Welcome back to another one of our Brothers from Another Mother episode. Chuck Cotter once again joins host Elliot Begoun, and this time it’s to talk about all things business funding. How you fund and angle your business for growth might vary depending on what kind of product you have, what market you’re in, and the audience you’re targeting. Do you take in debt or find investors? If you want people to invest in your business, what opportunities are you providing to make your proposal attractive? Do you even need investors, or is something else a more viable option to fully realize your business’ growth? Chuck and Elliot mull over these questions and exchange more ideas on funding. Tune in to hear more business insights and get the direction you might not know you needed right here.

—

Listen to the podcast here

Finding The Best Way To Fund And Grow Your Business With Chuck Cotter

It’s one of our brothers-from-another-mother episodes. We have not had one of these in a long time, and we’ve both not matured very much since then. I would think that you can look forward to the normal banter about how I’m a much more advanced and handsome older brother than my younger one. Before I turn it over to Chuck, here are two reminders. I want to tell you all again if you’re interested in being surrounded by amazing advisors who cross over hundreds of different subject matter expertise or expert areas, join the TIG Collective. It’s amazing.

You get access to over 40 advisors. You get to learn how to become a more effective entrepreneur in terms of leveraging the input and impact advisors can have on your business and how you can present and ask for help in a more actionable way. At the same time, you’re helping us build the next group of board members. These are folks that are more diverse and experienced diverse in thinking. Also, we’re seeing more women, BIPOC, and LGBTQ+ people. We need that in our boardroom. If you want to learn more, hit up any one of us here at TIG Brands, we’ll be happy to tell you how it all works.

The other thing we want to talk about is the TIG Venture community. I’m going to use this one specifically for all of you out there who are Angels or part of family offices, etc. We’re going to talk about some of this in this episode. We’ve got to do a better job of funding these early-stage brands. Also, you all need to do a better job of portfolio management. If you look across the space and see 6% of the representative portfolio companies are responsible for 90% of the return, that honestly means we’re not managing our portfolios very well.

We’re stepping over great brands and entrepreneurs in search of these few and far-between mythical unicorns. If we augmented our portfolio with great investments in these earlier-stage brands that can build to EBITDA profitability and cashflow positivity, then we could wind up with a better return performance than banking on that one unicorn. We’re going to prove it and do it.

We’re under the hood of these brands and making sound investments using some of the creative approaches to terms and structure that we’re going to talk about now. If you want to help fund these amazing entrepreneurs, make good returns and money, and learn more, talk to us. Hit me up. I’m happy to share more about it, but it’s also a good way for us to help our industry and our entrepreneurs. My two commercials are done. Chuck, first of all, let me ask you this. As someone steeped in all the M&A activity that’s going on there, both the fun side and the brand side, what’s your take on where things are right now? Let’s straight talk.

There are lots of words that could pop to mind. Some of the words I’ve used with a few people is carnage. It’s carnage out there. Another one is consolidation. Let’s dig into both of those words. What I want to remind people, so it’s not all doom and gloom, is while you need to reposition yourself for where the market is, we still are seeing things here and there. Roses are growing from the concrete. We get a term sheet and we say, “That’s nice. That looks like a term sheet that one of our brands would’ve gotten a few years ago.” That seems to be contrary to where the winds are blowing, which is good.

Digging into carnage, to your point about good brands and whether they’re getting funded, part of the ugliness out there is all the macroeconomic environment, fear from investors, and all of that. Part of it is the destructive impact on small brands. Acquirers and investors are radically changing what they want from brands. From my perspective, the business model a lot of brands were told that they should achieve is, “Grow your top line 50% to 100%, maybe even more if you can. Don’t worry about how much money you’re losing.” Now, it’s, “What do you mean you’re not profitable by the time you hit $2 million in revenue?” It’s radically different.

Carlotta was laughing when I saw her and said, “Yours is a great message. Everything you talked about, you were the contrarian, and suddenly you’re the centrist now.”

You’re the canary in the coal mine.

The funny thing is that’s been the way businesses have been built in this country forever. It wasn’t until there was a ton of entry money that moved into this space that the model changed. This concept of growth for the sake of growth became the primary, not profitable growth.

