My guest on this episode is Bill D’Alessandro, CEO of Elements Brands. Elements buys digitally native consumer brands and uses their expertise and playbook to scale them upward. Bill also co-hosts a podcast called Acquisitions Anonymous with Michael Girdley and Mills Snell, which I highly recommend checking out.
Bill and I talk about his experience starting a skin care brand while working in investment banking, why he decided to acquire more brands, the use of debt to acquire them, and the growing Elements Brands ecosystem. If you want to buy any online business, this episode is for you.
https://alexbridgeman.com/podcasts/bill-dalessandro-acquiring-and-scaling-e-commerce-brands-ep-46/
Links Mentioned:
Think Like an Owner Sponsors
Live Oak Bank – Live Oak Bank is a seasoned SBA lender focused on search funds, independent sponsors, private equity firms, and individuals looking to acquire small companies. Live Oak has closed billions of dollars in SBA financing and is actively looking to help more small company investors across the country. If you are in the process of acquiring a company or thinking about starting a search, contact Lisa Forrest or Heather Endresen directly to start a conversation or go to www.liveoakbank.com/think.
Hood & Strong, LLP – Hood & Strong is a CPA firm with a long history of working with search funds and private equity firms on diligence, assurance, tax services, and more. Hood & Strong is highly skilled in working with search funds, providing quality of earnings and due diligence services during the search, along with assurance and tax services post-acquisition. They offer a unique way to approach acquisition diligence and manage costs effectively. To learn more about how Hood & Strong can help your search, acquisition, and beyond, please email one of their partners Jerry Zhou at --@----.com
Oberle Risk Strategies – Oberle is the leading specialty insurance brokerage catering to search funds and the broader ETA community, providing complimentary due diligence assessments of the target company’s commercial insurance and Employee benefits programs. Over the past decade, August Felker and his team have engaged with hundreds of searchers to provide due diligence and ultimately place the most competitive insurance program at closing. Given August’s experience as a searcher himself, he and his team understand all that goes into buying a business and pride themselves on making the insurance portion of closing seamless and hassle-free.
If you are under LOI, please reach out to August to learn more about how Oberle can help with insurance due diligence at oberle-risk.com. Or reach out to August directly at --@----.com in sponsoring? Send me an email at --@----.com Transcript:
Thanks for joining us, Bill. It’s been great to have you. I’ve been following your Twitter for a while. It was very kind of Mills to recommend I reach out to you and I’m glad I did because it’s been fun to get to know you a little bit. I’d love to hear about Elements brands and how that’s developed for you. You’ve, of course, talked on other podcasts about your time, living The 4-Hour Workweek. We’d love to hear a little bit about that and just your background for now.
Glad to be here. Thanks for having me. My business is called Elements Brands and we are a holding company of direct consumer CPG brands. We own five brands in the portfolio today, everything from pet products to laundry detergent to what I call lotions and potions, so think anti-aging creams, skincare, things like that. I started the business in###-###-#### After reading The 4-Hour Workweek, I was working in investment banking and then private equity at the time. I have this distinct memory of, we sold a business. This guy was a franchisee of chain restaurants and we sold his business for something like $250 million, just a huge number. This guy wore camo pants to the closing. I remember I was sitting there with all my investment banking colleagues, my boss’s boss, and everything in these really expensive suits and we thought we were super cool masters of the universe, but then I look over at this guy.
He’s wearing camo pants and he just took home 200 plus million dollars. I go, “Wait a minute. I’m on the wrong side of the table. I want to be on that guy’s side of the table.” That was right about the time I read The 4-Hour Workweek. I realized I needed to make a change, so I left private equity and started a business called KP Elements, which was a skincare business. I got it up to the point where I was making about 50 grand a year and that’s when I quit my job. I started it at nights and weekends. I’d of come home and stay up till 2:00, working on my business and then take orders to the post office on the way in, in the morning, et cetera until I finally was making 50 grand a year. I thought, okay, I can quit now. For the first couple of years, I very much did the digital nomad thing. I traveled around.
I skied on Tuesdays. It was really great, but what I came to, I said, “I’ve won this game. I have this little Internet money machine, but I’m never going to make a difference in the world or for anybody. I’m not going to make an impact. I feel like I have the horsepower to build something bigger.” That was when I hashed the plan to acquire small businesses and add them on to what I already had. This was back in 2013 when I did my first acquisition. It’s very cool now to roll up small businesses, but I started in###-###-#### I did my first deal. What I realized was I had infrastructure and business systems that could run much more revenue than I have.
