August 11, 2019
We’re old enough to remember when subscription boxes were all the rage. The e-commerce trend became so explosive that the Washington Post estimated in 2014 that there were anywhere between 400 and 600 different subscription box services out there. We reckon that — given the the arguably-successful-because-it-got-to-an-IPO-but-then-atrocious-public-foray by Blue Apron Inc. ($APRN) — the number today is on the lower end of the range (if not even lower) as many businesses failed to prove out the business model and manage shipping expense.
And so it was only a matter of time before one of them declared bankruptcy.
Earlier this morning, Loot Crate Inc., a Los Angeles-based subscription service which provides monthly boxes of geek- and gaming-related merchandise (“Comic-con in a box,” including toys, clothing, books and comics tied to big pop culture and geek franchises) filed for bankruptcy in the District of Delaware.* According to a press release, the company intends to use the chapter 11 process to effectuate a 363 sale of substantially all of its assets to a newly-formed buyer, Loot Crate Acquisition LLC. The company secured a $10mm DIP credit facility to fund the cases from Money Chest LLC, an investor in the business. The company started in 2012.
Speaking of investors in the business, this one got a $18.5mm round of venture financing from the likes of Upfront Ventures, Sterling.VC (the venture arm of Sterling Equities, the owner of the New York Mets), and Downey Ventures, the venture arm of none other than Iron Man himself, Robert Downey Jr. At one point, this investment appeared to be a smashing success: the company reportedly had over 600k subscribers and more than $100mm in annualized revenue. It delivered to 35 countries. Inc Magazine ranked it #1 on its “Fastest Growing Private Companies” list. Deloitte had it listed first in its 2016 Technology Fast 500 Winners list. Loot Crate must have had one kicka$$ PR person!
But life comes at you fast.
By 2018, the wheels were already coming off. Mark Suster, a well-known and prolific VC from Upfront Ventures, stepped off the board along with two other directors. The company hired Dendera Advisory LLC, a boutique merchant bank, for a capital raise.** As we pointed out in early ‘18, apparently nobody was willing to put a new equity check into this thing, despite all of the accolades. Of course, allegations of sexual harassment don’t exactly help. Ultimately, the company had no choice but to go the debt route: in August 2018, it secured $23mm in new financing from Atalaya Capital Management LP. Per the company announcement:
This financing, led by Atalaya Capital Management LP ("Atalaya") and supported by several new investors (including longstanding commercial partners, NECA and Bioworld Merchandising), will enable Loot Crate to bolster its existing subscription lines and improve the overall customer experience, while also enabling new product launches, growth in new product lines and the establishment of new distribution channels.
Shortly thereafter, it began selling its boxes on Amazon Inc. ($AMZN). When a DTC e-commerce business suddenly starts relying on Amazon for distribution and relinquishes control of the customer relationship, one has to start to wonder. 🤔
And, so, now it is basically being sold for parts. Per the company announcement:
"During the sale process we will have the financial resources to purchase the goods and services necessary to fulfill our Looters' needs and continue the high-quality service and support they have come to expect from the Loot Crate team," Mr. Davis said.
That’s a pretty curious statement considering the Better Business Bureau opened an investigation into the company back in late 2018. Per the BBB website:
According to BBB files, consumers allege not receiving the purchases they paid for. Furthermore consumers allege not being able to get a response with the details of their orders or refunds. On September 4, 2018 the BBB contacted the company in regards to our concerns about the amount and pattern of complaints we have received. On October 30, 2018 the company responded stating "Loot Crate implemented a Shipping Status page to resolve any issues with delays here: http://loot.cr/shippingstatus[.]
In fact, go on Twitter and you’ll see a lot of recent complaints:
High quality service, huh? Riiiiiiight. These angry customers are likely to learn the definition of “unsecured creditor.”
Good luck getting those refunds, folks. The purchase price obviously won’t clear the $23mm in debt which means that general unsecured creditors (i.e., customers, among other groups) and equity investors will be wiped out.***
Sadly, this is another tale about a once-high-flying startup that apparently got too close to the sun. And, unfortunately, a number of people will lose their jobs as a result.
Market froth has helped a number of these companies survive. When things do eventually turn, we will, unfortunately, see a lot more companies that once featured prominently in rankings and magazine covers fall by the wayside.
*We previously wrote about Loot Crate here, back in February 2018.
**Dendera, while not a well-known firm in restructuring circles, has been making its presence known in recent chapter 11 filings; it apparently had a role in Eastern Mountain Sports and Energy XXI.
