
Birchbox reached a deal, but it will leave some investors with nothing - marban
https://www.fastcompany.com/40567670/heres-why-nobody-wants-to-buy-birchbox-even-after-vcs-spent-90m
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untangle
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.

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phkahler
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
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.

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tripletao
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-
viki...](https://www.recode.net/2018/5/1/17305940/birchbox-recap-viking-
global-qvc-merger-sale)

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
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
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
I'm glad that I'm not the only one puzzled by this.

But as I said, I'm naive.

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mirimir
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?

~~~
mathattack
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
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?

~~~
mathattack
When companies are worth less than their debt obligations, the debt holders
get all the claims. This means all the revenue in a sale, or they can wind up
owning the company. (This is oversimplified but directionally correct)

With Birchbox, one equity investor later provided debt. Others didn’t. When
the company dropped in value, the debt holder wound up owning the whole thing.

Sears seems to going through something similar at a larger scale.

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

~~~
rahimnathwani
Two reasons:

\- profit != cash flow

\- 2016 profitable != 2018 profitable

~~~
nikanj
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
Yes, but just because they were profitable at some moment back in 2016, that
doesn't mean that they're profitable today.

~~~
hmahncke
That's probably right.

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listenallyall
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.