That’s shaking out. It’s leading to some brands who followed that model and then maybe experienced some challenges, hit 70 or 80% of their plan, but were an unprofitable business model. All of a sudden, they need cash and can’t get it, or if they can get it, it’s on bad terms. That would lead me to the second word, which is consolidation. What we’re seeing is funds investing in their existing portfolio to shore it up or the M&A activity, which is not the type of M&A activity you might have seen a few years ago. It’s salvaging what you can out of a situation.

Again, there are chutes and roses growing from the concrete. There are good things happening too, but it’s a much tougher market. On the other hand, it’s an opportunity for tardigrade-type companies. They’ve already been positioned that way. For those who haven’t, it’s an opportunity to do that. I don’t want to act like there are tons of these people out there, but there are people like a friend of mine who’s a very successful entrepreneur.

Every time I’d introduce him to a company in our space, he’d say, “I don’t understand these business models. I built my company with it being relatively profitable almost all the time. That meant I had to grow slowly. Why would I give a $10 million valuation to a company doing $3 million of revenue and losing $2 million a year?” It makes utterly no sense to him in the new business model and opportunity.

That’s what I see. Honestly, if you’re one of the earlier brands, I’m talking about brands that are doing $3 million or less in revenue and still have a little bit of money in the bank. It’s not too late to change course. The brands that I feel most concerned about and worry the most for are those that have been out in front of their skis, have been growing their top line, and are at that precipice now of trying to raise capital and have not performed. Let’s face it. In the market, most companies haven’t had the explosive growth in the last 12 to 24 months that many were experiencing pre-pandemic and all of that.

Most aren’t seeing that 100% growth or that doubling of growth year over year or more. They’re seeing significantly less than that. Now, they’re at this place where they’re raising money. They’re too far into that valley of death. They can’t get to the other side and turn around and go back, but if you’re at the edge of that valley, don’t go in it right now.

This is what I want to spend a little time talking about. The other thing is how we help these brands and entrepreneurs change the conversation with investors. Two things need to happen. First, we need a new gaggle of investors in this space who think more like the friend you were discussing who are looking for businesses that are either profitable or have a very demonstratable clear path to profitability. Also, we need to educate the investors. True venture funds are what they’re there for and they make venture bets. That’s the other hard conversation.

I was sitting at Expo East, and we had this wall of products behind us. I looked up and down this wall of products and all these brands. The thought that came to me is that, for the most part, none of them were truly venture-backable. They were not brands that were either disruptive, innovative or carved such a new path that they had some clear direction in which they were going to have explosive growth to $100 million and be something that the big strategic start a bidding frenzy for.

Many of them had the potential to build a good $10 million, $20 million, to $30 million businesses in the next couple of years or so and get to EBITDA profitability and cashflow positivity, and they needed money too. If you can get to that stage, then you can choose if you can find a way to the platform and grow. How do we help them and investors see the potential there? There are lots of ways for investors to make money in that scenario. There are lots of ways to rethink structure if it isn’t a true venture model. Riff on that.

Maybe it’s a diversifying opportunity, lower risk, lower reward, but it’s more about looking outside the classic venture fund because it’s a smaller check and a different model. We got to the point where the idea of a business that looks like it’s going to reach a limit, maybe not 0% growth, but very small growth once it hits $20 million or $30 million in revenue, was all of a sudden, a shitty business. A business that tops out at $20 million or $30 million a year in revenue but makes a 10% profit is a great business. It’s just not a business that makes sense for a venture fund that needs you to go sell that thing for hundreds of millions of dollars. It doesn’t mean it’s a bad business for an entrepreneur, and it won’t make them money.

On that note, I’ve seen a lot of blaming on venture funds for the pivot. The pivot is bemusing for all of us who’ve been in the space, but everyone has a little bit of blame to go around. Venture funds are trying to make money. That’s what they do. They’re seeing people acquire businesses based on top-line revenue and top-line growth, then that’s what they’re going to prioritize.

Founders were not obligated to adopt the business models that the venture capital funds wanted them to adopt. The truth is lots of founders that I talked to in the last few years had it in their mind that they could build a business, sell it within five years, and make themselves tons of money. That only works with that grow top-line burn money and maybe fail model. There are lots of blames and opportunities to go around for brands with a new model.