My investment banking mindset kicked in and I said, “Well, what if I went and bought more revenue and put it onto the same system? What if I grew inorganically?” That was when I discovered, seven years ago now, eight years ago, that these businesses can be bought for three times EBITDA. I went, “Three times EBITDA? That’s a 33% IRR if I do nothing, don’t grow it, and use no leverage.” I thought I could do both of those things. I thought I could grow it and use some leverage. As is more popularized now, the numbers pencil really well. Of course, the trick is doing good deals. Since 2013, we have done six acquisitions of e-commerce brands.
We look for brands now with between three and 15 million in sales. We like for them to be profitable and we like for them to do at least half of their revenue outside of amazon.com, and we like for them to be consumable products. That’s where we focus. I mentioned we’ve done six. We have five in the portfolio now because we actually recently divested our three smallest, which were in aggregate about 5% of revenue, to focus on bigger brands. We also just completed an eight-figure capital raise here on###-###-#### We’ve got some fresh dry powder to go buy more brands.
Nice. Well, congrats on the capital raise. That’s pretty exciting. Back to your-
Thanks.
Company though, the first one, why skincare and then why did you start it versus going out and just buying one, to begin with?
Well, I wasn’t smart enough to realize you could buy them at the very beginning. If I could do it over again, I might just start with that. Although I tell people, “When you buy a business, it’s essentially like going in to operate on a live patient for your first operation,” but if you’re a medical student, you don’t start on the live patients. You start on the cadavers or you start on the animal dissections or whatever. When you start a business, it’s just much lower stakes. You can screw up a lot, but when you buy a business, a large portion of your net worth is on the line. That patient is alive. The heart is beating. You really can’t screw up. I think a lot of people think, oh, I’ll just buy a business, but they don’t realize it’s analogous to jumping into the OR with a live patient.
I think sometimes starting a thing, even if it remains small and doesn’t become the main thing, I think you can learn a lot. You can screw up on the cadaver or the animal dissections before you operate on a live patient. I didn’t do that on purpose, but I think it’s served me very well. The reason I actually started KP Elements is it’s a skincare product for a skin condition called keratosis pilaris. If you’ve ever seen people with red bumps on their triceps or their thighs, it’s a genetic condition where your skin just makes a little bit too much keratin. Keratin is a protein. It’s the building block of skin, hair, nails, et cetera and it causes what looks like acne, purely cosmetic, not painful, et cetera. I have it. I was googling one night. “What is this? How do I get rid of it?” I realized I’d been googling for 30 minutes and no one had tried to sell me anything.
I went, “Whoa.” Then I saw on Wikipedia it affects 50% of adults. I went, “Double whoa.” A huge market here and no one is trying to sell to it. I went on all these forums where people were posting about the skin condition and they were using foot cream and avocado oil, all this off-label stuff, and saying, “Hey. It helped with my KP.” I bought all of them and I just cross-referenced the ingredients list. I said, “Okay. What ingredients seem to be in all these things that are working for people?” Having no skincare background myself at the time, at all.
I identified three or four things that seemed to be popping up with frequency. I researched the condition and then those ingredients to figure out, okay, yeah, it does track. Knowing what I know now about these ingredients, it does track and they would help with the condition. Then I called five or six contract manufacturers and said, “Hey. I need you to make me a cream with X, Y, Z in it. I need it to be white. I need it to smell nice. Give me your best price.” Before I knew it, 5,000 pieces showed up at my apartment in Denver, Colorado, where I was living at the time. I went to town from there.
How much space did that take up, those 5,000 pieces?
It was about one palette, so nooks and crannies in the apartment. It mostly fit in my bedroom, but it was just … Imagine a big pallet size stack of boxes.
How long did it take for you to sell it all?
A couple of months. I think four or five months. The way I started was I started going on all those forums and posting, and saying, “Hey. I’m a member of this forum too. I made this product. Here’s 50% off for anybody on this forum.” Then I also was doing Google Ads as well. If you’ve read The 4-Hour Workweek, Tim Ferriss, the author advocates for this test where the website doesn’t actually sell anything, but you run a few ads. Then people go to the website.
Then when they click checkout, they get a page that says, “Hey. I’m sorry. We’re out of stock. We’ll email you when we’re back in stock,” but you register that mentally as a conversion. I knew that I was able to spend so much. That was part of my research. I spent a couple of hundred bucks on ads and I converted ‘five or $600 of revenue,’ so I knew that when I actually had product to sell those people. I could make money on ads. That was how I got started.
It was that simple, just telling them the ingredients you wanted in this cream and certain specifications, and they could create something for you?
