does the process look like?(24:17) What do you think about this deal from a diligence and structure perspective?(26:52) How well do you know the business at the bidding stage?(28:26) Let's say you give it a go, how do you decide what the proposal is going to be for lenders and equity holders?32:00 DIP loan: Debtor in possession financing [Clip](32:43) What is the downside risk here? How does Karta add a layer of coverage?(34:46) Let's take about the operation side: How do you start a turnaround?(40:02) What are specifics about diligence for your company? Why are product teams so important?(44:05) BH got purchased at $4Mio. Was it expensive?(48:35) Tell us about the Return Profile, & how does it relate to equity value?-----Links:* BH Cosmetics Deal Link-----Past guests on Acquanon include Nick Huber, Brent Beshore, Aaron Rubin, Mike Botkin, Ari Ozick, Mitchell Baldridge, Xavier Helgelsen, Mike Loftus, Steve Divitkos, Dzmitry Miranovich, Morgan Tate and more.-----Additional episodes you might enjoy:#Subscribe to weekly our Newsletter and get curated deals in your inboxAdvertise with us by clicking here Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel. Do you enjoy our content? Rate our show! Follow us on Twitter @acquanon Learnings about small business acquisitions and operations. For inquiries or suggestions, email us at [e-mail]

Hey, everyone. Welcome back to another episode of Acquisitions Anonymous, the internet's number one podcast about buying and investing in small businesses. I'm your host for this week, Bill Dallisandro, and I'm really excited to introduce this week's episode. This week we have Metab Bogal from Carta Ventures. And Metab and Carta are specialists in e-commerce, direct consumer, distressed acquisitions and turnarounds. I've gotten to know Maytab over the past couple years through the e-commerce fuel community and he and I have become good friends and I'm always so impressed with just how savvy he is. And he takes us through in this episode, the ins and outs of a bankruptcy auction. And we do it through the lens of a cosmetics D to C company that is going bankrupt right now.

And because bankrupties are public, we are able to use names and real numbers. So I think you will really love this episode with Metab Bogle from Cardav Ventures. But first, a word from our sponsor. Hey, guys, Michael here. I want to talk to you about one of our sponsors in our never-ending quest to make Acquisitions Anonymous break even. And that sponsor is cloudbookkeeping.com. It's actually run by my neighbor, Charlie, who's a great guy.

And he has been our longest tenured sponsor. And we're super grateful for him to support. the podcast. So what cloud bookkeeping does, it is a set of cloud bookkeepers that if you're a small business person, help you get out of the business of doing your books and let you focus on the business of taking care of your customers. So they do all the complexities, bookkeeping, payroll, and they come across in our very client service first. That's their phrase, but I know that's true, because I've spent time with Charlie and dug into their business. So full suite of accounting services, sophisticated reporting, QuickBooks software solutions, and full-service payroll options.

So definitely talk to Charlie if you want to get out of doing bookkeeping and outsource that to a trusted third party, and you can find them at cloudbookkeeping.com. So thanks again for sponsoring today, cloudbookkeeping.com. All right. I am here with Metab Bogle from Cardav Ventures. And Maytab and I have gotten to be good friends through the e-commerce field community over the last couple years. He is one of the smartest folks in e-com I've ever talked to, and it's fascinating because he specializes in turnarounds. So distressed e-commerce companies, he comes in and acquires

them, and we have got some very interesting perspectives from him today. So Maytah, great to have you here, man. Yeah, no, great to be here. Thanks for having me. Can you give our listeners just a little bit of background on, you, Carter, what you do? Yeah. So I bootstrapped a few D-to-C brands. kind of my early 20s, I started making angel investments. Actually, tried sourcing deal flow on Reddit, and then I met my business partner there. We invested in a handful of companies together. He'd done some turnaround before when he worked for CSC generation, and then he dragged me into doing turnarounds. So here we are. So do you guys have a fund? Do you raise deal by deal? How's it structured? Yeah, we're more of an independent sponsor, so we do raise on a deal by deal basis.

We'll usually actually just put all the equity up ourselves for any sort of transaction that we close. And then we'll bring investors in later, if that makes sense. That just allows us to move much, much faster, given you're essentially paying more for the asset if you wait. Yep. Yep. In distressed, time is money. So can you tell the, you know, kind of target-wise, what size do you guys typically look at? Yeah, we really want anything we can carve down to about two or three million in EBITDA. I've just found you're going to end up doing the same amount of work anyways. It's a deal smaller.

And there tends to be more going on on the credit side, the larger the deal is. It doesn't mean we won't look at smaller deals. It's just that's where it becomes a little bit more appealing for us. So 2 to 3 million in Eidavad probably leaves you around 20 to 50 million in top line ballpark? Yeah, and then we have to carve that down. So we always, obviously it's much easier to bring a company down in size than it is to grow top line revenue. You need commerce especially as you tend to shrink size, your cost per acquisition goes down on the customer acquisition end. So it's a nice little dynamic if you find something that looks like it can be downsized, seemingly.

So I want to expand on this a little bit because a lot of people might say you buy a business and then you downsize the business and you aim to shrink revenue. I'm guessing this is because, as a fellow DDC guy, in direct consumer or in any kind of marketing-driven business, your incremental customer is the most expensive. right to acquire one more customer is the highest CPA. So I imagine what you're doing is sort of shaving off those highest CPA cohorts, right, to get down to the profitable ones. Yeah, just like you said, the last 10% is always the most expensive. So shaving that away, getting back to kind of the core customer and cleaning up the company. It's a bit of obviously the less revenue there is, less need there is for kind of additional overhead expense.

Yeah, yeah. So tell me, can you tell our visitor sort of what's the portfolio of Carter look like now? you can be a specific or as general as you want. Yeah, so there's three primary platforms. One's a succulent company, completely vertical. So we have 24 acres of farmland down the middle of Newark, California. And that means we grow the plants, pick them, ship them via customer. That's nice because it keeps the typical e-commerce guys out.