***The full details of the bankruptcy filing aren’t out yet but this seems like a pretty obvious result.
⚡️UPDATE: August 18, 2019⚡️
On August 12, we published — and you should revisit — 📦Nerds Lament: Subscription Box Company Goes BK📦, a report on the bankruptcy filing of a company called Loot Crate Inc., an e-commerce subscription service that ships all kinds of nerdy sh*t to dorks who like comics and stuff (PETITION Note: for the record, we’re not making fun of nerds…we’re nerds…we’re just not nerds who subscribe to nerdy e-commerce subscription boxes and collect nerdy lunch boxes, nerdy bobbleheads, nerdy trinkets and super-nerdy action figures…there are levels here, people). While this company is generally a pimple on the U.S. economy’s very large a$$, we think it’s important for our readers — bankruptcy pros, investors, operators, startup/tech enthusiasts — to understand some of the reasons behind its demise: the small to middle market, after all, tends to get short shrift in a sea of bankrupted retailers with a formidable brick-and-mortar footprint or bankrupted oil and gas companies that have shredded public equity and debt value to the chagrin of many an investor. And as if that isn’t justification enough, how can we NOTrevisit this company when there’s THIS summary in its bankruptcy papers:
In short, despite liquidity constraints unlike those I and the Debtors’ other professionals have ever seen, the Debtors have created a path to get through Chapter 11, albeit quickly, to maintain their going concern, reduce the backlog of shipments (and Vantiv’s potential exposure), allow for renewed dealings with valued vendors and licensors, and achieve a result that is the best we could foresee over the last few distressing weeks and months. (emphasis most definitely added).
HAVE. EVER. SEEN. HAHAHAHAHA. Restructuring professionals see a LOT. This is really saying something.
Anyway, to set the mood, let’s start with this choice quote from the company’s filing:
This is a company that has succeeded from ground zero – it is not an “old economy” business, shrinking every year, trying to determine how to remain relevant. Instead, it is the view of the Debtors’ management that once better capitalized and freed from legacy liabilities through the proposed sale of assets in these cases, the Debtors will return to success.
Some might take exception to the use of the word “succeed” here given the company’s current predicament. Just saying. Some might also be forgiven for viewing the conclusions of “Debtors’ management” with a glint of skepticism. Why? Keep reading: we’re about to explain the myriad reasons why this company failed.
First, and this is something that PETITION has focused on considerably over the last several months as digital advertising supply reportedly decreases, prices increase, and more and more DTC brands are seeking targeted eyeballs to sell product. Choice bit here:
By late 2017, the Debtors were having financial issues. The subscription and entertainment market has a healthy and sometimes insatiable appetite for marketing dollars. While the Debtors were very popular with their fan base, the need to continue to spend on marketing was hampering the Debtors’ finances. (emphasis added).
We cannot over-emphasize how critical this is. As more and more B&M retailers underscore their need to leverage social media, influencers, etc., they’ll find it’s not so easy in today’s hyper-competitive DTC environment to generate revenue while avoiding astronomical customer acquisition costs. The upcoming presidential election, meanwhile, might put increased pressure on retailer budgets as Facebook Inc. ($FB), Google Inc. ($GOOGL), and others attempt to limit the number of ads in users’ feeds in the name of “user experience.” Meanwhile, we’ll continue to see both of these behemoths on lists of top 30 creditors: Facebook, for instance, is listed here. Google is one of Avenue Stores LLC’s largest creditors.
All of which is to say that it appears that Loot Crate’s CACs were through the effing roof.
Second, PROGRESSIVES!!! And MAGA!!! The company initially had a distribution system based out of California, “a very high wage stage.” Now the company fulfills “most of their shipments with a third party warehouse and shipper, operating out of Tijuana, Mexico.” We wonder if the facility is wired up with Maxcom tech!?!?
Third, the company blames the Supreme Court’s Wayfair decision (which, for the record, we had highlighted long before the mainstream media) for some of its liquidity problems; it alleges that the decision “require[d] them to accrue sales tax charges for goods sold in the past.” More on taxes below: as a preview, there was seemingly some shady-a$$ sh*t going on here.
Fourth, this company got to experience first hand the dangers of venture debt. Because of the issues noted above, the company ran afoul of its $15mm credit facility with Breakwater Credit Opportunities Fund, an LA-based private investment firm that specializes in direct debt and equity investments in lower middle market companies. The company defaulted on the loan in 2017. This, naturally, gave Breakwater leverage to extract economic concessions from the company and juice their governance rights.
Needing to refinance out Breakwater to avoid Breakwater taking over the board (and presumably tossing the founding management team out the window), the company refinanced the Breakwater loan with a $21mm term loan from Midtown Madison Management LLC, an affiliate of Atalaya Capital Management (MMM also received a now-worthless warrant for 17% of the company’s common stock). Breakwater got out whole, with accrued and unpaid interest, default interest, fees, and repayment of OID provided at the time of default. Savage play by Breakwater. As a condition to the refinancing, the company issued $4.4mm in convertible subordinated notes and warrants to a number of holders, including the proposed DIP lender, the founder’s daddy, and Dendera Advisory LLC (which took notes and warrants in lieu of payment for services rendered in connection with the refinancing). Apparently, only Money Chest LLC, the proposed DIP lender, perfected liens.
The refinancing, while beneficial to Breakwater, did not prove the salvation for the company that it had hoped for. Per the company:
While the August 2018 Financing provided the Debtors with a slight liquidity reprieve, the fees and expenses that had to be repaid to Breakwater made this amount far less than expected, resulting in continued difficulty with vendors after the transaction, resulting in turn in difficulty in filling crates due to missing custom items, causing subscriber chargebacks and cancellations, and then resulting in serious concerns by the Debtors’ credit card processor, and its withholding of funds from the Debtors. All of this caused greater liquidity issues with each passing week and month. In short, the cycle in this unfortunate paragraph never stopped, with each negative event causing other negative events, again and again, and liquidity problems continued into 2019 and until these filing of these Cases. (emphasis added).