Yeah. That oversimplifies it a little bit, but it is not much more complicated than that. Contract manufacturing today, as we sit here in the early days of 2021, is so much more advanced than it was in 2011, actually, when I was starting with my own product that didn’t do the first acquisition till 2013, but in 2011, when I was doing this, it was basically a bunch of phone calls with these people. They didn’t have websites. I had to ask them for references. You just tell them what you want and some of them might say, “Hey. We’ve actually got a formula already off the shelf, that does exactly what you want. We can just put your logo on it.” Then it’s about positioning in the marketplace and branding, as much as the formulation.
How did you price it?
Actually, I did an interesting experiment. I ended up pricing at $35 a jar. I wanted to price it premium because I said, “All else being equal, I’d rather sell half as many and make the same amount of money. I want to ship fewer boxes.” I did an interesting pricing experiment. I priced it at $35 with free shipping or $30 flat with###-###-#### I ran a side-by-side comparison. Effectively, it’s the same price at the end of the day, but the 35 with free shipping offer had doubled the conversion rate of the $30 plus 4.99 shipping offer. To this day, the product is $35 with free shipping.
You did that with two simultaneous Google Ad campaigns?
Yeah, with Google Ads and then just posting myself on forums. The nice thing about, and this is one of the reasons we focus on skincare, personal care generally at Elements Brands, is that they repeat purchase items. If you buy this once and it helps you, you can come back and buy it again, again and again. We become a permanent spot in your bathroom. It’s not as good as SaaS recurring revenue, but I much prefer it to I sell you a bicycle once every five years and don’t hear from you again. There’s a big range of consumer products when it comes to repeat.
Absolutely. With the premium price point for your first company, is that a price point you’ve stuck with, with most of your brands? Or is that something you look for? Or do you flex up and down as you go?
We generally try to shoot for 25% above the median price point. Super luxury, I think is a whole different ball game and that’s not one that we play, but we shoot for that masstige, prestige, plus mass price points. There’s also this concept that I call the death zone in e-commerce. In e-commerce, my rule of thumb is any product priced below low teens, anything below 12 or so dollars, it’s very hard to make any money at all. The reason for that is that almost everybody wants free shipping. In this world of Amazon, free shipping is table stakes. It’s going to cost me five bucks to ship you anything. That’s a fixed cost, whether the thing retails for 12 bucks or 100 bucks.
As you get in those lower price points, there’s just not a lot of margin available above the fixed costs. You just got to do so much more work. You got to sell more things. You’ve got to sell 10 things for $10 or one thing for $100. All else being equal, we try to look for that 20, 30, $40 price range, is where we like to be. Another thing I’ll say about that is that’s high enough to be above the death zone, but it’s low enough to be impulse purchasable. If you’re going to spend a couple of hundred bucks online, you’re going to read a whole bunch of articles about it, et cetera. If you’re going to drop 25 bucks online, you might see a Facebook ad, click through and buy it. That’s why we shoot for that sweet spot, above the death zone, and below the thoroughly-researched purchase zone.
Is there a slightly different formula just in terms of marketing, ad spend and building a brand once you get to those ultra-luxury categories, that changes enough of your existing playbook that you’d rather not go there? Or is there some other reason that that game, in your words, is something you don’t want to do?
It becomes much more about heavy, heavy brand, heavy influencer prestige, scarcity. There’s a whole bunch of things that act differently at the top end of any market. This doesn’t necessarily just mean high dollars. This could be, I’m trying to sell you a $20 tube of ChapStick, which is way over priced for ChapStick, but you’re going to want to know that a celebrity uses that and it’s got some exotic ingredient. It’s just a lot more work, whereas I can hit you with an ad that says, “Hey. Look, this is a cool flavor of ChapStick you’ve never heard of.” Boom. $5. A bad example because it’s in the dead zone, but you get the idea.
Absolutely. What do you think you learned from starting a brand, that you would not have learned if you had purchased one, to begin with?
Just how long hard it is to start a brand. Starting a brand is super hard. When I speak, I have the slide where it’s the six years of revenue of the first brand we bought. It ticks along. It grows five, 10, 15% a year or whatever. Then we buy it and it doubles in our first year of our ownership. What it took them six years to do, we achieve that same amount of growth in one year and it was so much easier. Just doing things with scale is so much easier. Willing something into existence is incredibly commendable and brutally hard. The creation act that entrepreneurs do is just one of the coolest things in the world and so hard to formulaically get right. What we’ve decided to do at Elements Brands is recognizing how hard that is. We outsource the creation act to the market because there’s this element of randomness in it.
There’s lots of really cool products and really cool brands that just never take off for whatever reason, despite the best efforts of the founder. What we do is we let the marketplace sort it out and eliminate some of that randomness and we start to look for the things that have traction. That could be as much as the thing that got luckier than the thing that didn’t. Then once it starts to have some of its own momentum and field of gravity, then we can buy it after some of the luck has been taken out of it, and then we’re executors. Instead of taking it from zero to M, we want to take it from M to 3M. That’s our skillset. There are other folks out here who are great creators and they go zero to M, but we know what we’re good at. We try to stay in that circle of competence.
