8 ms·

Birchbox reached a deal, but it will leave some investors with nothing

53 points by marban 9y ago

hmahncke 9y ago
Always a puzzle - if they were profitable (as they say), why did they need capital on these terms?
- abenedic 9y ago
  Possibly they had funding from early investors on very bad terms. I have worked at a startup that ran into issues with early investors expecting a return before the product launched. Depending on how the terms were negotiated it could be just a bad deal.
- rahimnathwani 9y ago
  Two reasons: - profit != cash flow - 2016 profitable != 2018 profitable
  - nikanj 9y ago
    I think the key question in parent comment was "on these terms". Getting financing for a profitable, growing business should not be this painful.
    - rahimnathwani 9y ago
      Yes, but just because they were profitable at some moment back in 2016, that doesn't mean that they're profitable today.
      - hmahncke 9y ago
        That's probably right.
mirimir 9y ago
I'm just a naive guy, I guess. And I'm puzzled how new money plus hand waving can "leave some investors with nothing". Is it just that their investments had escape clauses? Or is this something like bankruptcy?
- georgeecollins 9y ago
  If the alternative is a bankruptcy in which the investor gets nothing and ill will, the investors can agree to a deal where they get nothing and the entity remains intact.
  - mirimir 9y ago
    I get that. But damn, it'd suck if Birchbox does become successful, and the new investors get all (or most of) the benefit. I guess that it's like poker. The initial investors could have increased their investments, to meet Birchbox's operating losses, but they didn't. And that's like folding on a hand.
- mathattack 9y ago
  It’s a matter of who gets paid first. To oversimplify... Let’s say I have a company with 100M in debt. If the company is sold for 150M. The first 100M goes to pay debt. The other 50M goes to the owners. If it’s sold for 300M, then 200M goes to equity. They get all the upside. On the flip side if the company sells for less than 100M, the all the money goes to the debt holder. What’s going on is debt holders trade upside for downside protection. Equity holders give up downside protection to get equity. Life is a little more complicated (some equity holders have more protection than others, and some equity holders may be debt holders) but usually it’s just trading off upside for downside or vice versa.
  - mirimir 9y ago
    OK, thanks. So in this case, are you saying that the initial investors had equity, but held little or no debt? So they retain equity, but the company has no equity, so they have nothing? And the new investors are paying off debt to service providers etc? And also getting some equity?
tripletao 9y ago
They're not too clear on the mechanics of this deal. Previous investors get diluted in a down round, but not usually to zero (especially given liquidation preferences, etc.). But: > If Birchbox’s venture investors had fought the deal — which they could have done as debt holders who gave the company a lifeline in 2016 — the company and its employees could have been staring down bankruptcy. https://www.recode.net/2018/5/1/17305940/birchbox-recap-viking-global-qvc-merger-sale https://www.recode.net/2018/5/1/17305940/birchbox-recap-viki... So maybe they're saying that Birchbox's earlier investors accepted a deal where their equity became worthless, to preserve the value of their debt? Or maybe the "nothing" isn't strictly correct, and they just mean it's highly dilutive?
- mirimir 9y ago
  To me, "nothing" implies no equity and no debt owed. So maybe they could have forced Birchbox into bankruptcy, but would have gained nothing except bad will. Or could there be tax implications?
  - tripletao 9y ago
    From the facts reported, I don't see how they could come away with worthless equity and worthless debt. Whatever the tax implications, their liability should be limited--they could win the thing at the bankruptcy auction for $1, and then turn off all the lights and go home, only $1 poorer. So if someone wants to inject new money and keep running the business, then they should at least get some hostage value. Maybe Birchbox has enough trade creditors with claims senior to the investors' debt to somehow wipe them out? That sounds pretty weird, though. If only all financial journalists were trained as securities lawyers...
    - mirimir 9y ago
      I'm glad that I'm not the only one puzzled by this. But as I said, I'm naive.
- ealexhudson 9y ago
  It's being reported in a few places as an acquisition as opposed to an equity investment per se - Viking may be purchasing the positions of the previous investors, and probably doing it for very little. There was some venture debt on the books, so potentially they're doing a deal to repay that debt, rather than have Birchbox default on it?
listenallyall 9y ago
When a company refuses to release revenue figures -- which I assume is the case since neither this article nor the Recode article includes any -- its situation can't be very good, much more likely, it's very bad.
untangle 9y ago
I recently sold a company that was in an ostensibly similar position. The information on this deal is incomplete, but here are my thoughts. Given how lean they were running, they probably broke the covenants on their loan(s). This would make them "technically insolvent" -- a very uncomfortable position for their (VC) Board members. Further, it's quite possible that the lender required a substantial number of Preferred shares as collateral. So the company was probably in a bind, even if cash-flow positive. Bankruptcy was probably not an option either. It kills any residual value in the company, as modest as that may be. And it requires Board and/or lender approval. A takeover by the lender would be more likely. Another important dynamic to consider is that debt stands first-in-line for any proceeds. If necessary, all equity would become zero-valued if that's what's required to pay off the debt. These are the reasons that debt is shunned in startups: if things go south, debt will make it 10X as bad. IMO, debt should only be used in healthy startups with predictable cash flows. The ability to make the payments isn't enough. The covenants are the first thing that bites. With this as background, I would guess that management, debt, and the new equity got together and reached an accord that allows the company to try to get to a better place. Hopefully much better. The deal probably contemplates a strategic buyout within the next few years. Disclaimers: I am a CEO -- not a lawyer, banker, or accountant. These are my opinions and analysis and I apologize to the parties involved if I got something wrong.
- phkahler 9y ago
  Thank you for the explanation. I came to the comments to ask how the company may be sold while the existing investors get nothing. It makes more sense to me now, but it still seems like the previous investors must have agreed to the deal. Perhaps it was easier this way than actually having to deal with bankruptcy? On a different note, this quote bothered me: “We are prioritizing product innovation, the evolution of our digital experience, and scaled partnership opportunities,” she says. This doesn't actually mean anything tangible. It may be CEO-speak for something meaningful or not.
  - tripletao 9y ago
    Investors will sometimes agree to write down their equity to ~zero, if it's obvious that bankruptcy would yield the same result with more legal fees. In this case, the previous investor was also the lender. So nothing above explains how they could end up with "nothing", unless that's counting only the equity and ignoring the debt.

