The Very Failed Blog

AKA

My Ecommerce Book of Job

Online business, baby! It’s the future. Everything is online, and everyone wants to make that internet money. Tired of your office job? Why not start drop shipping? Those Instagram kids did it in like 3 weeks. From zero to hero with no capital, no skills, and no knowledge. Fuck, that describes me to a tee! I too have nothing to offer, and yet would like to make money. And what would be better than sitting back hearing the gratifying cha-ching of Shopify whilst the rubes slave away for their bread?

Ok, I’m done with the satire. I couldn’t resist. There’s so much grift in this space it’s insane. Of course, ecommerce is totally legitimate if you do it right. But you don’t need a course. You need to avoid doing all the things I did. If you can manage that, you’ll be in good shape.

This is the tale of how my partner and I go into direct-to-consumer e-commerce (DTC). It’s a less catastrophic tale than the Amazon saga. But it contains many costly lessons which you can use in your own journey toward internet riches..

Origin

In my article on how to lose $1.6M in ecommerce, I gave the broad strokes of a couple of DTC brands we bought in 2023. This article will dive into more detail on each brand and what went wrong.

As you may recall, my partner and I were part-time Amazon bros up until last year. We had zero DTC experience. But we did have a lust for acquisition. After gobbling up the two Amazon brands, we were still greedy for more companies. The indigestion hadn’t yet set in.

The First Deal

In December 2022, a broker reached out with a deal. This broker knew that we were looking to buy cash flow, and needed a strong ROI. We had worked with him on another deal that didn’t happen, but he liked our style. He said another broker at his agency had just listed a deal that might interest us. It was young and wasn’t likely to get the attention of big money, so we could likely work out favorable terms. There was only one catch. This was a Shopify store, not Amazon.

We were hesitant at first. We knew nothing about Shopify. To low-level Amazon bros, DTC customer acquisition was alchemy. But the numbers were strong. So we figured we’d at least have a call.

On the call, we started to warm to the idea. We jived with the seller. He was willing to do an earnout and stay on to help with the marketing for a year. This alleviated our fears about our lack of customer acquisition knowledge.

The Numbers

The numbers were exciting. It was only 8 months old, but it was doing strong profits, and they were growing. At the time, the store was doing about $60k/mo in net. Nothing to sneeze at! Definitely more than we were used to. Gross margins were decent at around 30%. (I learned later that what I called gross margin is actually contribution margin.) Net margins were also good, at around 20-25%.

The product was a generic piece of tech. Nothing proprietary. The angle was that he brought it to a new audience of non-techy people. He made them aware of it, and offered explanation and support. So it was an education/ service company more than a product company. (I’m still running this company and don’t want to invite competition from you fine hustlers, so I won’t say more.)

We were so excited by the numbers that we didn’t dig too deep into the mechanics of the value. We didn’t realize the true value mechanics of the company until a couple months after closing.

The Deal

We offered the seller a deal structure calculated to be win-win. I explain in my article on SDE multiples how it’s critical to protect your downside, while providing upside for both parties. In this case, we achieved that by offering a modest multiple on earnings (about 1.5X) upfront. $730k. We offered an additional $150k as an earnout. This would pay out to the seller if the company continued to grow with his marketing. He would get everything above the current profit baseline until he had the $150k. We also gave him a royalty on our portion of the deal. He would get 10% of our distributions, and 10% of proceeds if we ever sold. (“Our portion” means mine and my partner’s, as distinct from the investors). This tied him into the long-term success of the brand. And it worked. So far, despite ups and downs, he’s been one of our biggest assets on this journey.

We raised the equity from investors. I put up $45k of my own money, which was all I had liquid at the time. The rest came from business colleagues from prior ventures. The deal I struck with them was that our company would own 51% of the LLC, so we had control. We would distribute 80% of the cash profit to them until they recouped their original investment. At which point the distributions would be according to equity. My partner and I would run everything. With the sellers’ help of course. We estimated their payback period to be 15 months. We all thought this was pretty damn good.

Early Success

The first couple months were a dream come true. The brand continued its upward trajectory. It smashed sales records and posted monthly profits over $100,000. March was huge. We thought this was the natural way of things. The brand was growing, and there was nowhere to go but up! We set our expectations around this.