Do you think those individual creators and brands could take it to 3M? Or is there something about your scale and just depth of experience that is one of the few ways to get it to 3M?
I don’t want to discount. There are incredible entrepreneurs out there that can create things and take them all the way to scale, but having the scale that we have gives us some advantages over that person. For example, if you’re two or three guys or girls, either metaphorically or literally in a garage starting a company, you’ve got to be good at all of these things from Google Ads to web design to manufacturing to label design, graphic design, working with Amazon, Facebook Ads. There’s so much and so you’re running around like chickens with your heads cut off and you don’t really have deep expertise in all the areas, but for us, with our scale, I can hire an ex-Amazonian, which we do, who runs our Amazon program.
She knows more about how Amazon works than any generalist entrepreneur running around in a garage. We can hire those experts in every area. I’ve got a Facebook Ads expert. I’ve got a finance team that just looks at how we allocate capital all the time. We can be better executors in all of these verticals. It’s just often easier for us. Not to say the entrepreneur can’t do it, but oftentimes, the entrepreneur is burned, man. They’ve been doing it for five, 10 years. They want to take their money off the table. Even if they could be the grower, maybe they prefer to be the curator. There’s a lot of people out there like that. They sell to us. They can go back and create a new thing. They can go to the beach for a little bit before they do, but we take it from M to 3M.
The answer may be obvious, but I’m curious. Do you feel that you’ve enjoyed being a grower more than you were a starter?
I think for all entrepreneurs, you have this entrepreneur’s disease, where you’re like, “Oh, I just love creating something.” I see all these opportunities. I have this shiny object syndrome, but I actually think I am better at executing. Obviously, I started Elements Brands and I’ve started brands before too, which we still own, but we are very, very good executors. I’m a really good systems thinker, so I’m really good at seeing the whole picture and setting up, putting good people in place with good feedback loops so the business can scale itself. I just found it’s a longer lever for me than creating things, but I still do love dabbling. I started a lemonade stand when I was in fourth grade. It’s in my blood. I’m an entrepreneur, but I try to stay focused on what I believe is the long lever here, which is creating systems, processes, and scales, which you can be very creative in, especially in an industry like e-commerce that changes all the time. I try to channel my creativity to that.
In a prior podcast, you talked about, when you buy the whole business the seller doesn’t have to stick around that long, maybe two weeks or so. You prefer them to leave generally, just because there’s lots of changes and updates that you’re making to the business. Is there any one particular change that you have to do fairly frequently than a previous owner might be upset in happening, while they’re still working in the business with you?
It can be all kinds of things. I know you’re out in Portland. I’m in North Carolina. Around here, there’s this company that buys and flips houses. They have all these billboards that say, “We buy ugly houses” because what they know how to do is renovate a kitchen and a bathroom and flip the house. I always like to joke that we buy ugly websites because what we know how to do is we redesign the website. We look at the branding of the product. We optimize their ad campaigns. We look at their Amazon. We have internally what we call the playbook, which is 144 different dimensions now, of what we believe excellence in e-commerce is. When we buy a brand, we evaluate it against the 144 different dimensions and we say, “Where’s the lowest hanging fruit in this brand?” Metaphorically, sometimes it’s renovating the bathroom.
Sometimes it’s upgrading the kitchen. If the website’s fine, but the brand’s not on Amazon, the first thing we’re going to do is take it to Amazon. One of the problems that we see just tons of entrepreneurs have is that they rely on agencies for a lot because when you’re small, it’s really tempting. “Why don’t we just hire a Facebook Ads agency to run my Facebook Ads?” I’m not knocking all the folks who run agencies out there, but the intrinsic problem with agencies is they have multiple clients. Even if you love your agency, they think about you, at best, one day a week, but if you do that stuff in-house, you think about it all the time. I’m sure your listeners know who Paul Graham is. He has this great essay called The Top Idea in Your Mind, where he posits that there can only be one thing that you think about when you’re not thinking.
It’s the thing that you have epiphanies about in the shower or on your drive to work. It’s just percolating in your unconscious mind. Paul calls it The Top Idea in Your Mind. With an agency, your brand is never the top idea in their mind, but when you do it internally, when you can task a dedicated resource with it … Our Brands, Facebook Ads, I have in my mind right now, somebody’s face. It’s the top idea in their mind all the time because that’s what they do. We make major strides often by moving away from agencies and hiring full-time people, for whom the brand is the top idea in their mind.