I had this conversation, and I want to call this out too. There is nothing wrong with that model if that’s the model, as an entrepreneur, you’ll want to choose. If you’re cool with the risk, you want to take that moonshot, believe this is your moment and opportunity, or got something capable of this, you’ve got my full support. It’s the right model for a venture fund. All of that works.

Don’t take it that we’re throwing shade on that. My analogy has been a lot of you are trying to put rocket fuel in a Camry. You’ve got this good, solid, dependable thing that’s going to get you down the road and can deliver you to where you want to go. It’s going to go a lot slower and you can’t put rocket fuel in. It doesn’t make sense.

That’s such a good analogy. To circle back to, “We’re not looking at the venture model and some things have changed, or at least we’re not for this conversation,” how do you track investment? What you’re not offering folks a 10 to 20 times return potential. That’s generally not what you’re offering because you’re not saying, “I’m going to get to $100 million in revenue in 5, 6, or 7 years.” What are you offering? You can offer lower risk. Hopefully, that’s true. You can offer different investment structures which can provide people with a different type of return. It’s not a boomer bust liquidity event at the end of the road, building a company that’s going to spin off $2 million in cash in a few years, and we’re going to share that proportionally, and things like that.

Again, it’s a somewhat different investor, but it’s also a trainable moment because I will say that just like many of you as entrepreneurs have fallen into the growth at an all-cost model, so does many of the Angels. A lot of the Angels are investing in what they think is going to become investible businesses or brands through venture funds. They’re following the venture money model early, but it doesn’t mean they have to.

As with anything else in your profession, you need to hone your craft. Part of honing the craft of entrepreneurship is becoming conversant and educated around investment structure and how you can potentially lock in interested investors through your path to them and see some monetization of their investment and so forth.

That’s going to take a commitment from you to learn, but it’s also one of the things I’m trying to pound the desk on. I’m totally generalizing here, and you can bust me for it. Entrepreneurs, in general, are innovators, problem solvers, creatives, and all of those things. That’s where brilliant products, cool brands, and interesting go-to-market strategies come from.

When it goes to raising money for your businesses, you guys become lamey. You all do the same thing. You start with a convertible note and try to create a value cap that’s probably unreasonably high. You’re showing up in line to these investors, presenting that investor with exactly the same thing within a reasonable standard deviation of the same terms and offers and asking them to discern which one of them makes a better investment. Whereas if you showed up like the creator, problem solver, and innovator that you are and present a radically different investment case, you might get to know faster, but that’s a good thing and you also potentially get a yes. Am I smoking something when I say that stuff?

No, depending on the business and, as you said, the path that you’ve chosen. Either is a viable intent for your particular business. You may have come out with a product that is too niche to ever be a $500 million a year revenue business and therefore nothing a strategic will want to acquire, but it could be a great business because it’s got good unit economics and you’ll end up at $20 million or $30 million. You’re not smoking anything there. At least, not at the moment.

The question is, how do you have those conversations with investors? You’ve got to convince them that they’re going to make money with the investment regardless of the fact that you’re not a unicorn opportunity. The answer is you can. You can present to an investor how they can make money. It can be through cashflow, whether you decide to structure something as a loan with actual payable interest, which convertible notes don’t generally do, or if it’s an equity investment, but you’re going to be to profitability soon and not do the thing that everyone has done, which keeps all cash and grow. You’re going to distribute some cash. There are various ways you can tell people they can still make money.

A couple of things that we’ve been talking to brands about and, quite honestly, looking at through the TIG Venture Community is the use of venture debt and subordinated debt. That could be a way to create upside for an investor, especially in that sub-$3 million range. Many times, the money that you’re raising in the form of equity is primarily going to be used for working capital. For all of you, if you can get debt that’s serviceable and without signing your life away, it’s going to be less expensive, more than likely than equity.

Venture debt is one way to do it. If you’re trying to raise a couple hundred thousand dollars, you could potentially go to an investor with an offer such as a venture debt, a term loan for four years where the first year is interest only and then years 2, 3, and 4 are principal and interest. You amortize it over those years, and then at the end of that fourth year, there’s a lump sum. Let’s use simple math and simple interest. If you’re paying an investor 10% simple interest on an annual rate and borrow that $250,000, you’re going to pay $100,000 for that $250,000.

