New Economic Realities   //   July 10, 2024

Zombie brands, fire sales & quiet closures are plaguing the DTC world

When 2.0 Ventures, a private equity firm in Salt Lake City, took a majority stake in an apparel brand called Feat Clothing this May, it talked up the “exponential success” Feat Clothing had demonstrated. Specifically, its press release pointed to the $75 million valuation Feat had achieved in its last funding round in March 2022. 

What 2.0 Ventures didn’t disclose were any recent growth metrics or the size of the acquisition. But there are signs that Feat’s acquisition likely did not exceed the sky-high valuation touted in the press release. 

According to multiple sources who spoke with Modern Retail, Feat’s online sales peaked in 2021. And in the months leading up to the acquisition, at least one investor was not expecting to get a sizable return from any sale of Feat, as pointed to in public documents. The Sweater Cashmere Fund, an interval fund that offers non-professional investors exposure to venture capital and one of Feat’s backers, invested in the startup via a SAFE. Its latest annual report was filed on March 31, just two months before the Feat acquisition was announced. In it, Sweater Cashmere Fund estimated that the fair market value of an investment in Feat was worth less than what the firm paid. 

There were other signs that Feat’s ambitious growth plans stalled in recent years. A Santa Monica retail store, opened in July 2022, has since closed. A Retail Dive story noted that Feat had seven employees at the time of the acquisition. That would be down from the 20 employees Feat said it had in a Women’s Wear Daily article published in 2021. 

Back then, Feat had dreams of rivaling Lululemon, as it was projecting its sales would double in 2021. “The next two to three years we’ll be in hyper-growth mode, then it’s about becoming a household name, then on from there,” Feat’s co-founder Taylor Offer told WWD at the time. time. Offer and 2.0 Ventures did not respond to requests for comment. 

The rise of Feat, and the subsequent paring back of its ambitions, isn’t an isolated incident. The founder of one CPG startup, speaking under the condition of anonymity, described the general tenor of the consumer landscape this year as one in which “a lot of people are seemingly hanging on for dear life.” 

Founders are wondering what’s happening to some of their former top competitors after they’ve gone radio silent. Boards are having contentious discussions about whether or not to sell after founders have spent years attempting to grow sales and cut costs yet shown little progress.

There’s a name for many of these companies: zombie brands. The CPG founder has a way of sussing them out: “When the company stops posting on Instagram — that’s usually a [sign] that something’s really not OK.” Then, the founder may check the brand’s LinkedIn page and find that only a few people are still working there. If the CEO is fundraising in a frantic way — sending emails to a wide swath of investors not to miss out on the last $300,000 in their convertible note — it could mean that a brand is eventually headed for zombie land. 

“If you are talking about zombie brands as an investor or a consumer or a founder — I think it means something different to each of us,” said Azora Zoe Paknad, a former founder and writer of First Rodeo, a Substack about her experience with — and after — entrepreneurship. Paknad is also currently working to help turn around the CBD skin-care brand Prima as its CEO-in-residence.

Like its namesake, zombie brands are caught between the land of the living and the dead. To some consumers, a zombie brand is one that feels like it’s lost its soul and identity after an acquisition. Some investors, meanwhile, define a zombie brand as one that simply isn’t growing. Maybe it has enough money to keep operating but not enough to pay off its liabilities. It has almost no chance of superseding its liquidation preference. It can perhaps survive for a few years by cutting more expenses. Yet, whether it decides to sell within the next 12 months or five years from now, the prospects don’t look promising. 

What founders decide to do with their stagnant companies is proving to be the defining issue of the DTC space in 2024. The consumer startup industry is littered with companies — ranging from athleisure brand Outdoor Voices to modern convenience store Foxtrot to non-alcoholic retailer Boisson — that are trying to mount a comeback after flirting with or filing for bankruptcy. In many cases, they’re facing resistance from their most vocal customers. “This isn’t Outdoor Voices, this is just another beige bland athleisure brand,” one Instagram commentator wrote after the brand was acquired by Consortium Brand Partners in June, several months after Outdoor Voices underwent massive layoffs and closed all of its retail stores. 

Then there are companies like Feat, whose acquisitions are abruptly announced with little fanfare. Multiple signs suggest that these brands were hitting a wall pre-acquisition and the founders wanted an exit ramp. Havenly, a digitally-native design startup, has spent the past two years scooping up brands in the home goods space. Some of them have been outright distressed (like Interior Define, which filed for an Assignment for the Benefit of Creditors in 2022 before Havenly bought it). Others, like the textile and decor brand St. Frank that Havenly acquired last month for an undisclosed amount, were just struggling to run their business in a capital-constrained environment. 

“Despite the fact that they were doing pretty well, it was just too small of a business to support independently with the capital stack they had,” Havenly founder Lee Mayer told Business of Home. “And I think [the St Frank founders] just wanted an ending — a good home for the brand.” 