We told our investors we projected we’d pay off the earnout in May. So we projected we’d return their full investment by the end of the year. Wow! Then we’d be awash in cash. Our biggest worry would be tax planning. My partner quit his job in anticipation of us being able to pay ourselves.

But DTC is capricious and volatile. Amazon is a river that pulls you slowly and steadily toward insolvency. But DTC is the open ocean. Winds whip up that accelerate you toward golden shores. Then, just as quickly, they can turn into a maelstrom that will send you to Davy Jones’ Locker. Facebook giveth and Facebook taketh away. Despise not the cries of your people, and turn thy wrath away from us, O Zuck!

But we didn’t understand any of this. We were in fact riding a wave of strong performance from new creatives from November. This, coupled with the tailwind of low Q1 CPMs, yielded amazing results.

Trouble

This couldn’t last. CPMs rose in Q2, and the ads aslo started to fatigue.

We were still oblivious to how Facebook ads worked, so this was lost on us. The seller was iterating on those ads to try to find new winning creative. But the process wasn’t yielding much. And we weren’t going after any new angles. Once your audience sees the same ad enough, it starts to decline in performance. We were trying lookalike audiences, but nothing was working.

In April the store did about two thirds of what it did in March. With less margin. Ads  performance had gotten worse.

We also made a grave error in March by putting the product on Amazon. This seemed like a no-brainer, since there was a ton of organic search volume for our brand there. However, when we launched Amazon, it killed our share of Google search results. Amazon had been running ads on our branded keywords for months, but had no listings that were an exact match. So a customer looking for us specifically wouldn’t find anything there.

Once we launched on Amazon, they bid more on our keywords, and ranked higher organically. Customers saw our Amazon listing pop up with an exact match and navigated there. Once on Amazon, they shopped. Competitors were able to sell similar products for less, because they were riding the wave of customer awareness we had paid for. So their CAC was much lower.

We compounded the problem by having a lower Amazon price than on Shopify. We did this because the prices for similar Amazon products were lower due to lower CAC. But it meant all the sales we did capture were less profitable. It also cannibalized sales which would otherwise have gone through our website.

At the time, we attributed the drop off in sales to the Amazon issue. In retrospect this was less of a factor than the Facebook ads performance. That was where we did 80% of our volume.

We killed our Amazon listing, and thought that would bring back the Q1 numbers. (This reminds me of a story about how Pacific islanders built runways after WWII, hoping the planes would come back. Correlation and causation are tricky things to decouple!)

This is an educated guess on the mechanics of what happened with Amazon. After consulting with several people familiar with Amazon and Google, we’re still uncertain. Someone with better insight into the alchemy of the algorithm may have a different opinion. All I know for sure is that we ate it. Hard.

Service Issues

In Q2, we realized we had a big problem. The product required a robust service component, and our service sucked. There was no phone support, and the VAs doing email support were using canned scripts. They were sending more detailed technical questions back to the supplier. They relayed those answers back to the customer. The VAs and the supplier were talking in English, which is their second language. So you can imagine the quality of what came back to the end user.

My partner spent 3 months doing tech support calls to get to the bottom of it. At the end of that time, we had a deep grasp on our customer base and their problems. We better understood who was buying the product and what issues they were having. We hired a native English speaking tech support agent. This way we could provide live phone and video support. Support is now an asset to the brand rather than a liability.

I would recommend anyone getting started as an operator to do some tech support themselves. Especially at the beginning. There’s no better way to get to know the customer. I respond to reviews in person as well.

We had another revelation during this process. Many of the seller’s ads were misleading. They overstated what the product could do. This caused a lot of customer service issues and returns, and damaged the brand. We rectified this by cleaning up the ads. But that change also disrupted ad performance.

We Got Hacked

We started to see some improvement in early May, as Amazon’s Google share started to recede to its prior level. But the big earner, Facebook, was still dragging. And in late May, hackers got into our Facebook business manager. They kicked us out and ran ads for almost 3 weeks. They racked up an impressive $136k of spend. I still don’t know what they were advertising. Once we blocked the payment method they deleted their ads and bounced.

We were able to get back in when the hackers tried to reverify the profile they’d hacked. It turned out it was one of our VA’s profiles.

We were fortunate to have Amex, so we got the money back. But we had no Facebook during that whole 3 weeks. So that hurt May’s numbers and crushed June.