I certainly don't want to be bidding against some of these guys who are really, really strong on the marketing side. So that gets around that. They're not going to boot up a farm in the middle of nowhere. The second platform is a floral company that makes artificial flowers made in wood. That was interesting too because it has a really complicated supply chain as well as a bit of a U.S. manufacturing dynamic. So we have about 100 people in the manufacturing side out in Utah, which is where I am right now. And the third platform is a fast fashion woman's clothing company.

That was a little bit more straightforward. It's just interesting because the fast fashion side, there's a bit of logistics play there, if that makes sense. And then there's a handful of minority equity investments where they're either completely hands off or were involved. but not. It really depends on the specific position, but there's nothing we're overly involved with right now. So will you guys, is your general thesis to buy it, fix it, and then sell it once it's stable, or do you try to hold for a while? Yeah, I guess it depends on the underlying asset. The floral company, for example, our intentions to hold that for quite a while. Really just keep picking up the low-hugging fruit. Until we feel that's done, we don't really want to solve a company, even then we'd rather just,

pull cash out of companies to make new acquisitions. In turnaround in distress, I guess it's unique because you don't need much cash to actually get a deal done, especially in D2C where there's no real competition. If you look at, you know, industrials or something else like that, there is a roster of turnaround operators and turnaround focused private equity firms that an upside down lender can go to. In D2C, there's no such thing. So there's really not much competition. Assets don't get bid on much unless you maybe go past 100 and 150 million range in revenue.

even then it's a pretty dead market. So cash isn't really a concern. It's more so of a bandwidth thing, if that makes sense. You kind of end up paying blood. Yeah. So help me zoom in on that a little bit because sometimes when I think about turnaround, I think about cash is king, right? These companies are bleeding cash.

Liquidity is often the problem. If you can come in with cash and kind of recapitalize the company, that often stabilizes things right away. Can you kind of zoom in and explain to people, you know, maybe what the cap structure looks like before close and right after close? And why do you say that you don't need a ton of cash? Yeah. So typically, if you're looking at a company,

let's just use, you know, your average company doing 15 or 20 million a year in revenue. And let's assume they're both, it's an income statement and balance street turnaround. So, you know, there's some very large liabilities coming up that they're not going to be able to meet. and there's kind of ongoing cash that they're hemorrhaging. In that scenario, coming in, turning off the bank, as far as entry in the capital stack, there's usually a senior secured lender, and then you'll see someone kind of junior,

more on secured lending gains, the cash flow. You probably won't have like the second lien or third lead or anything like that. And then you will have a handful, in e-commerce especially, you'll have a handful of these, programmatic lenders so clear bank maybe way flyer maybe a shopify capital or the amazon equivalent um or or some of these you know paypal capital is another good example and those are all

insecure in most cases so do those got this is the unsecured folks you come in and you basically approach the secured folks and you say look this is this is on the edge of bankruptcy take a haircut and then you go to the unsecured folks and go this is zero for you sorry is that typically how it goes I guess it depends on the specific deal. They're typically going to want out of their position, and that tends to be the most logical way into a company. So you can offer them a certain percentage. So maybe they have, I'm using really simple numbers here,

maybe they made a loan of $10. You might offer them $2 for the position, and that will basically essentially get you control the company in some cases or whatever the fulcrum ends up being. The fulcrum is just a phrase for whatever the control, whatever converts to equity and lets you control the company. A lot of these cap structures are pretty simple compared to what you see upstream.

So anyways, you come in, maybe you take over the senior secured position and you end up running the company. From there, there's the unsecured lenders, et cetera. Some of them will be critical vendors. So Facebook, for example, you don't want to default on. You can't be a D-C brand without access to Facebook. Same with Google.

And then a handful of others like FedEx, UPS, et cetera. Anyone that's not critical will typically work with the unsecureds to build out. a plan. We'll walk through them, we'll walk them through what a subchapter five bankruptcy would look like. And subchapter five is a very, very interesting tool. It was just came out about, I think, 2020, right before COVID. And it's basically an inexpensive version of Chapter 11 for small businesses with under $7 million in debt. So do you typically, you come in, you offer the senior guys 20 cents on the dollar, and they say, yes, we want to take that. Do you have to, is it a separate transaction

wherein you take the senior guys out and you actually have to put the company through a bankruptcy process in order to take the equity, or do you just go to equity and go, look, just hand us the keys. It'll be less miserable for everybody. Yeah, it depends on what the, it depends on what the, with the structure of that loan looks like. Sometimes it's easier. Other times it's not. We try to avoid anything that looks like it's going to require protractive legal work on entry, if that makes sense.

Typically, the equity is on board with what's going on. and we can convert, you know, if the founder's still around, we're happy to, if it makes sense and if the reason the company is distressed, then we're happy to keep them around. Like the, one of our platform companies, we have both of the original founders around still because they do a good job, and it wasn't really their fault that they were distressed. So when you say the equity is usually on board, when I think about distressed or bankruptcy, on board means accepting of zero. Is that always the case, or do you try to leave the equity guys in order to get them to commit to this transaction,

some bite of the apple on upside? Is there a way to structure that? Yeah, essentially granting them equity in whatever the post-transaction company or NC looks like and having that vest, if that makes sense. Obviously, they're not going to go back to owning the entire company or a big chunk of the, they'll still have some upside, they'll still have a salary in some cases.

So it's a lot smoother for their personal finances. Okay, so you convert them from, kind of a founder with a lot of equity and very volatile salary to essentially an employee with option grants, right? Yeah, yeah, exactly. And we found in a lot of cases, people do want to make sure that the company kind of gets through things okay, as opposed to, hey, you know, let's burn everything down the type of thing with their exit.