There are the quiet bankruptcies that don’t get much notice because a particular brand never became a DTC darling. Loungewear brand Jamby’s, for example, filed for Chapter 11 bankruptcy in April, while home decor brand Burke appears to be headed for further financial distress after its founder personally filed for bankruptcy, Business of Home reported, and complaints from unpaid vendors pile up. 

Behind-the-scenes turnarounds are also happening to try and bring a brand out of zombie status. These often don’t get reported on unless news of layoffs or internal memos get leaked. Super Coffee, for example, executed multiple rounds of layoffs last year and discontinued 30 products (which led to a decrease in revenue) betting that the company could return to growth this year, Modern Retail previously reported

Fan Bi, the CEO of turnaround firm The Hedgehog Company, believes that “we’re at peak zombie in DTC land.” This is due to a confluence of factors such as continued inflation, sources of capital drying up and more brands finding themselves in a position where they have now reported multiple years of near-flat e-commerce growth in a row. 

In an interview with Modern Retail, Bi — whose company has helped turn around Baboon to the Moon and Felix Gray, among other brands — described the conundrum a brand founder might face this year: Let’s say that a business made $8 million in revenue when it raised money three years ago at a $24 million valuation. Now, three years later, that business is still only doing $8 million in revenue. There’s little chance that the founder will sell the business for $24 million.

The question becomes: Does the founder hold onto the business, and oversee another year of cost-cutting in the hopes that they hit, say, $1 million in profit? They’re still not going to sell the business for $24 million, but perhaps they could sell it for $4 million. 

“I cannot underscore how big of a mental shift that is,” Bi said. In turn, he went on, “I think a lot of founders are despondent.” 

The next question is existential: Do founders want to keep scrambling and searching for a new lifeline in the hopes of achieving a better exit in a few years?

For more founders, the answer this year has been no. 

“I think the prevailing theme is it has been a really tough few years,” Paknad said. “Founders need and deserve a break.” 

“There are a lot of owners who believe they have exhausted what they can do for their business and are prepared to take a smaller position in the company going forward,” Cory Baker, the managing director at Consortium Brand Partners, told Modern Retail in June shortly after his firm acquired Outdoor Voices. 

How we got to peak zombie 

Bi, for his part, estimated in May that his firm was “on track to see twice as many brands in the first five months of the year as we did this time last year.” Given that his firm specializes in turnarounds, “almost all the opportunities we receive are in some kind of zombie status.” 

There has been no single cataclysmic event that has led to the creation of more zombie brands. There are the evergreen issues that can topple any startup at any time, from co-founder infighting to betting too much on a disastrous product launch. But the most straightforward explanation is that it has been a tough few years in the consumer business, challenges show no signs of abating and more founders are deciding they don’t want to slog it out through another tough year. 

Part of the issue can be traced back to consumer startups being incorrectly valued years ago. Now, domino effects are being felt as startups that raised at a sky-high valuation early on in their history are finding that acquirers and investors are no longer valuing them the same way

Manica Blain, an investor and advisor to early-stage brands like Blume and Left on Friday, and also an early investor in Figs and Cotopaxi, said that when the “DTC 1.0 wave” started ten years ago, “we didn’t necessarily know then what sectors, or what categories of consumer would lend themselves to exit as much as we do now.” The so-called DTC 1.0 wave began when direct-to-consumer startups that launched by exclusively selling online started to receive significant amounts of venture capital. 

Take Dollar Shave Club. Founded in 2011, Dollar Shave Club sold to Unilever in 2016 for $1 billion, generating a 10x return for some investors. At the time, Dollar Shave Club brought in about $152 million in revenue and was unprofitable. 

The billion-dollar pitch to investors was that a company sold a product more cheaply online by cutting out the middleman and acquiring customers for cheap through online advertising would become the de-facto leader in its category 

However, Dollar Shave Club struggled under the management of Unilever. To keep Dollar Shave Club growing, Unilever hustled to launch the brand in as many retailers as possible in 2020, from Walmart to Target to Walgreens. Still, by 2022, it was only “marginally profitable,” executives said, but sales “continued to decline in a competitive market.” By 2023, Unilever sold off Dollar Shave Club to a private equity firm for an undisclosed amount, and Unilever took an impairment charge on the deal. 

Data from the public markets didn’t help either. Today, Allbirds — which also reportedly achieved a $1 billion valuation on the private markets — only has a market cap of $94 million after reporting multiple quarters of double-digit sales decreases, combined with losses. 

“We have seen a lot of growth expectations that people invested under, or assumptions of future growth, that just haven’t come to pass,” Brandon Yoshimura, director at Solomon Partners said. 

In turn, since the first wave of DTC startups, investors have been able to gather more data on what types of businesses may actually be able to hit — and exit — for a 10x valuation. The growing realization is that a company has to be able to generate EBITDA — not just sales. 