They’re going to make $100,000 on a $250,000 investment in four years. It’s not 10X money, but it’s reasonable if you overlay that with some type of a warrant where they have a lottery ticket, as you always like to call it, that they can keep in their desk drawer. Let’s say you give them a warrant of the equivalent of $250,000 in shares at the current 409A that they can execute at any point in time, but the loan remains open. What you’re giving them is an opportunity to put risk on the sidelines, watch your business, see if you can get to that profitability, and then they can choose to execute that warrant and come in. In order to execute that warrant, they have to write you another check. It’s a way to build future rounds.

They’re making money on a term loan in which every month, they go to the mailbox and get some cash. At the end of the ride, they’ve made a reasonable return and you’re giving them an opportunity to stay on the sidelines. Keep that part of their powder dry, but potentially, jump in front of the line and invest in you when they’re ready at a much better value than the investor who’s investing in you at that moment in time.

That’s a totally viable path and then a way you can pitch potential good returns to an investor. For the brands out there, neither you nor I are saying, “Raise this way, not that way,” but what we are saying is, and you’ve been saying for a while, “Get out of the mentality that there’s only one way to do this,” which is raising millions of dollars. There are two ways to adjust that mentality. One is how you build your business for its profitability and cashflow. The other is how you raise money.

If you want to raise in smaller increments and you’re not pitching to folks, those big rounds in the future or present, then you’ve got to be creative because, as you said otherwise, our space has been flooded with brands and startups. There are hundreds, if not thousands, of brands in this space that are sub-$5 million that are trying to raise money.

I want to go back to the point and say I am not saying that raising a convertible note, an equity round, or trying to win from a fund, even an early seed stage fund, or any of the things that are being done wrong. I’m not trying to discourage you from continuing to do that. What I am trying to do is to feel the adage that doing the same thing time and time again and expecting different results is the definition of insanity.

After 200 rejections, at some point, you got to wake up and say, “I better do something differently. Either my business is inherently not investible for this type of investor or I need to make an offer that allows me to show up differently.” What I’m trying to encourage everyone is to take that same innovation and creativity that you employ in so many other aspects of your business and do the same around funding, but that only comes with two things. It only comes with you becoming a student of it. This is not a paid-for endorsement by Chuck, but you also need to make sure you have good counsel around you so that you fully understand what your innovative ideas are.

I have come up with some batshit crazy ideas around raising that I’ve wanted to float. I run by Chuck and the team. I get a very nice email like, “Did you think about this? What about if this happens?” You want to have that checked as well so that you don’t wind up with any unintended consequences. The other thing to know is to know your personal risk tolerance and also where you’re going to get the source of the money.

I’m seeing a lot of people right now, frankly, keeping their businesses afloat with lines of credit cards.  It’s crazy because that interest rate right now is so high and they’re signing personal guarantees. That’s your call. I’m not saying right or wrong, I’m saying know and understand what that means, or they’re going to their close friends and relatives borrowing money in a state where they know their business is in peril and then going to Christmas dinner with them. Christmas dinner turns into a board meeting and they’re pissed off because they’re getting questioned about how’s the business, where’s the sales, and what’s going on. All of these things you need to think through as you’re building your capital strategy.

It’s funny, but a lot of the people who will charge 18% interest on a credit card or got a loan offer at 18% would be like, “That’s crazy. Why would I ever borrow money at that interest rate?” It just adds up because you do it in smaller chunks. I would love to see a lot of these tardigrade-type businesses in 5 and 10 years because they could be successful.

Another thing founders have to do is a little soul-searching on why they’re here. If you’re here because you genuinely want to grow a particular business or solve a particular problem, then you won’t give up if someone says, “A 5 to 7-year time horizon for an exit is not reasonable for a business like yours. This is a 10 to 15-year marathon or longer.”

There’s nothing wrong with being the person that says, “I saw a business opportunity in this space. I have a chance to grow and fund a business in five years that would make me tens of millions of dollars in exit value, and now that’s probably not going to happen,” then maybe this isn’t the space for you. Maybe it’s not worth grinding out another five years because you’ve discovered that this is not a five-year business.

That is a hugely important point. You’ve got to be able to check in with yourself and make sure you’re in it because it is grueling. I will tell you that the myth of the five-year exit has been a myth for a lot longer than this current economic climb. The number of brands that have had significant exits five years after launch can be counted on fingers and toes. There aren’t that many.