Raising capital, I assume you did that for the first few acquisitions, and obviously, you’ve raised some more now too. Is that what allowed you to hire and build this team? Or do you think it could have gotten there organically without capital raising?
That was actually a very conscious decision I made. I’ll take you through the capital history of Elements Brands. A very hot topic on Twitter as we record this is the use of personally guaranteed SBA loans in small business Twitter. I would absolutely not be where I am today without a series of personally guaranteed SBA 7(a) loans. I started. As I mentioned, in my first business, my total capital was $8,500, which is what I basically spent for the first pallet of inventory that I mentioned, but then my first acquisition was done with an SBA loan. I borrowed 80% of the purchase price and the rest was profits from my business. Then we did two more, so three total acquisitions with SBA loans, on the way up, which were just phenomenal. The terms are incredible. The paperwork’s a nightmare, but I wouldn’t have been here today without that program.
Then in 2016, I reached a crossroads where I realized I could only do deals after I’d saved up enough profits for basically the equity injection on the loan. I could only go so fast. I was diametrically opposed. If I grew my business and hired a Head of Growth, I would be spending money on people and I wouldn’t be able to save as many profits to do the next deal, but if I save profits in the next deal, I couldn’t hire a Head of Growth. I felt like I had this trade-off that I didn’t want to make. That’s when we raised about three million bucks of, I guess, it’d be called a series seed these days. We raised about three million bucks of friends and family office money, primarily a couple of family offices that I was lucky enough to be introduced to.
We raised three million bucks and that allowed me to run the business at break-even, to hire a Head of Growth, and then use the equity capital as the down payment. We still use debt. We’ve used SBA loans. We’ve used non-SBA loans. Then, I’d mentioned, we just recapitalized here with a combination of some debt and equity. Debt is a super powerful tool. We used debt and equity together. That’s the history of … I wanted to go faster, but I didn’t want to compromise hiring a Head of Growth. By raising a little bit of equity, it let me build the platform, while I also continued to do deals.
Was part of it that you were also just seeing deals that you couldn’t act on because you didn’t have the capital to do so?
Yes, to some degree. I’ve been in e-commerce, as I mentioned, since 2010, 2011, so I see just a ton of deals, and still, I see deals. It’s really nice to have some capital in the bank now because in 2020, we saw a ton of cool deals we couldn’t execute on. I’m really pumped for this year. We have a whole bunch of gunpowder in the cannon.
That’s certainly a nice thing to have. How has your thinking on debt evolved over time?
I am a huge fan of debt. I have become a larger fan of debt the more I have used. Now, I can hear everybody cringing. They listen to this podcast. My friend, Brent Beshore, is very anti-debt. I’ve got other buddies who are anti-debt. There’s good reasons to be anti-debt, but a moderate amount of debt, also known as leverage, can really magnify your outcomes and allow you to retain more equity. There’s a reason debt is called leverage because if you’re right, you’re really right. If you’re wrong, you’re really wrong. If you really believe you are right, debt will magnify your outcome and it will allow you to keep more equity ownership.
Had I raise all the capital we raised as equity, I would have a tiny percentage of Elements Brands now, but because I was able to use millions of dollars of debt, I still control the company. It’s still my company. It’s a huge dispersion in outcomes, being able to use debt. Also, the other thing I’ll say, equity is hard to raise. Debt is easy to raise. You just go down to your local bank branch. Debt is much more available, especially to first-time entrepreneurs, especially to maybe underprivileged entrepreneurs who don’t have a family safety net or anything like that.
If you’re willing to sign on the dotted line, debt is available to you, which is a lot harder to say for equity. Raising equity is tough. I’m a huge fan of debt, especially if you’re young too, even if you’re going to personally guarantee it. This was my thought. I was young. I was in my 20s. I had no spouse. I had no house. I said, “I’ll personally guarantee it. If I go bankrupt, I’ll just start over.” Luckily, I didn’t. The younger you are, the more tolerance you have for things like that. I’m a big fan of debt and I think more people should use it.
The personal guarantee didn’t scare you very much because you didn’t have much, of course, assets, at the time. No house, wife, you said. Was there something else about it that scared you? Was it just the importance of it or the magnitude of taking on all this money and having to guarantee it? Did that scare you a little bit?
The responsibility of it is what’s heavy for me because no one that has ever invested in me or with me has ever lost a dollar. In fact, they’ve all done very well. That includes my debt investors and my equity investors. That is really important to me. I care less that I made my bank money. I care much more about my track record of doing the right thing and getting everybody paid back. That was what was heavy for me, would be losing other people’s money, who had trusted me. That was heavy. The personal guarantee, and maybe this is the entrepreneur’s mindset, I just never thought it would come to that because, in my view, I was in control. I had a lot of confidence in my ability to pivot the business around challenges if need be.