They realize they're upside down at that point. It's a little bit different from, it can be different. Some people are very, very delusional, but we try to stay away from that. And it really depends on the upside, I guess. Maybe sometimes we're happy to look at it, even if they are delusional, it requires a little bit more legal force. Legal force. I see deals sometimes where the equity is delusional about the value. And my typical sense is, okay, call me back in six months.

Maybe you're right. You know, maybe everything's going to be fine and it's going to be worth a zillion dollars. Call me back in six months if I'm right. Is that often all you guys play it? Yeah, I'd say we, some of these companies, we end up starting. starting to talk to them. A good example actually, we were looking at a company that I did at making a loan to in Q3 of 2021. And then Q1, we ended up making a loan. And they were just a little bit more confident in their turnaround than we were. We told them we're happy to kind of provide

you to liquid to get through this and give you guys the tools. And it was a really solid operator. He did a really good job. And we were kind of happy to learn the company. So you just mentioned making a loan. Are you guys, that would be a dead instrument. had assumed you guys were always equity investors. That seems to not be the case. How do you guys think about, is it like loan to own in some situations, you know, where it's where essentially, if they're right, you just make a nice current return on your debt. And if you're right, you own the company? Yeah, it's a mix. I guess it really depends on how good we feel about the founder. In some cases, what we'll typically do is we will write the debt. It'll be senior secured,

whatever first lien. And they'll have a lot of, they'll have some level of pseudo-secured debt on their cap table. What we've noticed actually happens quite frequently is you will see that certain creditors have the right to file a lien. That doesn't really mean anything because you have to perfect a lien before it's actually legally gives a priority. So whoever perfects first along with actual priority and we're usually first.

So that'll happen. And then we'll help them start, just implement our standard tool set. It's fairly straightforward. You know, get a 13-week cash flow model going, starting to push some vendors for net terms, et cetera, and that will usually create enough cash to get them through the hump that they're going through. And then we'll help them get more unsecured debt. And that essentially builds a liquidity mode around us. So we're essentially guaranteed payments, if that makes sense.

If they do default, there's usually an asset. there that we'd be happy to own. So. Yeah. I've always thought, and it sounds like you're, you're circling around this model. There's such a dearth of debt capital for midsize e-commerce businesses. And I think it's because banks can't get comfortable with the underlying collateral, right? They're not really cash-loenders, they're asset-light businesses. And the bank doesn't want to own a succulent farm in the middle of nowhere with the primary go-to-market as, you know, direct consumer, right? Right. Yeah. But if you were D-to-C savvy and you didn't mind, owning the asset if it didn't go well, it would probably allow you to get a lot more comfortable

with a lot of different credits that there's not really markets for right now. Yeah, exactly. Okay, cool. So you brought a fascinating deal, a public bankruptcy from earlier this year that you and I chatted about in January and all the details have come out. So we're going to walk our listeners through this deal. And the cool thing about public bankruptcy is that all the names are public. The whole situation is public, and we can talk about all the numbers and the names, et cetera.

So I'm going to read a little teaser, and then Metab, I'll throw it over to you to kind of frame the financial situation that they were in and then we'll get into how we would look at this as investors. So our subject today is a company called BH Cosmetics, which is a leading direct consumer color cosmetics brand focused on the millennial and Generation Z customer. It was launched in 2009 with a focus on eye pallets and has since developed a full suite of, of high-quality color cosmetics, including products for the face, lips, eyes, brows, and brushes and accessories. They have a worldwide social media following across multiple platforms and utilize a deep influencer network to drive brand awareness, trial, and customer acquisition. We will get back to that deep influencer network in a minute. Given the company's heritage, B.H has developed an advanced e-commerce platform with proven capabilities. And so B.H was acquired by a private

equity firm called Mid-Ocean Partners in December of 2017. So Mid-Ocean, they don't just do a consumer, they do a lot of different stuff, legitimate private equity firm, they put some debt on it when they bought it. And by the time, you know, they bought it in 2017 and it did not take long for things to unravel after that. So, Maytab, can you kind of take our listeners through what happened after a Mid-Ocean bought it? Yeah, so it looks like Mid-Ocean purchased it shortly after the original.

founders left, they swapped in a new CEO and they ended up having to push debt back, I think, in 2019. Yeah. So the first forbearance started in February of 2019, which is also when the founder and CEO resigned and an entirely new management team was hired. Obviously, things didn't get better with COVID. So COVID happened and, you know, make up in general is a different vertical. Sorry, a difficult vertical to make work. And it gets even more difficult when COVID happens. And from there, things slowly deteriorated. And eventually they filed for bankruptcy, I think Q4 of 2021 or Q3 and Q1 of this year, 2022. The asset was finally sold by a 363 auction for the, essentially the IP, really. So Medaub, can you kind of, do you have numbers on

kind of revenue trajectory? Yeah. What were those? So pulling them up here. So 2019 was 55.8 million in revenue, 2020 was 33.6 million revenue, 2021 through November was 18.6 million with negative 14.4 million of Iveda. Whoa, negative 14 million of evadda on 26 million in sales. Yeah. Do you have more detail on where the hell all the money was going? So when I looked into, I pulled up, this is kind of a funny way of doing it, but I had just pulled up, LinkedIn and I used the little graph that they have to go further back. And it looks like they had quite a few staff still. It almost feels like they were geared up to run a $60 million, a $100 million as far as staff goes and kind of the way their setup was instead of a company during, you know,

$20 million, $15 million. And I get back because they're distressed, but they've been distressed for a while. So I think they're a little bit slow to start making cuts. I would say so. And there is a crap load of debt on it. So the article you sent me said that Mid-Ocean acquired it with a $25 million credit agreement for Fifth Third Bank. And there's about 21 million currently outstanding. And it started to go into forbearance in February of 2019. So that is less than 18 months after Mid-Ocean acquired it. So it did not take very long for things to start to unravel. No.