Some of the ones that you think and you hear about that were overnight huge moonshots had ten years that they lingered in relative obscurity before that five-year visibility. You’ve got to check that you’re in it. One thing I’m hearing a lot now from entrepreneurs as things get grueling is, “I don’t think I have it to be the CEO. I can’t stick with it. It’s an opportunity maybe to get somebody to join up,” and all that stuff is hard when you’re in business. You got to be realistic there too.

It is. I’ve had a number of brands in the $2 million to $10 million revenue range come up to me, “How much can I sell my business for? This would’ve been funded three times the revenue. Therefore, if I’m doing $5 million, can I go sell it to someone for $15 million?” I’m telling person after person, those deals happen occasionally, but there’s essentially no market for companies that are doing $3 million to $5 million in revenue because there are so many of them.

You have not proven or differentiated enough. If you’re at $3 million to $5 million in revenue and don’t want to do this anymore, you’re going to have to have the creative problem-solving mindset that Elliot talked about. You’re going to have to get in that mode because it’s not as simple as, “I’ll go find a buyer to sell for three times sales.” There’s not a market for companies that small.

The other thing that we’re seeing is a lot of people thinking they can solve their cash problems by something like that. They don’t have cash left and have any investors and they’re going to other brands and saying, “How about a stock swap or how about a license you the brand and you pay me?” Those things are wonderfully thoughtful on paper but rarely ever transact and do because most other brands of similar size or even slightly larger size are as cash strapped if not more than you are.

The thing I want to come back to is truths or ways to articulate to investors who you want to take through to invest in a brand. Let’s use this scenario. The brand right now is somewhere between $2 million and $3 million in revenue and is not yet profitable, but is probably $1 million in revenue away from that tipping point where they become EBITDA break even. Probably, another $1 million away from where they start having a positive cashflow within 5 to 7 years of a path to $10 million to $20 million EBITDA, somewhere in that 8% to 12% range and positive cashflow.

Right now, they’re raising money. Let’s say they need $500,000 or $1 million. What are ways that the entrepreneurs might think about developing and articulating an offer to a potential investor? Either a seasoned Angel in this space or an Angel who isn’t familiar with CPG, family office or something. Again, this is not going to be an investment for a venture fund. That’s where so many of you get so much heartache.

Venture funds hate saying no. You would agree that most of the ones that I know, if they can, they’ll take the time to get on a call with you. They’ll help and suggest or make recommendations. You, as an entrepreneur, are getting on thinking, “I’m going to get a deal. They said yes to a meeting.” They’re getting on thinking, “I’m trying to be a good-hearted person to give this person advice, but there’s no way I’m going to invest in this business.” It doesn’t work. That’s where that horrible disappointment comes in.

If you’re one of those brands, be real. You’re not likely going to appeal to a venture fund. The family office, an Angel, an impact, slow money, that’s where you’re going to find it, but if I’m sitting in front of an investor who is in one of those camps or who is open-minded to an investment like that, how do I present a scenario or an offer? We’re spitballing here. Again, what we’re saying is not to do this. We’re trying to say this is something you may do as an illustration, but there are other ways to do it too.

First of all, if an entrepreneur came to me like that and I didn’t think or they didn’t want that this is one of those classic venture backable companies, the first thing I would do is challenge the premise that they need $1 million. If you’re at $3 million, use your creativity and get scrappy. Do you need as many folks as you have at your business, or could you personally fill more of those roles? Could you grow slower so that some retailers are eventually pulling you in instead of you trying to force yourself in and get better terms?

I challenge the premise that they need $1 million because it’s going to be easier to get a smaller amount of money and then structure a smaller amount of money creatively. For example, if you’re going to take a $1 million debt burden with interest and warrants, that’s pretty significant. On the other hand, if you were to take a $250,000 debt burden, you could be really creative. It could be, “I’m not going to be able to pay you anything in the first year. This is the business plan. In the second year, I’m going to make these payments every month. In the third year, I’m going to make these payments every month. By the way, I’m giving you a warrant, a chunk of equity, or whatever as some upside.”