Also, with an SBA loan, the payments are over 10 years. There’s so much cushion in it, especially with interest rates, where they are today. The business can decline by a significant portion before you’re at risk of not making your payments. The way I saw it is the worst case, I just have to own this thing for five to 10 years and run it out. Then I’ve got five to 10 years to innovate my way out of the problem. That was how I thought about it. There’s a large margin of safety and it was something I control. Would I sign a highly-leveraged personal guarantee on an asset I didn’t control? That would be totally different, but for a business that I owned and was CEO of, that scared me less.
Do you try to pay down debt a little quicker than that 10-year period? Or do you try to keep as much of that equity as possible for later deals?
If you’ve got a ten-year loan that’s amortizing over 10 years at 3.5%, you would be insane to pay that, just from a capital allocation point of view. They’re essentially investing capital to save three and a half percent. Our internal benchmark for IRR is significantly higher than three and a half percent. If I can use that money to do another deal, absolutely that’s what I’m going to do rather than pay the debt down. Now, you might … If we’ve got revolving lines of credit where the cash is sitting on my balance sheet and I can pay it down and save the interest for a couple of months and then redraw it, that’s just a cash management problem, but in general, moderate amounts of leverage, especially at historic low-interest rates, should not be paid off. You should reinvest the capital in a higher rate of return places.
Do you still think the SBA loan is the best way to buy these online e-commerce businesses? Or is there some other debt tool you’ve seen and used?
I think it depends a lot on your definition of best. Best terms, hands down, it’s not even close. The standard SBA loan is a 10-year amortization and it’s liable plus 300, so it’s three, four, or 5%, something like that. You’re not going to get that anywhere else. That leaves a ton of cash flow month to month to pay yourself. It leaves a ton of cash flow to do another deal. SBA loans can go up to $5 million. Actually, I think the new COVID Relief Bill takes it up to $10 million in some circumstances. This is credit you’re just not going to get anywhere else because it’s government-backed. It’s artificially cheap and you’re willing to PG it, but even if you’re willing to PG private debt, it’s still not going to be that cheap.
We spent a lot of time in the capital markets for a small business. I’ve identified a really interesting opportunity which is above the $5 million SBA loan threshold and then below probably the $20 million check size where traditional debt funds will start to get involved. There is a real dearth of capital. I think the result of this is that over the last five to 10 years of really low-interest rates, I have created a lot of capital that is chasing yield. A lot of the mezzanine mid to low market debt funds that I used to work with in private equity 10 years ago, they had $100 million dollar fund before, which means they could write five and $10 million checks. Now they’ve got a $400 million fund, so they can’t write a check less than 40 million bucks because they’ll just never deploy their fund.
All of this liquidity that you’re searching for yield, plus the incentives of fund managers to raise ever-larger funds has ballooned fund sizes. There is a real hole in the market for entrepreneurs who are buying a two, three, $4 million EBITDA business and want to lever it three times and need to borrow 10 million bucks. It’s very hard to get debt on terms that are reasonable. You’ll be probably borrowing from a mezzanine capital fund that’ll be targeting IRRs in the high teens and they’re going to get some warrants and your business, et cetera. If you can get an SBA loan and you’re comfortable with PG, it is hands down the best terms and it’s not even close. Ironically, if you are not willing to do that, you’re looking at very expensive debt or equity. There’s a huge gulf between SBA and equity financing, as far as expense.
Is there any idea you have for fixing or filling that debt gap between the SBA and then those larger debt funds?
It’s a tough problem because as I mentioned, if you’re going to deploy capital of $10 million at a time, you can’t have so much capital. That’s impractical. Folks who are paid as a percentage of capital under management, always want to have more capital under management, obviously. Then the other thing that’s tough is if you have more capital in our management, if you’re going to write smaller check sizes as a percentage of your fund size, you don’t have enough time to diligence every investment as well because you just got to spray money out the door. Most lenders too are terrified if it goes sideways and they have to own the business or liquidate the business. Most lenders are not in the loan-to-own space, but I think it would be really interesting to see some capital attached to operating businesses.
For example, if Elements Brands were loaning to e-commerce businesses and it went sideways, I might not be terrified to end up owning that business because we wouldn’t have to liquidate it overnight. We actually might be able to rehab it or take a lot of cost out. We essentially did loan to own, even though that’s not what we went in to do. I think it would be interesting to pair debt capital in the soft spot of the market with an operating company that could essentially help you do your workouts, which would allow you to deploy more capital in smaller check sizes. It’s something I think a lot about. I haven’t fully solved it. I think there’s just a ton of opportunity out there.
Is this something you might do one day with Elements Brands?