53 points by marban 9y ago

hmahncke 9y ago

Always a puzzle - if they were profitable (as they say), why did they need capital on these terms?

abenedic 9y ago
Possibly they had funding from early investors on very bad terms. I have worked at a startup that ran into issues with early investors expecting a return before the product launched. Depending on how the terms were negotiated it could be just a bad deal.
rahimnathwani 9y ago
Two reasons: - profit != cash flow - 2016 profitable != 2018 profitable
- nikanj 9y ago
  I think the key question in parent comment was "on these terms". Getting financing for a profitable, growing business should not be this painful.
  - rahimnathwani 9y ago
    Yes, but just because they were profitable at some moment back in 2016, that doesn't mean that they're profitable today.
    - hmahncke 9y ago
      That's probably right.

mirimir 9y ago

I'm just a naive guy, I guess. And I'm puzzled how new money plus hand waving can "leave some investors with nothing". Is it just that their investments had escape clauses? Or is this something like bankruptcy?

georgeecollins 9y ago
If the alternative is a bankruptcy in which the investor gets nothing and ill will, the investors can agree to a deal where they get nothing and the entity remains intact.
- mirimir 9y ago
  I get that. But damn, it'd suck if Birchbox does become successful, and the new investors get all (or most of) the benefit. I guess that it's like poker. The initial investors could have increased their investments, to meet Birchbox's operating losses, but they didn't. And that's like folding on a hand.
mathattack 9y ago
It’s a matter of who gets paid first. To oversimplify... Let’s say I have a company with 100M in debt. If the company is sold for 150M. The first 100M goes to pay debt. The other 50M goes to the owners. If it’s sold for 300M, then 200M goes to equity. They get all the upside. On the flip side if the company sells for less than 100M, the all the money goes to the debt holder. What’s going on is debt holders trade upside for downside protection. Equity holders give up downside protection to get equity. Life is a little more complicated (some equity holders have more protection than others, and some equity holders may be debt holders) but usually it’s just trading off upside for downside or vice versa.
- mirimir 9y ago
  OK, thanks. So in this case, are you saying that the initial investors had equity, but held little or no debt? So they retain equity, but the company has no equity, so they have nothing? And the new investors are paying off debt to service providers etc? And also getting some equity?