Man, these guys give good Declaration. For any business, not just a startup, that paragraph is utterly painful to read.
Let’s break this down: management (1) took an unfavorable deal to refi-out their venture lender and protect their a$$es, (2) quickly realized that, after all was said and done, the company still had severely constrained liquidity, (3) stretched vendors, (4) irritated vendors, resulting in inventory issues, (5) couldn’t ship their product, (6) pissed off customers, (7) sparked credit card chargebacks presumably en masse, and (8) red-flagged their credit card processor to the point that it, too, wanted to run for the hills (more on this below).
Yeah, sure, these guys are totally dependable.
Fifth, the company is prisoner to two large creditors. One, Clear Finance Technology Corporation d/b/a Clearbanc, paid the company’s vendors for the company in exchange for a royalty on billings. Clearly this was meant to provide vendors with comfort given the company’s liquidity shortfall. There will be some litigation to determine whether this arrangement is a financing vs. an ownership agreement and, in turn, whether Clearbanc is, by virtue of Clearbanc’s alleged failure to file a UCC-1 perfecting its interest, an unsecured creditor. The other, Vantiv LLC, is the company’s credit card processor and the company’s patsy for why shipments haven’t timely shipped and customers are pissed off. Per the company:
Vantiv has a contingent claim to the extent the Debtors do not ship goods to their customers for which such customers have already paid via credit card. Such customers could then, depending on their credit card agreements and applicable law, reverse or dispute prior charges, which may then have to be returned to the customers’ credit card issuer (and in turn, the customer) by Vantiv. Due to serious liquidity issues over the past months – including Vantiv’s withholding substantial sums to protect itself against this risk – the Debtors’ have over $20 million in customer orders for which the Debtors have obtained payment, but for which the Debtors have not shipped goods….
Vantiv is holding approximately $1.7 million of collections it made for the Debtors and, as of the Petition Date, continues to reserve 100% of the Debtors’ customer billings thereby guaranteeing a continuation of the vicious cycle that has strangled liquidity.
Right. Credit card processors aren’t typically in the business of losing money and they, generally, understand risk. This is what happens when a business starts to spiral: counter-parties who are more than happy to service your account when you’re, say, a high-flying startup ranked at the top of growth lists and featured in Techcrunch, abandon you like you’ve just fallen into a putrid pile of horse manure. Indeed, Vantiv’s threats to terminate credit card processing precipitated the chapter 11 filing: the company simply couldn’t function as an online business without credit card payment processing.
Sixth, we may be reading into things too much but it sure seems like the company engaged in some accounting shenanigans to help with liquidity — switching revenue recognition methodologies while in the midst of its liquidity issues. It helped…maybe…until it didn’t and when it didn’t, the company got pounded in a big big way with a big big outstanding tax liability. In many respects, the bankruptcy filing saves the debtors in this regard: through a customary tax motion and with DIP proceeds, the debtors seek to pay the approximately $5.87mm in back taxes owed. Death and taxes, baby. Death and taxes. Or, more appropriate here, bankruptcy and taxes. But we digress.
Finally, this bit should be a cautionary tale for startups in the e-commerce subscription business:
Unfortunately, the complexity of the transaction, the uncertainty surrounding eCommerce subscription companies, the amount of the Debtors’ funded, trade, and tax debt, and the recent challenges of the Debtors’ operations due to liquidity shortfalls, made it difficult to entice investors. Breakwater was one of the parties interested, and it spent substantial time and incurred costs in mid-July 2019 doing diligence and working on preliminary deal documents. But its interest waned, and sale discussions ceased. (emphasis added)
Riiiiight. Why would that be? Because, like, nobody has figured out how to make these subscription businesses actually work?!? 🤔
It’s telling when the entity that knows you the best and has been through the ups and downs with you wants no part of you going forward. Godspeed, Loot Crate. May the loot be with you.
Jurisdiction: D. of Delaware (Judge Shannon)
Capital Structure: $15mm credit facility (Breakwater Credit Opportunities Fund LP)
Legal: Bryan Cave Leighton Paisner LLP (Brian Duedall, Leah Fiorenza McNeill, Andrew Schoulder, Khaled Tarazi) & Robinson & Cole LLP (Jamie Edmonson, Natalie Ramsey, Mark Fink)
Independent Directors: Alexandre Zyngier, Osman Khan
Financial Advisor/CRO: Portage Point Partners (Stuart Kaufman)
Investment Banker: FocalPoint Securities LLC
Chief Transformation Officer: Theseus Strategy Group (Mark Palmer)
Communications Consultant: Sitrick and Company
Claims Agent: Stretto (*click on the link above for free docket access)
Other Parties in Interest:
Prepetition Convertible Noteholder & DIP Lender: Money Chest LLC
Legal: Bayard PA (Erin Fay)