We learned all the wrong lessons from this experience. Because the seller was running the ad account, we blamed him. He must have been careless. (He was, in that he gave VAs access. And they lived in a place crawling with hackers. Although we verified they weren’t involved themselves.) We also weren’t happy about the misleading ads. But what we did next wasn’t the logical solution.

The Agency Grift

We were ripe targets for an agency. If you know anything about ecommerce, you know that for every 7-figure brand, there are 10 media buying agencies telling them how they’ll make everything better. Better ROAS! More scale! We were no different. One such agency had been courting us to take over our Google account. The guy the seller hired was mediocre, so we were open to it.

They pitched us on taking over the whole account. Their contention was that all the channels should work in tandem. If we had one agency managing everything, we’d get much better efficiency. We also thought our account would be more secure. Although in retrospect, there was no reason to think this. We decided to pull the trigger. They wanted a 3 month contract with 10% of ad spend. There was no stipulation for profitability or other performance metrics. They also provided no creative direction or production. So we hired a separate agency for that.

They got the account a few days after we had gotten back into Facebook. The ads were already performing as well as before teh hack. So they just scaled them. Except they scaled way back on creative testing. And didn’t do much retargeting. And we didn’t love their communication style. They were very laid back about everything. They liked to take their time responding and taking action. Our post mortem a couple months later showed that they had run the account in the laziest way possible. I imagine they passed it off to a newbie once we sign up.

The results will not surprise you. The revenue came back, by virtue of the ads being back on. But efficiency tanked. Of course, the agency took credit for bringing the revenue back up. As if switching the campaigns back on was some kind of magic. So at the end of the month we saw minuscule profit. And we ended up paying half of the profit in agency fees. It was infuriating.

The agency of course, claimed they were doing great. “It’s seasonality you see!” And it was really our fault, because of our low returning customer rate. Never mind that this had nothing to do with ads performance. And the same time the prior year the ads had performed much better. And the product didn’t make much sense for returning customers, as it was a one time fix. Their suggestion was to launch new products. They weren’t wrong, but it was a bald-faced deflection from the issue of their performance.

August was even worse. About half way through I realized that we were on track to have a cataclysmic month and pay huge fees to boot. We canned them. But we didn’t take ads back in house. We gave the account to the agency that had been doing the creative. They had been trying to get all our business for a while. They were a lot more proactive and responsive and had a stronger work ethic. They agreed to a comp structure that was more aligned. We based their compensation on contribution margin.

They did a better job. But, after two months, they hadn’t paid for themselves. Some of it was seasonality. We were in the doldrums of Q3. But their creatives hadn’t moved the needle, and that was the main thing we needed.

(A little aside here. The original agency actually did a great job at Google. That seemed to be their core competency. Had they stuck to that and doubled down on it they would have been fine. There’s a lesson in that. Focus on your core competency. A company that does everything does nothing well.)

Becoming Ecomm Bros

In October we had to take over the ad accounts for our other DTC brand. We’ll talk about that company shortly. This experience opened our eyes. We realized that what the agencies were doing was not a black box. It was… pretty basic. So at the end of October, we decided to take all the ad management in house.

One of our greatest assets is my partner’s brain. He has the ability to turn complex operational information into clear action steps. Starting from zero ads knowledge, he was able to improve on our ads performance in a couple of weeks.

We also started making ad creatives in house. I liked this more than I expected to. Generally I thrive on sales, deal making, high level analysis and things of that nature. Anything that involves talking. I don’t like operational stuff. (You can see now why I’ve been so successful!)

But making ad creative proved to be an engaging and interesting task.

Summary of DTC Deal #1

As of this writing, we’re doing better. The tailwind of Q4 is a large part of it. But we’re still underperforming the numbers the store was doing when we bought it. I had runout of savings and assets to liquidate. We had to restructure payback to investors so that we could make enough to eat. Originally, the deal was doing well enough and I had enough other income and cash that this wasn’t even a thought. Oh how times have changed! So our projected payback time frame went from 15 months from closing to 30 months. Not terrible, but a totally different deal than what we all expected.

If I had to do it again… I’d still do this deal. But I’d jump into the operational side right away and understand all the ins and outs. I should have ingested every DTC podcast, forum and thread I could in the 45 day due diligence period. Made sure I understood how DTC works. Had I done so, we would have gotten the jump on most of the issues we faced and they would have been less severe.

