Episode 87 – Knowing When to Shut Down
FEBRUARY 1, 2023
I don’t know any founders that would advise a peer to shut down their business. Maybe if they were a brother or sister of the founder. Or a spouse.
Look, telling another person to liquidate ‘their baby’ violates our ever-optimistic American business culture. It’s heresy, really. She needs to figure it out on her own.
But, I’m going to have this conversation with you instead. It’s a sensitive topic that should be addressed more often in public, even though most new founders have little appetite for listening to what I’m going to say. That hasn’t stopped me ever on this show.
A related, huge problem is that the media prefers happy tales of eight-figure ‘startups’ that got through the Death Funnel years ago. Advertisers prefer selling ads next to that kind of sunny, inspirational content. No one wants to advertise next to a litany of failures and explanations of the patterns behind them.
Shutting down a business you put your life into is no easy decision. But it happens every day in America. And, I always maintain that it’s better to make these adverse life decisions intentionally, with a plan, than to have external forces do it for you. Suddenly.
The main take-away of this episode: you should shut down when the P&L becomes toxic, AND you don’t have a growth playbook that can help rescue you from it in time.
Independent Signs of a Toxic P&L
The following signs of toxicity assume that your business is in the Death Funnel or selling less than $500K annually.
- Less than six months of operating cash on hand – By ‘operating cash,’ I mean cash/liquidity to fund bare minimum expenses (insurance, office rent, inventory storage, debt payments, etc.) It’s true that 20% interest, short-term loans can get you through this situation IF you have 90% confidence that you will receive a distributor payment within that time. But, if you do not have inbound cash, it’s time to pause the business essentially. Scrambling for a hail Mary source of funds is your choice, but you should never have brought yourself to this point. In most cases, the founder simply didn’t know how to manage cash or minimum appropriate gross margins to fund operations. You should wind down, learn those fundamentals and return to the market when you’re ready. No broker, distributor, or retailer will likely remember who you are. Trust me, this kind of Phase 1 wind down is so common that it can’t sociologically form a ‘Scarlett letter’ on your name.
- Gross margins fall below 10% – In the current environment, this is happening to many founders dependent on foreign ingredients and supplies whose transportation expenses have ballooned to unparalleled degrees. It’s even worse if you import finished, packaged products into the U.S. Your gross margins probably negatively. Gross margins should be 35% or more for a healthy, under-capitalized consumer brand. This allows just enough oxygen into the P&L., But when gross margins tank, only businesses with millions of dry powder are likely to survive a tight cash flow quarter or two. There’s a reason serial entrepreneurs start their second venture with a lot of money inside the LLC. It’s not just because they have it. They know enough to place it there as an insurance policy against black swan events.
- Managing your company finances makes you feel hopeless enough to harm yourself – We do not talk enough about entrepreneurial depression, let alone suicide by founders. However, you are a class of workers much more likely to suffer from depression than the general population. And depression is the emotional consequence of hopelessness. When unchecked, hopelessness can lead to suicide in our individualistic society with abundant ‘alone time.’ If you are experiencing suicidal thoughts, stop reading this, and please call a crisis counselor immediately at 800-273-8255. It may not even be the finances that make you feel hopeless. It could be managing stakeholders and employees or balancing family with the venture itself. If it’s bringing you this low for weeks, you must stop. If you have a co-founder, you could step back and heal. But, since most of you start alone, winding down is the best idea in this psychological situation. I’d rather risk discouraging those with potential than encourage those in distress to push themselves over the edge. Your business is not worth your loved ones losing you.
The result of these P&L death signals is that you don’t have enough cash to meet your co-man’s minimum order quantity for another production run to save yourself. In other words, you actually can’t sell your way out of this in a B2B hail Mary. You are out of fuel. Adding debt to debt (even if you could obtain any quickly) eventually becomes unserviceable. This early debt trap differs from raising debt much later to finance a manufacturing facility.
AND the Growth Playbook Isn’t Working, Either
There can also be clear signs that your growth playbook is failing so badly that you should wind down even if cash on hand is sufficient to keep going for 6-12 months. But if you have any of the above P&L problems, either of the death signals below, you’d be crazy not to wind down. Or at least pause.
- Declining same-store velocities in ALL retail channels (and declining unit sales online) – If your sales are declining in ALL channels month-over-month for 12 months or more, you have a product or a product symbolism problem. Usually, there is a mixed velocity report on many emerging Phase 1 brands. Some accounts are growing velocity, others declining. This is something you can recover from, but not from what started this paragraph. Combined with the cash flow crisis assumed above, you have no way out. Even if it takes a year to burn through inventory, the delisting will start. Adding households on top of happy repeat purchasers is the real secret behind exponential growth. And, though it is rarer than we would like, it is reflected in steady monthly velocity growth of 10% or more. When you have ultra-low velocities that are stagnant or declining, you won’t have time to get past your cash flow crunch.
- Ultra-low velocities – 1 U/S/W or less in most categories. This is evidence of basically no-repeat purchase or no trial. Probably both. Your brand could be invisible on the shelf. But, if you have the cash-flow problem above, you simply don’t have time anymore. Even if you have inventory to sell, you’d have to wait months and months to generate partial payment to cover minimal costs. If velocity increase can’t be forecast, you shouldn’t expect retailers to reorder more; they’re more likely to slow their reorder rate as they now know you are simply a placeholder (one highly likely to get bumped for slotting fees paid by a competitor).
At any given time, roughly half of Phase 1 brands have been declining in revenue for the past three years. I don’t know how many of these also have a toxic financial situation. I suspect most of them do because far too many founders enter the CPG industry without much finance or business training. Perhaps this made sense when the only people who wanted to innovate in the industry came at it from a more ideological than business perspective. But, today, founders should focus on their financial management skills from day one if they want a fighting chance to get through the Death Funnel.
This issue has been dark, for sure. I get it. But, I sense a few on my e-mail list may be avoiding the decision to wind down. Market timing, financial timing, and life timing are crucial to making innovative businesses work. And not even my book can help you align all three.
The good news is that if you wind down a Phase 1 business, you almost assuredly have learned a ton about business and the CPG industry. More than one successful exit has a founder who had this experience early in their career.