tripletao 9y ago

They're not too clear on the mechanics of this deal. Previous investors get diluted in a down round, but not usually to zero (especially given liquidation preferences, etc.). But: > If Birchbox’s venture investors had fought the deal — which they could have done as debt holders who gave the company a lifeline in 2016 — the company and its employees could have been staring down bankruptcy. https://www.recode.net/2018/5/1/17305940/birchbox-recap-viking-global-qvc-merger-sale https://www.recode.net/2018/5/1/17305940/birchbox-recap-viki... So maybe they're saying that Birchbox's earlier investors accepted a deal where their equity became worthless, to preserve the value of their debt? Or maybe the "nothing" isn't strictly correct, and they just mean it's highly dilutive?

mirimir 9y ago
To me, "nothing" implies no equity and no debt owed. So maybe they could have forced Birchbox into bankruptcy, but would have gained nothing except bad will. Or could there be tax implications?
- tripletao 9y ago
  From the facts reported, I don't see how they could come away with worthless equity and worthless debt. Whatever the tax implications, their liability should be limited--they could win the thing at the bankruptcy auction for $1, and then turn off all the lights and go home, only $1 poorer. So if someone wants to inject new money and keep running the business, then they should at least get some hostage value. Maybe Birchbox has enough trade creditors with claims senior to the investors' debt to somehow wipe them out? That sounds pretty weird, though. If only all financial journalists were trained as securities lawyers...
  - mirimir 9y ago
    I'm glad that I'm not the only one puzzled by this. But as I said, I'm naive.
ealexhudson 9y ago
It's being reported in a few places as an acquisition as opposed to an equity investment per se - Viking may be purchasing the positions of the previous investors, and probably doing it for very little. There was some venture debt on the books, so potentially they're doing a deal to repay that debt, rather than have Birchbox default on it?

listenallyall 9y ago

When a company refuses to release revenue figures -- which I assume is the case since neither this article nor the Recode article includes any -- its situation can't be very good, much more likely, it's very bad.

untangle 9y ago

I recently sold a company that was in an ostensibly similar position. The information on this deal is incomplete, but here are my thoughts. Given how lean they were running, they probably broke the covenants on their loan(s). This would make them "technically insolvent" -- a very uncomfortable position for their (VC) Board members. Further, it's quite possible that the lender required a substantial number of Preferred shares as collateral. So the company was probably in a bind, even if cash-flow positive. Bankruptcy was probably not an option either. It kills any residual value in the company, as modest as that may be. And it requires Board and/or lender approval. A takeover by the lender would be more likely. Another important dynamic to consider is that debt stands first-in-line for any proceeds. If necessary, all equity would become zero-valued if that's what's required to pay off the debt. These are the reasons that debt is shunned in startups: if things go south, debt will make it 10X as bad. IMO, debt should only be used in healthy startups with predictable cash flows. The ability to make the payments isn't enough. The covenants are the first thing that bites. With this as background, I would guess that management, debt, and the new equity got together and reached an accord that allows the company to try to get to a better place. Hopefully much better. The deal probably contemplates a strategic buyout within the next few years. Disclaimers: I am a CEO -- not a lawyer, banker, or accountant. These are my opinions and analysis and I apologize to the parties involved if I got something wrong.

phkahler 9y ago
Thank you for the explanation. I came to the comments to ask how the company may be sold while the existing investors get nothing. It makes more sense to me now, but it still seems like the previous investors must have agreed to the deal. Perhaps it was easier this way than actually having to deal with bankruptcy? On a different note, this quote bothered me: “We are prioritizing product innovation, the evolution of our digital experience, and scaled partnership opportunities,” she says. This doesn't actually mean anything tangible. It may be CEO-speak for something meaningful or not.
- tripletao 9y ago
  Investors will sometimes agree to write down their equity to ~zero, if it's obvious that bankruptcy would yield the same result with more legal fees. In this case, the previous investor was also the lender. So nothing above explains how they could end up with "nothing", unless that's counting only the equity and ignoring the debt.