The truth is that for most loans for businesses at this stage, unless they’re charging you 20% to 30% interest, they’re not charging you interest. That’s commensurate to the risk. They need some other reward to say to themselves, “This is going to make me good money.” That sounds silly to compare things as separate as a venture investment and a savings account, but as interest rates have been higher and higher, people can make more money at virtually no risk, which changes their analysis of what they need to think they will get in order to take a risk. This is why there has to be an equity portion if you’re an early-stage company in almost any debt instrument.

I 100% agree with that. First of all, taking less and growing slower is so important. I would encourage you all to do this. In any transaction or a new piece of business you’re looking at, build a waterfall. Start with the price that you want to be on the shelf or online, and then out from underneath it, take out all of the direct cost with it. That would include promotional trade expenses, freight distribution, brokerage, paid acquisition, and all of those things. Come down to the bottom and see what the contribution is or the remaining dollars. That’s the money that that transaction or those series of transactions are providing to absorb all of your other fixed costs.

I would argue that in most cases in this industry, once you get that done, that number is very close to zero, if not negative. If you think about it that way, growth is an investment. If you think of growth as an investment, then the challenge you should ask yourself is, “Why am I investing in this particular growth? What is it doing for my brand? Is it improving product market fit? Is it getting me to my MOQs or to the next big reduction in cogs? Is it a strategic account that’s going to help me grow? Is it ego or any of those things?” It can slow that growth pace and take a lot of pressure because growth is the most voracious consumer of cash.

The second thing is the structures we’ve talked about. Venture debt welled with some equity play is terrific. I also think you could do some type of straight equity, but if you’re not a venture play to think you’re going to be able to get somebody to invest in your brand now when you’re doing $2 million at a $15 million valuation, you’re kidding yourself. You take less money and give the investor a reasonable valuation of the business. There are other things, too, like grants. Find a good grant writer and apply for grants. There are lots of those out there. You’ll be surprised.

On that note, I was talking to a brand. They said that they’ve received a good amount of grant money and asked if I have any experience with that. I said, “Not at all.” That’s relatively new to me, but there is evidently grant money out there for a lot of these early-stage brands depending on where they’re located, what they’re doing, etc.

There are grants based on diversity, locations, municipal grants, and all kinds of things. That’s free money, everybody. It takes time to find it. Let’s come back to something that you and I don’t do well in conversation. I’m sitting in front of an investor and I’m going to say, “Make an investment in me.” In this particular circumstance, let’s say it’s an inequity investment. Your business that you’re articulating has that path to $10 million or $20 million in EBITDA profitability, cashflow positivity, and so forth. The question the investor is going to ask is, “How and when do I make money?” What are the options for that?

These are the ones I’m thinking so add, change, or disagree. There’s distribution. Business starts producing positive cashflow and you’re distributing that cashflow on a pro-rata basis to a portion of that cashflow to your investors. If you can get to that $10 million or $20 million and be EBITDA profitable, you’re likely to suddenly have access to commercial banking at much better rates and be able to build there. That’s one.

The second one is you might realize now, “These three SKUs I’ve been building and the way I’ve been doing it, everyone loves this brand. I could see all these adjacent categories. I’m profitable. I’m going to put a plan together to take this business to $100 million. I’m going to proliferate my SKUs and platform into other categories, and now I’m ready to go to venture.” There’s the more traditional venture exit, which is an early investor.

There are also PE firms who are looking to make majority investments in good profitable businesses that are long holds that fit their portfolio or that they can aggregate into a larger thing. They’ll make that investment and allow founders and early investors to take a portion of their money off the table at a reasonable return and multiple.

There are even the less common things if you’re making good money, good EBITDA, good cashflow, and as a founder, you want to own more of your business again, so you go to your investors and say, “I’m going to buy you out.” You agree upon a buyout plan or there’s ESOPs, where you’re selling a portion of the company to employees. There are so many different ways. What am I missing?

I want to reverse one of your last ones for a second. If you’re pitching an investor and you’re effectively saying, “I can grow a good profitable business,” at some point, there will be acquisition interest, but that’s not the type of business that I’m growing. I’m not focusing on that. You might also offer to them. You have to think through the pros and cons, but you might say, “Once we hit $15 million of revenue, I’m happy to buy you out at a valuation of two times revenue.”