And it looks like Mid-Ocean continue to inject equity, even through the forbearances. Is that right? So, yeah. In Mid-Ocean, initially purchased 60% of the company in Q4 of 2017, more of the company in 2018, 2019, 2020, and 2021. So overall ended up being about $32.5 million in equity. This is interesting because you'll often see private equity firms kind of play games or with the company go further along into kind of an approach bankruptcy. My guess is that they felt

they could float it through COVID and things would pick back up post-COVID, but obviously COVID lasted a little bit longer than people thought. Otherwise, you normally see more games being played with lenders, being more aggressive, pushing back on debt, et cetera. That's wild. So they're in for, so Midoches is in for 32 and a half million of equity and the lenders are in for about 22, million of debt. And the thing has fallen from 55 million in sales to about 15 million in sales in 2021 was what they were tracking for. And then they filed for bankruptcy, you said, in early 2022. It was late, late 2021. And then the sale was completed. They ended up selling the assets That's why a 363, I think, and someone purchased it, well, and someone.

I think they were a German or UK-based company purchased it for around $4 million. Wow. Okay. So let's kind of dig in for how you as a distressed investor, you know, they file for bankruptcy. What is a 363 auction? Yeah. Essentially, it allows you to bid on the assets of the company without worry of another lender or someone else coming in and claiming that those assets.

were fraudulently transferred to you and you would lose those, right? So if a company is distressed, let's say Bill made a, you know, has a lien against those assets and they were sold off anyways to me and I never bothered checking to see if there were any liens or anything like that. I purchased them. You know, Bill could allege that that was fraudulent conveyance, that they were transferred out fraudulently and he could essentially get the assets back and I might just be completely out of cash.

I wouldn't get any cash back. So the 3603 auction gives you comfort as a bidder that you can acquire these assets free and clear. Exactly. Exactly. And that's, you know, or enforced. And there are, I assume there are brokers that, you know, or lawyers or some clearinghouse that kind of takes you through this, this process? Yeah. Yeah. So typically, it depends. It's a few players for distress deals. you obviously have just straight up lawyers that are specialized in restructuring, bankruptcy, etc. You then have investment bankers who are specialized in the space as well. And they'll pop up kind of closer to the, I'd say really $40 to $100 million range is where you'll start to see them. I'd say $40 million even feel small in most cases for them.

So you might see them here and there. And then you'll see a lot of consulting and turnaround based firms. So in this case, they brought Riveron in, which is really interesting. Actually, the first Q of E ever had done was from Riveron. So it's funny the thing. I didn't even realize they had a restructure in practice, but I guess they do. So they brought in someone from Riveron's team to essentially manage the company through the sale. And that's what we saw here.

So take our listeners sort of through the process. So the company decides, okay, we're actually screwed. We need to go through this 363 process. I assume there is, you know, like an information packet that goes out to, you know, a little bit in advance to help bidders kind of get comfortable. And then is there a literal live auction like on the phone? There's so in most cases what will happen is you'll have a stocking horse bidder who basically sets the fore for the auction and they're compensated in some way for doing that.

So in this case there was an actual fee that was paid to the stocking horse bidder. It can be quite lucrative if you're willing just kind of go out and make a bunch of bids. And they essentially get an advantage. And they're incentivized to kind of follow through in the bit if that makes sense. So in this case, you know, they set the floor and then there's a period where people are allowed to make offers on the asset being put up. And yeah. Okay. So that's essentially it.

It's fairly straightforward. So your card adventures, you specialize in discressed ecom, this deal comes across your desk, right? The revenue is a falling knife. There's a ton of equity already into it. There's a private equity equity into it. and there's a bunch of debt on top. How do you start to think about an opportunity like this from a diligence and then what structure will we propose?

You know, kind of take us through your mindset. Yeah, so we like to break a company out into its parts and see what it could look like post-transaction. We actually build out a 13-mead cash flow model based on financials that way available to catch out what it might look like if there wasn't that massive debt load sitting there. certain economics to be improved, right? Like maybe they implement lead manufacturing. They cut variable labor, obviously they're not manufacturing in this case, but if it was a company with the manufacturing component, you implement something like lien, you can cut variable labor

costs by 40%. You can build that into your 30-degree cash flow model and see how that flows. And that all creates room for payments to lenders. And you can show that to lenders, right? You can say, hey, look, here's what we did elsewhere. We could do that here. This is what your repayment would look like. And it often comes down to convincing lenders. And then obviously there's legal sides to seeing what can be pushed back, what can't be pushed back, how flexible are certain lenders. In most cases, lenders do not want to be the ones to run the asset, just given their lenders, they're not equity. So that's our approach at a really, really high level. And looking at the liquidity within the business, in a lot of cases, someone is distressed

and thinks they don't have enough runway, but they really do. They're just not pushing for as much float as they could get. So maybe, you know, maybe they have a large Facebook bill. They're paying a million dollars a month for Facebook ads. And for some reason, that bill's still being paid by a credit card when they could push Facebook for net terms. You can actually pay Facebook 19 days late. They won't ban you until the 20th day. So you essentially get your net 30 plus another 19 days on top of that. So you just created 19 days of whatever that ads, bend cashes, if that makes sense, within the business to use his working capital. So you come in, you're looking at the income statement to try to figure out where we can reduce expenses,

be it at the very highest level of interest in amortization expense. But also, are you looking at, are there too many people here? Do you know the business well enough to know that at the bidding stage? So for the smaller companies, we'll typically have full financials from the, that the lender will just shoot over that they have. And we'll rebuild everything. We'll build a 13-week cash model to make those decisions.