I’ve thought about it. We still have so much white space in acquiring our own brands and capital to do it. When you’re lending, you’re generally making a spread. You’re shaving percentage points on whatever your cost of capital is versus what you can deploy it at and that spread is typically in single-digit percentages. We’re doing significantly better than that, as far as deploying our own capital. What I think would be interesting is to partner with some sort of debt lender and to be their workout partner, where we could say, “Hey. Send us the ones that go sideways and let us buy them from you.
Or let us take them from you and pay you back over time. Let us help you liquidate the stuff that goes sideways at a not-rock-bottom valuation” because there’s no law that says, “The capital provider and the workout provider have to be the same entity.” We’ve started to have some conversations with e-commerce-focused lenders, to say, “The ones that you guys thought were going to be unicorns and it turns out they were just okay, why don’t you flip those over to us? Get your capital back. Close your fund up and deploy and go look for more unicorns. Why don’t you let us take the moderate growth?” Because that’s what we do.
I assume if you partnered with some capital provider, you probably wouldn’t want to take all of the companies that didn’t work out. Are there some, at least, base filters you’d have to make sure that …? You definitely want the ones that are not working out, of course, but is there a point where a company is failing so badly you don’t want any part of it?
Oh, sure. Of course. Although I think that that typically comes from wrong product choice or wrong industry choice or a shifting industry dynamic. One thing that we avoid like the plague in Elements Brands is fad-products. The fad of the week is different all the time, everything from weighted blankets to fidget spinners, pick it, everything. Even in cosmetics, there are fad ingredients that come and go every three or four months, depending on what’s on the cover of Oprah or Teen Vogue or whatever. Those businesses, we avoid like the plague. We actually see them a lot, where these businesses have taken a nose dive and I go, “Yeah. That’s because your thing is not cool anymore. You didn’t have a business. You were riding a fad.” We do try to avoid those.
How do you know if something’s a fad though versus a sustainable trend?
A fad versus a trend, the age-old question. I am not a venture capitalist. I am not in the business of predicting what is a fad or what is a trend. One of the filters we have at Elements Brands is we like to see five years of operating history on the brands that we buy. This is, again the identification of fad versus trend. I’m going to outsource that to the market as well. Then the ones that make it for five years, I’m reasonably confident this is a trend. Now, does this mean that we’re going to miss out on the 1,000 X billion-dollar brands? Yes, absolutely, but that’s not what we do here. That’s not what we’re trying to do or it’s not what our capital base requires us to do.
We’re trying to buy brands that we can own, grow, and cashflow. Sometimes we’ve been very lucky and we have five and six X brands. We bought a brand in 2018 in the pet space, which has turned out to be a really great place to be over the last two years. That brand has five X’d in a little under two years, but we don’t need that to happen. We’ll let other people play on the bleeding edge. We’re looking for the businesses that are going to be stable in cash flow. We’ll outsource the fad versus trend conversation to the marketplace.
I like it. At what point do you think your model starts to stretch a little bit? At six brands now, at what number of brands do you think it starts to become a lot harder to maintain your team and build a company around this company size, this brand size?
We actually hit it last year. We’ve done a ton of thinking about this. We used to structure our business such that everybody works on everything. You would come in and you would work on our pet brand and our laundry detergent brand, et cetera. What we found out is you just can’t be that schizophrenic. Each of these brands has a different customer archetype. Different types of marketing work in all these brands. When you do that, none of the brands is the top idea in your mind, coming back to the earlier point. What we did is last year, we restructured the whole company. We labeled every role. Is this a role that can scale and be a horizontal role?
Or is this a role that has to be a vertical role and focus exclusively on one brand? Things like operations and finance, if you’re just counting dollars, you don’t care where that dollar came from. If you’re just shipping boxes, it’s just a widget to you. Those people, our warehouse, our finance, our HR, all what could be called overhead, plus operations, work on everything. It’s just a widget here. You work on everything, but if you work on brands, you work on brand teams and you’ll go vertical. We’ve got brand managers for each of our brands with dedicated teams that are thinking, top idea in their mind, about these brands all the time.
I believe that’s what’s really going to let us scale, is having this home for lots of brands inside of Elements Brands, running autonomous and independently on a common operating system. Then me and my executive team, we provide the operating system like, “Here’s how we think about e-commerce. Here are the levers that matter. Here’s a 144-point playbook. Here’s our standard reports that we use.” We’ll help those people to run their business as well and that’s how you scale. If you look at Berkshire, Warren doesn’t run all the businesses. They have operating systems and good executives in place. We’re trying to mimic that with shared services bolt-on.
That’s something you solved last year. What’s something you’re working on for the next two years or so?