You’ve offered them a path to liquidity, which will be a concern of theirs if they don’t view you as a classic M&A acquisition target. If you put the right hurdles in there, you can control it a bit. Your option is not exercisable until we’re at least $15 million of revenue and $1 million of EBITDA or something, so you’ll have the cash to action do it.

From an attorney’s perspective, if you’ve got a client who is trying to put together an offer to take out to the market or investors, how do they approach you in terms of getting you to think like that? Correct me if I’m wrong, and I’m sticking more to these sub-$3 million or fewer. Typically, they’ll approach you and say, “Chuck, I need a term sheet for a convertible note. I need a term sheet for a SAFE.”

If they came to you and said, “I want to do something different. I’m not building this necessarily for an exit. Exit may happen, but I’d welcome that opportunity. I’m building this thing into a long-term profitable business, and then I’ll have choices. That choice may be that I can run it for a long time and pass it on to my family. It could be that I sell it to my employees or an acquisition. It could be any of those things. I don’t want to make that decision now. What I do want to do is make sure that I’m here tomorrow and the next day. I want to get to the point where I have those choices. What can I do?”

The first thing is to recognize that it’s by definition bespoke. The thing we were all doing for so much of the last several years is if you go out and try to raise on a convertible note round that looks like the other convertible note rounds, you probably have a pretty good chance of raising the money you want to raise at pretty good terms. That was the market. That may not be the market anymore and probably isn’t. It also depends on the business.

The way I would respond is to say, “Tell me more about your business and your plan,” only then can you create something bespoke that is going to pass a level of intellectual rigor with a potential investor.  You’ll be like, “You’ve got this bespoke thing. Tell me why it is what it is. Why does it work for the way you’re going to grow your business and why does it work for my desire to make a return on my investment and to mitigate my risk?”

That is the responsibility of you entrepreneurs. If you go to a lawyer, Chuck, or even to your advisors and say, “I want to raise a convertible note. I want to do this.” They’re going to help you raise a convertible note, but if you instead talk more about the result or outcome you’re trying to achieve, the question is, “What’s the best structure or best way to do that?” That’s where you can look at things somewhat differently.

I want to go back to the point you made about raising a convertible note being common and less challenging a couple of years ago. It was always challenging but less challenging. My personal belief is that it’s always been wrong for a significant number of brands. In my opinion, this isn’t why we have such a huge failure rate and the fact that it was less difficult to raise a convertible note a few years ago. You raised a convertible note, which then is incumbent upon you to raise a price round to convert that. What often happened is a lot of these brands never got to a price round. They’re renegotiating their convertible notes, trying to extend them, or they get to a round with an investor, and it’s an early fund or so forth.

Now, they’re set on this course where everybody is expecting them to double their revenue year over year and spend like that, even if they’re not a brand built for that. At some point, they will find themselves out in that valley. That’s what happened to so many brands. They were able to successfully get that first convertible note. Maybe they were able to successfully get that first round of a true price round or a seed fund, but then at some point, the arc of that growth slows.

Those current investors are less enthusiastic because they’re not likely to be one of the ones in their portfolio to get their 10X return. They turn their attention to either other portfolio companies or new portfolio companies, and then not investing in you again sends the signal to the rest of the market, and suddenly, you’ve never built the economics. In a lot of ways, this new recalibration is good for our entrepreneurs and this industry. It makes us put the focus back on building not only great brands but good businesses. There are a lot of great brands built, but crap businesses underneath them.

I’ve seen it and you must have seen it more. How many times have you seen a brand which, under normal business circumstances, meaning not flooded with potential investment money, might have rolled out a new SKU into 25 stores, seen the reaction, iterated on the product, iterated on the packaging and branding, and then a few years later it’s ready to go out into 1,000 stores? Instead, they felt pressure because they had to justify the sales growth, so they launched a new product in 1,000 stores. It fails for reasons that they would’ve noticed if they’d done it in 25 stores.

Yes, I see it every day. Retailers have monetized that. They want that and it’s fun. It keeps things but not a lot of things. They’re happy to have it. I had a very candid conversation with a very senior retailer that said, “For every one brand I say yes to that fails. I got nine others right in line ready to do the same thing. I keep my shelves interesting and fresh,” but they’re doing on the backs of the money that was being put into these brands. It changes if you think differently. If you had an opportunity to sit in front of an entrepreneur who is an entrepreneur with a business that is somewhere in that $3 million but has a path of what we’ve described, what advice would you want them to hear more than anything else?