We'll look at staffing and see how heavy it looks. In most cases, once we're actually there, or right before we're there, we can tell. It's fairly easy to tell. I think the biggest giveaway is looking at the reporting structure of each department and how that flows. It'll typically tell you how well-run a company is or a specific department really quickly. We've seen all sorts of ridiculous things. I think the best. My favorite of all time is still the accounting department that had a bunch of people in it,

where nobody was actually using Excel. They were manually entering number. They'd have a calculator. They'd calculate, say, 2 plus 2, right, equals 4. And then they would type that into Excel instead of using a formula. Oh, my God. And had no one told them that Excel had formulas? Was that the basic idea?

I guess, essentially, I guess. So they were just, they're very fat on staff, right? And we'll see a lot of that. Another good example, customer service. All D-DISD and e-commerce software, well, not all, but most of. It'll show you how many tickets someone's gone through, right? So say Bill and I are both customer service. We both do an average of 100 tickets a day.

We go on and we can see Gertley's only done one ticket today, right? And it's like, hey, what's going on? Explain this. And there's usually no explanation. They're just kind of lazy and no one's ever looked at it. So it's pretty clear what needs to happen. Or in some cases, they have large U.S.-based staff that does not need to be U.S.-based, right? And that presents massive cost savings opportunities.

Okay. Yeah. So, and then how do you think about, you know, you're going to go to the senior lender here, in this case for a BH cosmetics, there's $23 million or so of debt on it and $32 million in equity? Let's say you run your 13 week cash flow model and you go, okay, like we think we can make this work. If there was no debt or minimal memorization, we moved some people to Philippines and we fire Michael Gurdley because he's totally dead weight, you know, et cetera. Now you got to go to the lenders and the equity holders. and make a proposal. So how do you decide, hey, lender, it's 80 cents on the dollar. Hey, lender, it's 10 cents on the dollar. And you have to talk about amortization periods, new interest rates. How do you come to the proposal? Because your bid isn't just, it's $4 million. It's much more complicated than that because there's a whole deal structure and how we're going to do the work out terms with the debt. So how do you wrap your head around what you're going to propose? Yeah. So there's really two, there's kind of two main scenarios that you see in distress. One's pre-bankruptcy. So maybe the

very close to filing for Chapter 11. In this case, they filed for Chapter 11, then ended up doing a 363, which essentially you're liquidating a company. So, and more or less trying to do Chapter 7, right? Maybe they should have started there, but they still felt they could bring the company back. So if it's pre-bankruptcy,

that's where you tend to see most of the negotiation happen. If something's still sliding, even through bankruptcy, everyone kind of knows it's a write-off at that point. It's just a 363 bid, which is very straightforward. but pre-bankruptcy, like you said, there's extensive negotiations to lenders. So, well, we'll go to them, show them what we think can happen and come in fairly low. We like a nice moat around anything that we do. And you really never know what's going to happen, right?

Like in our case, we purchased that floral company, 75% of the customer base was bridal. And then COVID hit. We were lucky because the asset was really scalable. So we grew through COVID. But if it was something that maybe it wasn't as scalable or there was as much low-hanging fruit, we may have just kind of slid down, right? And in the same deal with the creditors and that deal, we're able to just kind of push them aside more or less.

So, yeah, I guess it really comes down to the specific asset. I'd say with D to C, it's really interesting again, because there's no go-to bench of operators for an upside-down lender to go to. There's no one really specialized in turnaround. So we can come in with a fairly low bid, if that makes sense. They're very happy to get anywhere from kind of 10 to 30 cents on the dollar would be considered a very good outcome for them. Okay. And so it just depends on if they've already gone through a bankruptcy process and it's in 363, they've already agreed how they're going to divide up that 10 to 30 cents on the dollar. Well, they're done. They're just going to be paid with the proceeds of the auction, if that makes sense, going through seniority. So they've already thought about who's senior, who's sub and they already know what the waterfall is. But before bankruptcy, that's when you maybe have to be a little bit more creative and get the lenders to let you agree to throw equity a little bone, right, to get it done.

Yeah, and in some cases, if there's a fulcrum security or there's multiple lenders, you can essentially buy a position and use that to make a dip loan as part of the dip loan, if that makes sense. What's the debtor in possession loan? Yeah, it's a debtor in possession loan. That gives you super priority over everything else so that you can actually cram down. So if you're senior secured, you're the bank, I come in, I'm the one that's actually willing to make the dip loan to the company. I can cram everyone else down. So you can come in at super senior secured ahead of everyone.

Yeah. So in most cases, you'll see the senior secure lender make the diploons themselves. And the terms on those can be pretty crazy. I think shot you one about a year ago. I can't remember who it was for. But the diplons tend to have pretty wild terms in them. So if a company misses a payment, more or less the dip lender then owns the whole company,

or you'll see some pretty wild interest rates, even on the larger side for some of these companies that are in all reality and pretty safe loan. They're being charged anywhere from kind of 14 to 18% when you factor in fees. Obviously, with a smaller company, it's even higher than that. So it's a very safe loan to make. So the thing that fascinating is about this whole world

is, you know, if you're listening and you're in, investor, right? You probably think, wow, like the rates return on these loans are fantastic. Like, there's such huge opportunity here. From a spreadsheet perspective, I can do all these fun spreadsheets that really make great IRAs. But ultimately, you have to be willing to own the company and run it, right? Like the downside, the threat of the dip loan is that they default. And then, oh, crap, you own it. Right? And you've got to run it. And you've got to run it. And you've got to run it. your principal's at risk. And if you don't run it well, you lose principle. And plus all the legal fees, you kind of don't want to get called on your bluff in a lot of these scenarios, right? If you're

the stocking horse bid or if you're the dip loan. And then, oh, crap, you own the business. And that's what has always fascinated me about your business at Carter is that you guys are extremely financially sophisticated on the front end from an investor point of view. But also, you're not afraid to own the asset at all. Right? I mean, you guys, you mentioned you're operating several companies right now. that. Yeah, I'd say we're probably stronger on the operating side to the financial side too. So for us, part of how we look at our moat and kind of margin of safety is what we can do on the turnaround side around ops or helping the company returning, but just implementing a few basic changes that would create plenty of cash for them. And again, just a moat around the loan if we did make a loan