When getting into a new field, some people like to dip their toe in the water. Some like to do a cannonball. When getting into DTC, I shove to get into a head on collision with reality at 95 mph. No knowledge, No problem! Buy that puppy.

Death of The Holdco Model

We got into the acquisition game thinking we were a holding company. A kind of micro PE fund. That didn’t make sense. The kind of businesses we were looking at were too small and too young. If you’re doing a holdco, you need to recruit an executive for each of your portfolio companies. They run the ops so you can focus on the bigger picture. Such a person is a 6-figure hire, plus profit share/bonus. So you need to be buying companies that are big enough to sustain that and still yield a good return. They should be established brands and not wildly volatile. Or, if you’re doing a turnaround or taking over a young brand, go in with that understanding. Don’t bank on taking profits early.

We bought companies that were small and young. They were subject to catastrophe with the slightest change in the market. This means we must be involved in every aspect of the business. We need to have our finger on the pulse of every function that drives revenue and profit, to protect our investors’ money and our livelihoods.

In short, we thought we were a micro PE firm, but we’re really a search fund. We’ve had to make a mental shift from being “investors” to being operators. Day in and day out. In the weeds. In the ad accounts, making creatives, doing CRO, you name it. Because you can’t hire for that stuff until you understand it. And until you’re making enough money to afford it!

Epilogue: The Cherry on Top

You’d think that by August of 2023 we would have learned a thing or two. Wisened up a little. But you’d be wrong!

In late August we came across an “opportunity” to buy another Shopify store. This time from a distressed seller. They needed money fast, to pay a tax lien. The company made a men’s hair product. They had started the company in May and scaled it fast. In August it did $340k in revenue with over $100k in profit. It’s a short track record, but hey! We were optimists, and this was the perfect nail to our hammer.

We offered them $250k upfront, which would cover their lien with a little left over. They had expressed interest in staying on and doing an earnout so they could continue to profit. And we didn’t think we had the bandwidth to run ads. So we structured a deal where they would stay on to run the ads for a portion of the profits. Investors would get paid back first, then we would start the profit split. We would close in 2 weeks.

What a great deal! They get what they need. They keep some upside (and a very generous profit split of growth). Investors would get paid back fast and then enjoy strong cash flow. Once we paid investors off, my partner and I would have the cash flow we desperately needed. It would bail out our fragile position. Sounds perfect, right?

Nope. I hadn’t learned my lesson. The sellers were classic drop shipping bros. They’re the kind of guys you see on Instagram and YouTube shorts. They’re vapid fools who think not just short term, but immediate term. They racked up huge living expenses during their successful run with another brand. They had agreed to run the ad accounts, and we had agreed that investors would get paid before we took any profits. But they never meant it. Upon closing they got full time jobs to support their idiotic lifestyle choices. And didn’t tell us. (Had they told us the situation, we probably could have figured something out.)

That was one problem. A bigger problem was the product itself. In due diligence, we rigorously audited the financials. I verified every bank and credit card statement, pulled Shopify reports, etc. We audited their customer service emails. Most of them were about shipping times, which we knew we could fix.

But because of the shipping time, we didn’t have a chance to get our hands on a product sample before we needed to close. We figured that because their chargeback rate was low, and most of the customer issues related to shipping, the product must be ok. We didn’t want to blow the deal waiting on the product to ship. In short, we felt like we needed this deal, so we overlooked the most critical factor.

Shocker, the product was in fact sub-par. That, combined with the shipping, had tanked the Facebook page’s feedback score. The sellers were migrating to a new page, but since they stopped running the account, it didn’t do anything. They also got their Tik Tok page restricted for duplicating too many ad sets.

After closing, sales plummeted. They didn’t have the courtesy to let us know when we needed to top up the ad accounts. So two weeks in, we confronted them, and they gave us their sob story about their living expenses. (They had a penthouse apartment in Europe and a bunch of cars). There was no profit coming in at this point, so there was nothing we could do about it. We had to jump in and start fixing all the problems.

The page health was the symptom, but the cause was a subpar product and bad logistics. We had the factory start working on new iterations of the product to improve it. We were already working on getting a bulk shipment to our US 3PL to improve delivery time. But we realized this would become uneconomical with the tariff. So we pivoted back to drop shipping. We found a much better provider who could give quick turnarounds and US packaging. Their delivery promise was in line with the domestic 3PL, and the all-in cost was comparable.