Make hard decisions and be willing to be patient. Be willing to look at this as a 10-year to 15-year growth cycle and make hard choices. There are brands out there because of the money they were able to raise that have too many employees or other G&A expenses that don’t make sense. If you’re $1 million a year in revenue, do you need $800,000 a year in salaries going out to people? You’d be surprised how many times I see that. They’re not fundraising-specific, but those would be my suggestions. They’ll come out the other end with a much better business. Question all of your costs.

It’s against my own interest, but I would even say with respect to working with people like us, for example. There are things entrepreneurs can do if they would sit down and try to do it that they ask me to do, which I’m happy to do, but they don’t need me for it. If you’re not going to raise millions of dollars, there are things you could still use people like us for, and then there are things you don’t need us for, or at least not right now. You can control your costs there.

I have a couple of things to add. One is that there is no easy button. If you’re not willing to do hard work, don’t do this. Build a business first. I have so many conversations where people think, “I need to be 299 on shelf, even if I’m not going to make any money.” Don’t do it. Be 399 or 499 and make money and only be on 20 shelves if that’s all the shelves you can be on. Think through it.

If you can’t solve that problem, then don’t. Be creative and innovative. Be patient and grow slower. Don’t let anyone control your narrative. Don’t let anyone tell you what you’re going to do. Again, remember what your job is when you’re in front of an investor. I don’t care who this investor is. Many of you start talking about all the awesome your brand is, how consumers love it, how cool and innovative it is, how it’s going to save the world and do all of this crap. As an investor, I’m sitting there going, “Tell me how I’m going to make money.”

If you can’t answer that first, don’t even bother meeting with an investor. You need to know the answer to that riddle before you ever talk to an investor. That’s the case you’re making. All the features and benefits, beauty, coolness, sustainability, social responsibility, and all the things that you’re doing with your brand are supporting arguments as to how you’re going to make their money, but you first have to lay out the case for making them money. The structure needs to be done in a way that makes them money and isn’t detrimental to what you want to do for the future of your business.

I’m optimistic. That sounds crazy, but this is a recalibration and an opportunity for founders who want to build good businesses and who can be patient in the long-term. The market’s going to be more accepting and interested in them than it was a few years ago. I don’t view this as a negative. I would view this as a negative if you were trying to show up the same way you were showing up in 2019 or 2020. If you can use this as a pivot point, which is what entrepreneurs do, then good on you.

One of the things that I want to call out on this, and tell me if you feel the same. Part of that reason is we’re sitting with a lot of you who are feeling a higher level of anxiety, fear, and terror than you have in the past. I say this not to make it go away or invalidate its realness, I say it to encourage you to understand that is right now the norm. Chuck and I get to talk to lots of entrepreneurs, and almost all of them are in this space. As you are in this space, I can’t make that go away. I can’t tell you not to feel that way. I can’t say that you’re wrong for feeling that way, but what I can tell you with 100% confidence is you’re not alone in feeling that.

VC is a broad brush. We’re talking about classic VC and there are all sorts of differentiated VC. In classic VC, if you can’t show them very fast growth in a space, that would result in a high-value acquisition by a third party. In other words, if you can’t show them a path to 10 to 20 times their money, maybe less depending on the stage at which they invest, but I’m thinking series A, pre-series A, it doesn’t mean they’re going to get it. It’s hard to say your VC material because, as Elliot said, they plan that much of their portfolio makes them no money, which means that the ones that make them money have to make them lots of money.

You have to understand that you have to be committed to trying that because if you slow down or stop that or decide midstream that you don’t want to pursue it that way, they’re going to write you off. They have to because it doesn’t fit their profile. To Chuck’s point, it’s not a negative. No one is saying there’s anything wrong with VCs. A lot of the reason we’re all here and the reason this industry is here is because of the money that’s come from our venture capital funds. It’s an alignment issue. It’s a matter of you making friends with people who you are aligned with. If they’re not aligned with you, they’re probably not your best friends.  Thanks, everyone. See you next time.

See you, guys.

Important Links

• Chuck Cotter – LinkedIn

• TIG Collective

Love the show? Subscribe, rate, review, and share! tigbrands.com/tig-talks/