or a moat around our investment on the equity side. When you say moat, you mean margin of safety? Yeah, yeah, sorry. I'm just using image of change. So, you know, a few things can go wrong and we won't necessarily be completely upside down. Whereas if someone who is just coming in on the financial side, they can't build that, right, that extra layer of protection. So in this case, we might say something like, hey, implement EOS, implement lean, implement top grading, et cetera. And you'll see X, Y, is that improved tremendously or make these cuts? And you'll free up enough cash to where suddenly the dead load isn't really that big a problem. So let's talk a little bit about the operation side because you've dropped a,

breadcrumbs during this interview that I want to go back to. So you mentioned with your wood flowers business, you said it was 75% bridle when you bought it. But then you said, but the asset was very scalable. So we actually grew through COVID. So that's obviously a post-transaction operational win. So can you kind of walk folks through what happened in that scenario? Yeah. So the company had scaled really cleanly, more or less organically. They weren't really doing much. So they were spending on paid, but it was literally someone who had absolutely no clue what they were doing, just buying Facebook ads. It was a wild that, it certainly wasn't working, like the paid ad side. The organic side was working ridiculously well, and the paid side was just burning money, right? So just fixing

that alone was a pretty big one. The website, for example, complete garbage. It looked like a 15-year-old had made it or something. So just ripping that out, replacing it. On the opposite, side. They were actually the ones with a customer service agent who had answered, I think, one or two emails through the day. We brought her in and were just like, hey, can you explain this to us? She said, no. I said, great, get out. Other good examples on the production side, they had people there. They had a guy who, this is the best story, just sounds completely made up. He claimed he had epilepsy. The previous owner was paying him under the table, and he wore a kilt every day. And he had a bunch of knives, like strapped to his calf.

And real lives? Yeah, yeah. I just thought it was the weirdest thing. And I was like, okay, well, this isn't going to work. You need to go. And it's just a lot of similar situations where there are people. I really couldn't figure out what they were doing. It didn't make any sense.

So a lot of these tend to be more black and white than you think, probably the most hilarious. It's just weird to me that this actually works is bringing everyone in, just saying, hey, who do you think does a good job? Who does a bad job? Do you mind walking me through what you do? Where do you want to be, et cetera, almost like a re-interview. but getting feedback on the rest of their colleagues tends to be strangely consistent. So if you have a team of say, you know, let's pull a marketing department out and there's seven of them, right?

If you talk to them, you'll typically hear who the best people are. And everyone will say almost the same names and same deal for the worst performers. And that lets us make decisions really fast within the week. In turnaround, it's a lot like running a startup. You have to be willing to make big decisions really, really quickly. And those might not be the right decisions in those. those cases, but you need to move fast. Otherwise, he'll be out of cash. So, you know, with the for-all company, I think I was personally losing about $6,000 to $10,000 a day. So that's a nice

fire under your ass to move a bit faster. Yep, that'll motivate you. So for you guys, because you are direct consumer experts and those, I assume, are pretty much the only businesses that you'll bid on in distress situations because you're not afraid of owning them. I imagine when you run your 13-week cash model. Let's say I start up, you know, Bill Ventures and I want to bid against you. You know, but let's say I'm not me. I'm just a regular financial guy and I don't know anything about DEC. And I bid against you. My 13 week cash flow model or my projections for the company will probably be fairly muted, right? Because I don't really know much about this industry. I don't know. Maybe I got to bring in a CEO and hope you can turn it around, et cetera. I would imagine that,

So I'll only bid so much, right? Because I'm pessimistic to average about the future of the company. I would imagine that you guys can come in and say, wow, like these Facebook campaigns are just lighting money on fire. But, you know, over here, if we scale these up, we can really grow this business. So I imagine that being a really good D to C operator allows you develop a more optimistic lens on the future than other bidders might. and therefore bid a little more, even a dollar more. Do you find that happening, or are you just very frequently the only bidder anyway, and it doesn't matter? I'd say more often than not, we're the only bidder.

Sometimes there is another bidder, and they might be more optimistic than we are. I've actually found it goes both ways, so either they're far more conservative or they're far more liberal of their projections, and it'll be the finance guy who are to consult it from a marketing firm, the marketing firm. Yeah, I totally would get this pumped in a 10x row ass. And you know, that's just not realistic, right? not going to happen. You know your CPA is going to go up 20% a year no matter what you do. So you need to account for that, et cetera, and underwrite to that. But, you know, a lot of these guys will just drink the Kool-Aid that they're being told from these agencies. So that is one advantage

we have those. We can move much faster on the diligence front, which tends to be the main selling point for a lot of these firms is, hey, you know, someone else might come in with a higher bid, but they're going to come in with a higher bid once you've lost another $3 million. So if you, we can move really, really fast. We can the diligence ourselves with our in-house team. We can have someone poking around in the accounts tomorrow. We can have someone else, you know, building out the 13 week later today versus a private equity firm that can't really do that because they don't have an operating team with deep,

deep distress turnaround experience on D-DISD specifically. Yeah. So what are some places when you talk about going quickly in diligence for you, and this is different in every industry, right? But for you guys, can you think of like one or. two things that you dig in much deeper on and also one or two things that you don't give a crap about that everyone else seems to care a lot about? I guess it really depends on the specific transaction.