We now have a better product, better ads and better fulfillment. We rebuilt the entire funnel and customer experience. Meaning we rebuilt the company from the ground up. It’s starting to turn around. It’s still a massive let down from expectations. But it’s making some profit, and we think it has a lot of long-term potential.

So what went wrong with this deal? We made the old mistake of looking at financials over product. We let FOMO and desperation get the better of us. This deal was the answer to our prayers! It had to work! That’s a red flag. Reality doesn’t care about your imperatives. When something has to work, or “we can’t afford not to” enters the conversation, beware! You’re about to make a catastrophic decision. Force yourself to look reality in the face. Look at all the risks and worst case scenarios. Can you mitigate them, or live with them? If not, walk away.

Summary and Learnings

If I had to do it again, I wouldn’t do this deal. I’d compete with them. They were offering zero value, so there was nothing to buy. We could have created a better version in a month, which is what we did anyway.

This is the problem with 99% of small ecommerce brands. What are you buying? A product? It’s generic, and it probably sucks. A system? Yeah right. A supplier relationship? There are dozens of them and they’re already selling to your competitors. A seasoned ad account and audience? That might be worth something, but nothing close to what people want for their company.

If I could redo the whole DTC experience, I would spend a lot of time looking at companies that work. Then bootstrap a store using the same principles. We would have learned all the same lessons in less time and with less money. We then would have been in a position to scale our own brand, or to buy a company. We would have known what to look for, and what to expect. We would have had a lot of the same challenges, but we would have been ready for them.

So if you’re interested in buying an online business, that’s my advice. Get familiar with the industry. Join some forums. Subscribe to some DTC podcasts that go deep on tactics. Spend 4-6 months bootstrapping your own store. Spend the money and the time and learn the lessons. It will cost you 1/20th of what it would to buy a store. Then if you want to, you’ll be in a position to buy one. You’ll have the confidence that comes only from competence.

What else do we learn from this series of internet debacles? I’ve distilled a few lessons. Some of these are specific to acquisitions, but some apply to ecommerce as a whole:

• Focus on product/ value. What drives value? What are your customers buying? If you can’t make sense of it, that’s a bad sign.
• Own what drives value. All the value driving parts of the business must be in-house. You should only hire out important roles once you understand them on a deep level. That way you can vet potential contractors or employees.
• For 99% of ecomm brands, your primary value is the marketing. Even if you have a great product, it’s probably not very unique or defensible. And even if it is, you still need marketing. You should understand customer acquisition inside and out. How you get customers is the lifeblood of your business. Don’t outsource that. Especially as a young brand.
• Don’t just buy the financials. If there’s not a product/value and competitive moat that supports them, financials are meaningless. They can and do evaporate overnight. 
• After product, ad creative is everything. The creative must speak to the need your customer has in a clear and actionable way. No amount of media buying strategy can fix poor creative, or make up for creative fatigue. 
• You need to audit all the individual ads when buying a company. Make sure that they make sense and are correctly representing the product. 
• Audit the page health and feedback of every social media account
• Audit the customer experience by talking directly to customers.
• Do a lot of customer support calls yourself. It sucks, but nothing will give you a  better understanding of what your customers want.
• DTC is volatile. Paid ads can be unstable and there’s seasonality, even with non-seasonal products. If your business relies on paid media you need to bank on volatility. 
• FOMO is a sign you’re about to get burned. This comes up every time. DO NOT act out of FOMO or desperation. We were too motivated to do the second DTC deal because it seemed like the answer to our problems. When something “has to work” that’s a sign you need to step back and re-evaluate. 
• You don’t learn the right lessons from your mistakes automatically. You need to analyze those mistakes in depth and drill down to the underlying cause. You then have to set up a   system for analyzing new decision in the light of those learnings 

Those last two points are the most important. Making decisions under from fear and scarcity caused most of my mistakes. Failure to learn the right lessons allowed me to repeat them.

Don’t be like me. Don’t be a fool. Learn from your mistakes. Create a system that ensures that you learn the right lessons and apply them in the future.

This article has turned out to be quite the tome. But I hope you found it useful.

Good luck out there. Stay safe, and stay solvent!