Scaling up. We spent a ton of time getting the process and systems, and a team in place. As I mentioned, we just did a capital raise, so deploying capital. We’re looking to buy brands, as I mentioned, between three and 15 million in revenue, consumable products, direct consumer brands. It’s execution now for the next couple of years for us, is to deploy that capital and get big. That’s what we’ll be focusing on.
Nice. Looking forward to seeing that. I’m getting into some closing questions here. What class in college would you teach if you could teach about anything you wanted?
I’m glad you sent these over in advance because I thought about them. If I could teach anything I wanted in college, I would teach a class called The Business of You and there would be some personal finance in here because I think it’s just not taught in our schools, at all. It would serve so many people so well, but it also strikes me that so many students, kids, people, adults, they go to their work and they work in a business with very regimented strategy and problem-solving, and long-term planning. Then they come home and just apply none of it to their life personally, at all. They don’t sit down and they go, “What are my income streams? If I actually make this much money for the next 50 years, will I have enough money to retire?”
Just a little bit of a basic Excel analysis. For example, at my house, we don’t do New Year’s resolutions. We do goals. We do a retrospective. My wife and I sit down and we have a business meeting about the past year. We’re like, “All right. What were our goals at the beginning of the year? What went well? What didn’t go well? Do we want to refresh some of these goals for next year? What are our five-year goals?” Businesses do this all the time and people do this almost never. A lot of people know how to do these things at their day job and they just come home and totally forget these principles in their day-to-day lives. I would like to teach a class called The Business of You, in college.
That’d be a great class. I’d be really, really interested in taking that if I could go back to school and you were there. What’s a belief you use to hold pretty strongly, that you’ve changed your mind on?
This one actually was this year. I’ll be a little bit real with you. I struggled this year with anxiety. With the pandemic, I had 60 plus people working for me, all kinds of stuff going on. I had my first child. For the first time in my life, I view myself as a solid rock, but I struggled with anxiety. I was able to get some help and work through that, but I used to think that if people were having mental health struggles like that, that it was just something you gutted through and you’re just needed to be strong, but now I really see it as a problem you can address like any other. It’s something that happens to a ton of people. You don’t need to be victimized by it, but you need to acknowledge it. If somebody is going through something, instead of saying, “Oh, you just need to work harder,” say, “Okay. Well, let’s get you some help. Let’s address the problem.” I see it much more pragmatically than willpower, through a willpower lens now.
I like it. What’s the best business you’ve ever seen?
I thought a lot about this one also. I think it depends a lot on the definition of the word best, which I believe is intentional, the question. I’ll answer it through my e-commerce lens and say, “What is the best e-commerce business I’ve ever seen?” This is actually the one that got away from me. I had an opportunity to buy this business and I didn’t recognize it for what a good business it was at the time. I bought other businesses that have done great, so no regrets, but this one was fascinating. It was an e-commerce company. They had a long-term contract with McDonald’s to sell uniforms, French fryers, signs.
If you’re a franchisee of McDonald’s, anything you might need, they were a distributor for all that stuff. They operated a private e-commerce site only for McDonald’s franchisees, under a long-term contract with McDonald’s and their only customers were the franchisees. They didn’t have to do any marketing. They had a total monopoly. The McDonald’s corporate just said, “Franchisees, you buy it from here” and they bought it. They were printing money. It was for sale for three or four times EBITDA. I should have bought it. It’s a fascinating business.
What about it scared you at the time?
Single customer, that it was just McDonald’s and that I also didn’t know how to scale it because your addressable market is as big as it is. It’s just McDonald’s franchisees. It looked much more like an annuity, but wasn’t priced like one, which I should have been excited about, more excited about at the time. Also, it was off thesis for us at the time and I needed to stay on thesis to make a track record.
With your track record today, do you think you would buy it if it showed up on your desk tomorrow?
No, because we need to maintain this plan for our investors. That’s not what Elements Brands does. I would definitely flip it to a friend who was looking to buy a business, maybe back-end or provide some capital or something. It wouldn’t make sense as part of Elements Brands.
That’s fantastic. What a fascinating business. I guess that is hard to grow.
It prints money. I believe McDonald’s corporate also dropshipped all this stuff, so they had no inventory either.
Oh, wow.
It was capital light. You don’t find any e-commerce business dropshipping margins that have been destroyed over the past five, 10 years, in e-commerce. You don’t see an asset inventory like an e-com business that actually has good margins, but they have a captive customer base and a long-term cost.
That’s incredible. Well, thanks, Bill, for coming on the show. I really enjoyed having you here. I’ll let you go here, but I really enjoy getting to hear a little bit about what you’re working on.
Sure thing. This was a lot of fun. Thanks for having me.
110 views
3 comments
Sign in to see all replies.
Create an account.