The thing that really concerns me most of the time is product and the product team because that's outside of the everything tastes like chicken layer, right? Everything else about the business is more or less going to be the same. But the product and the dynamics are really understanding everything about that and what the team looks like post-purchase is really critical. to us, especially if we're going to be losing a founder in the transition. They tend to be very product focused. They know the product side and the customer really, really well. And there's no way we can replicate that ourselves, right? Like, I can't come in. I'll give you a good example. I've only been to

maybe two weddings, like two American-style weddings in my life. I'm 28, so I don't have that many friends that get married yet. But the, like, I really didn't know anything about weddings. So I know I can't come in and build a lineup of flowers that look good for weddings, right? We needed someone solid on the product side. So that's where we run the deepest diligence and making sure that there's someone around or a team around that can handle that properly. And then going back to mechanics,

yeah, I'd say probably really thinking through the customer acquisition side and stability around that and ensuring there's no little tricks like, you know, you'll commonly see the email list just being blasted. In some cases, that's okay if it's a certain audience,

they don't mind being blasted. But in other cases, you're going to burn the list fairly quickly, and you'll see performance just drop off a cliff on the revenue side. So same deal with paid. There's a lot of little short-term tricks you can use, right? So making sure none of that's going on, really. Outside of that, it's just diligence with the liability side looks like and ensuring we're not stuck with something.

There's always surprises, I'd say, especially with turnaround, right? You never know what we're going to get. for example, we had a wood shop manager that ended up being on only fans. I don't know what to deal about this. So there's always stuff like that. That's not really a big deal, though. For us just ensuring there's no major liability sitting around that'll bite us. If you've heard the term like desk drawer liabilities for like, you know, secret or unisclosed

liabilities, that actually happened to me. We bought a business in 2017, you know, it was distressed. And, you know, they were losing, I think, I think you were losing, about 50 to 100 grand a month. And same thing. We came in. We basically got it for assumption of debt and then did work out with the lenders. And when we got in there, I flew out there, companies in Portland, Oregon, flew out there. And we are basically going through the office because we were breaking the lease. Like we were out. And we were going through the drawers of the company's accountant. And we literally found $50,000 of vendor bills on paper, paper bills.

that had just never been entered in the ERP. So there's no way we would have known about them ever. And they were from, as you said, critical vendor. It was from the company's contract manufacturer. So we couldn't say, what I wanted to say was, sorry, seller, you didn't disclose these. These are your liabilities, which I had every legal right to do. But had I done that, seller would have just stiffed the primary manufacturer who I needed to keep doing business with. So we took, you know, 50 grand in the teeth on that one. Yeah, which is, yeah, exactly. And in a lot of cases, there's no real place to go and get the money out anyways. Sometimes you can set up an earn-out-like structure, but in most cases, you're not really paying the equity tranche anything significant anyways.

Yeah, the classic phrase that, you know, price is diligence, right? At a low enough price, you know, you're willing to accept some body blows and just kind of add it to the purchase price. Yeah, yeah, exactly. That's a way of looking at it. So, Maita, back to B.H. this one ended in a $4 million purchase of the assets. So new owner owns the assets free and clear. Do you think that was too much or too little for this business?

I guess it depends what the new owner feels they can do with the IP afterwards. I think it was a little bit much given it looks like the company's probably profitably only able to do $8 to $10 million a year, right? Maybe, maybe. And that's a stretch, right? Makeup, like you were saying, is a lot trendier. I think it's really rough because there's so many skews. I'm surprised when you Google the company, the reviews are actually really, really good.

I'm surprised they didn't try to pivot into something else. Again, I really like to treat these as startups almost. So pivoting a whole product line, moving away from makeup, to me, it's a total no-brainer to try and give that a shot of the main business is crumbling so badly, right? they did point to the whole no makeup trend as being a problem. I don't know if it's really a problem. I think it's a bit of a weak excuse. The operator they brought in didn't really seem like he had significant D-to-C experience, plenty of retail experience,

but it looks like to me that their plan for turning the company around, it really didn't make sense on multiple levels. They paid Doja Cat and Iggy Azalea for influencer deals, which is something you would do if you were a $100 million brand, but it's not something you would do if you're doing, you know, 15 to 30 million a year. It doesn't really make sense to bring on that size of influencer in most cases. Maybe if you're profitable, you can afford to kind of take a shot that just seemed like

a little bit of a Hail Mary. And I'm guessing the cash out way for that was pretty significant. Yeah, the thing is that is, so we mentioned before we started recording how, what a terrible business makeup is. You know, people ask, it sounds like you, but also me all the time, because we do personal care and skincare. Oh, well, surely you guys are interested in this makeup brand. I say absolutely not.

The thing that's tough about makeup is you have tons of skews, right? All kinds of different colors and sizes. It can be very undifferentiated. You know, you're not going to invent a new color, right? And colors are often seasonal. So you have to keep coming out with the new on-trend color all the time. So your skew churn is crazy, which leads to dead inventory. You know, last season's colors that you can't sell.

you also have to, every time you come up with new products, you need a new photography. And if your photography has to be on a human face, right? Makeup's not very interesting if it's not a human face. So you're always hiring models. You know, it's hard to do all that creative generation. It's just a very hard business. And on top of it all, price points are usually not that high, which is kind of death for e-com. So in this case, the thing that was interesting is they've got, they got 3.6 million Instagram followers.

You know, who knows if those are real. But it seems that this brand actually has some recognition. So I would imagine, you know, whoever bought this thought, you know, maybe there's something here that I can leverage. And these guys are just incredibly overstaffed. I mean, is that probably what they were thinking? Maybe. Again, they just bought the IP essentially. So I have a feeling that that company,

owns a few makeup companies, I think, was to deal with them, so, or a few cosmetics companies. And I'm guessing their plan is to use an internal shared services team to basically relaunch the brand and get away with running it at lower volume. Maybe it is profitable, you know, that kind of $8 to $12 million range in revenue. And I would imagine the, I forget how big it was. They was mentioned in one of the court dockets. The email list is pretty chunky. So there's something there.