It’s also category-dependent. Apparel — which handles seasonal inventory, thus requiring more working capital — has fallen out of favor compared to a category like beauty, which has better margins.

What’s more, this shift in how consumer-facing startups are valued came at the worst possible time for brands. Many brands raised rounds in 2020 or 2021 at a time when they were experiencing record e-commerce sales growth. By 2022, inflation had hit a 40-year-high, while e-commerce sales, according to some data sources, reported the lowest growth rate since the banking crisis of 2008 to 2009.

“Part of what I think has been so hard to navigate for these brands is the velocity in which the environment shifted,” Yoshimura said.

“Trying to retrofit [your business] for a purpose and a structure and a setup that it just never had is such a hard ask — and, for some people, impossible,” Paknad said.  

The zombie playbook: cuts, cuts and more cuts 

In order to retrofit their operations, the answer, first and foremost, for many businesses has been layoffs. DTC aggregator Win Brands Group, for example, underwent three rounds of layoffs over the past 12 years. 

Another answer is cutting poor-performing product lines. A brand might also try to cut costs on packaging and outsource other functions they had previously had in-house, like marketing and customer service. If they can combine that with, say, a new convertible note, they might pair those cost-cutting measures with a growth initiative like opening up a new retail store or launching a new product line in a trendy new category with better margins. 

“It really comes down to how good are you at cutting your OpEx, or lowering your operating costs, and can you function so leanly with less?” Paknad said. 

But not all brands have achieved outcome they hoped for after all of these moves — specifically, increased interest from investors and potential acquirers.

“For many of these zombie brands — I think they thought they’d achieve [their desired] outcome much sooner, especially in those cases where they have delivered, where they have outlasted things like [Covid],” Blain said. 

On the flip side, sometimes a founder can seemingly make all the right cuts on paper but have little to show for it; in some cases, the brand posts even worse sales than it did in 2022. 

One investment banker, speaking on the condition of anonymity, shared with Modern Retail one recent example: This investment banker’s firm was approached by a brand that had raised $15 million in total and, at its peak, did $12 million in revenue. Now, it’s only bringing in about $3 million in annual revenue.

If this brand finds a buyer, the investment banker said, it will likely only sell for five figures — and to a buyer who may only be interested in the inventory and the customer file. 

Life after a zombie brand 

Of course, not every zombie brand is doomed to stay that way forever. In fact, given the high-risk, high-reward nature of venture capital, many companies find themselves on the brink of becoming zombie brands at some point in their lifetime. 

Yoshimura at Solomon Partners said there are two ways to turn around a zombie: Either the brand has to do it themselves, or it has to sell to a firm that can. 

The anonymous investment banker said that he sees a few common deterrents to achieving a sale for a zombie brand. One is that founders don’t give themselves enough time. 

“If you only have a few months of cash left, you should be fully committed to the process,” the banker said. 

Additionally, he said, when brands tout the sky-high valuation from their last venture round, that can actually be a deterrent to potential buyers. Potential acquirers may believe that the brand is going to fight tooth and nail to get as close to that previous valuation as possible. 

Perhaps most importantly, both founders and investors must be aligned on whether or not to sell.

“More often than not, we see equity investors and lenders encourage the founders to continue to build the business [in the hopes that they can still get a market-clearing price],” the investment banker said. 

The challenge is that it’s never clear exactly when that time will come. At this point, some founders have spent two-plus years trying to achieve a turnaround with minimal results. That is leading some investors to reassess whether they should continue pushing the founder to keep building the brand.

“With the general climate, investors seem to be accepting — or maybe have no choice — but to accept outcomes that are not gangbusters,” Paknad said. “For better or for worse, that sets the founder free.” 

Still, founders are “grappling with the idea that they have invested the last 10 years of their life into building a brand and that business may not have a good financial outcome,” the investment banker said. That’s a difficult pill to swallow.

Bi said he sees many founders simply keep with their zombie brands in order to maintain their salaries and identity. In a difficult job environment, they may not know what they will do next. 

That being said, selling a business allows a founder to get off the endless treadmill of brand building. 

Offer of Feat Clothing cheekily nodded to this in the press release announcing that his brand was acquired by 2.0 Ventures. As part of the acquisition, Offer stepped down as CEO. In turn, he said in the press release, “I am excited for long walks with my dog on the beach, only using my flip phone, and finally ordering guac on my Chipotle burrito.”

It’s a sentiment likely felt by other founders.

“I am never surprised when someone is like, ‘I need to get off the roller coaster,’ Paknad said. “You don’t want to see everything you have invested in die and go away.” Instead, she said, founders are increasingly asking themselves: “What is the next chapter, and one in which I can take a step back?’” 

This article has been updated to correctly identify where a quote from Havenly founder Lee Mayer originated; it came from an article originally published in the Business of Home.