You certainly squeeze cash out of it. Could you squeeze out $4 million in net profit within two years? Probably not. I think that's really hard to do, even with a shared services team, et cetera. They had some pretty real B2B accounts, but the margin's so low. It's so difficult in makeup because it's just commoditized like you were saying. So I think $4 million is tough because you need. Assuming it had no shared services team that you could use to boot this up inexpensively,

even then you're looking at it pretty significant that way, just to reboot, something up and running. And then you have to build a business that flows cash, right? So, yeah. So, you know, maybe, maybe as we wrap up, I'd love to kind of zoom in on how you think about return profile, because what you just described to me is, I'm going to pay $4 million. I'd better be able to squeeze $4 million in cash out of this business in two years. But that sort of leaves aside entirely the equity value, right? If you've turned this thing around and it's cash flowing $2 million a year, now some of that might have been balance sheet cash and might be one time or whatever. But essentially, we've created some equity value there, right?

And there's some terminal value. So maybe these guys are thinking about it from that perspective. How do you think about it at CARTA as far as I got to get my money back in cash, in balance sheet cash and operating cash flow in the short term? Or do you ever invest with a thesis on we can build huge equity value here? And that's fine. Yeah. For us, it really depends on the underlying asset and how we feel about it in five years. If it's something really commoditized, like makeup, I don't really know how I'd feel about an exit. So I would want cash out of it within a year, one to two years, really. It's probably closer to a year for a deal like that. For something like our floral company, where it's totally fine, not pulling any cash out of it,

reinvesting really aggressively and scaling it aggressively, because we think there's this pretty good underlying equity value, just given there's no competition. And net EBITDA margin could be quite high for that business. So same deal with the succulent company, really. Compared to other companies where things are just a little bit more commoditized, it might be harder to scale. Obviously, certain businesses get really difficult once you push past a certain range and you go out of your core customer.

So in that case, I like to think of it more from a liquidity perspective. And we do in all cases underwrite to liquidity to an extent, but we try to have our core cash back within 20. 12 to 15 months. So cash back in 12 to 15 months and then sort of the enterprise value is your upside. Yeah, yeah, that's the gravy. Or we can, if it's a company where we don't feel EV is going to be very high, you know, maybe the multiple just won't be great because it's a shitty vertical. In that case, we're kind of okay with layering debt on and then using that to create cash to pull more out of it, if that makes sense. So you essentially sell the company to the lenders

through a recap effectively. Yeah, yeah, essentially. And you're just layering that on as you go, right? As the company scales becomes more leverageable. A really good example is, I think a lot of retail works that way, where it's possible to hold a lot of debt capacity. Same with some of these, like the fast fashion company is a good example, too. It can hold a lot of debt capacity.

And you don't actually need that much FCF as a percentage to pay yourself significant amount of cash, if that makes sense. Yeah, and are those businesses financial because they're sitting, not a bunch of inventory and AR. Is that what makes it? Yeah, exactly. And in some cases, you'll see really fast growth, but that growth can go away really fast, too. So, yeah, like you said, there's the inventory side. And the inventories, like you said, it's not succulence, right? I don't even know how you liquidate succulence. I don't know what would happen. So they can get, lenders get a lot more comfortable with something like genes, right? Then they would supplement

plants. And obviously with scale, a lot of these programmatic lenders, will lend against trend pretty hard. So if they see a company scaling quickly, they don't really care about the net profitability, they rent the debt. Yeah. So you think about it, if you,

once you've got it turned around and it's scaling, you look at taking on debt in a way as monetizing your equity, you know, while the trend is good. And if the trend turns around, you know, it's debt.

So, yeah, that cuts both ways, but also, you know, once you get money out of the company, it's out. Yeah, it's also weird because it doesn't really cut both ways. With the programmatic lenders, they're all insured. So you can just push them back.

There's actually no downside. Yeah. So it's almost like a pre-sale of a small amount of the equity values. Let's just recap it out right now. And if things continue to go well, that's great. That was we'll pay off the loan at sale and we just got the money a little earlier. And if things go bad, we'll just push it up. Exactly.

So there's no real. It's kind of cool because there's no real downside. doing it. Man, remind me never lend you any money. Well,

that's like the unsecured programmatic guys who are a bit of a joke anyways, so. Right.

Yeah, they kind of, in some ways, deserve it they get for doing zero underwriting. It'll be like, it'll be like PayPal.

Like, I've probably seen about a lot of PayPal defaults and PayPal doesn't actually do anything. Obviously, you've then lose access to PayPal as a payment processor

or you might. I've seen some companies I was looking at a deal. They defaulted them, I think, like, a total of a million and a half in PayPal debt. And they still had PayPal on their website. I think it's two separate, like, branches. And they're completely separate from each other. So if someone defaults on that debt, you might not lose your payment processing ability.

So really weird dynamic. I don't know how PayPal does that, but. Very weird. There's a lot of money sloshed around in Silicon Valley right now wanting to lend a merchants. So yeah, yeah, exactly. Well, Metab, this was awesome having you, man, a fascinating discussion. I feel like every time I do one of these, you know, it reminds me of Patrick O'Shaughnessy's phrase, this is who you're up against.

And you know, as I talk to you like, holy crap, like if you want to do distressed ecom, this is who you're up against. So you better be good. So thank you so much for being here, man. This was super educational for me and I'm sure for our listeners. As we wrap up, you know, where can people find you on the internet, where they find you, Karta, is there any way that they can help you? whatever you want to say.

Yeah. Our site's just creditaventures.com. I'm on LinkedIn and Twitter, but prefer LinkedIn. I know a lot of our, a lot of the listeners love Twitter, but I don't know. I've had a really good experience with LinkedIn. I love it.

And I'm really fast there. I think you're the only 28 year old on LinkedIn, but that's great. Well, Matt Tom, thanks for being here, man. This was awesome. Yeah, thank you.