Nasty Gal filed for Chapter 11 bankruptcy protection last week, which allows the company to reorganize its finances but continue operating. The company, started by Sophia Amoruso as an eBay store selling vintage clothing in 2006, quickly grew over the past decade into a middle-market retailer that sold "limited-edition designs that cut through the noise" to west coast women and girls.
So how did Nasty Gal end up with a teetering brand and a precarious balance sheet? What follows is a breakdown of the numerous factors that led the company to this point. Unless cited otherwise, the data comes from the company's bankruptcy filing, one of the most informative documents about the Nasty Gal's actual health and performance.
Nasty Gal was, undeniably, a good story. Amoruso started an eBay store called Nasty Gal Vintage after reading the book "Starting an eBay Business for Dummies." She sold vintage wares at a markup, running the entire operation by herself. Early on, she used Myspace to build up the audience and grow the business. The venture grew and after getting kicked off of eBay after a spat with a fellow seller, she struck out on her own with a dedicated ecommerce website. NastyGal.com was born. From there, social media played a large role in the company's growth, as the brand used Facebook, Twitter and Instagram to reach more customers. Nasty Gal often cited its social followings as proof of its dominance, although there is no clear correlation in the industry.
Amoruso and the Nasty Gal brand were one in the same—a virtuous cycle. Even today, long after Amoruso stepped back to executive chairwoman, the Nasty Gal "about us" page reads more as a Wikipedia entry for Amoruso than anything specific about the brand. This lack of separation between church and state was both a blessing and a curse. If both the brand and the person remained focused, the intermingling would work. But if one separated from the other, the pact would begin to fall apart. (More on this later).
Growth and scale
Nasty Gal had about $215,000 in sales in 2008, two years after Amoruso started her eBay shop. In 2010, annual sales were $20 million. In 2011, annual sales were $24 million, an impressive growth rate of 11,200% that the company constantly touted publicly. 2012 revenue was just shy of $100 million. 2014 annual revenue was $85 million. And for 2015, revenue was down to $77 million, vastly smaller than the $300 million Forbes estimated it to be. 2016 revenue is expected to be flat. Nasty Gal's performance these last two years should be shocking, as its growth rate went from exponential to negative.
Nasty Gal spent heavily on customer acquisition. Although I don't have the numbers, I bet one could plot the money Nasty Gal spent on paid acquisition alongside it's growth rate and the two would at least be correlated, if not parallel. It's logical that this paid marketing came alive in 2012, right after the company raised a $9 million series A and a $40 million series B later that year. The company's growth rate reflects this exactly.
Paid acquisition is a lot like putting training wheels on a kid's bike, albeit expensive ones. The hope is that by investing upfront to "train" the customer, the company can slowly take off the training wheels and the customer will ride away into the sunset happily ever after. The commerce equivalent of riding into the sunset is a long lifetime value for an acquired customer, meaning the customer buys a lot from the brand over her lifetime. But the customer needs to be "sticky"—as in continually learning—for this to work. The problem, in Nasty Gal's case, is that when it took off the training wheels, the kid just fell on its face.
If customers aren't sticking around—often called a "leaky bucket"—paid growth only works as long as one is paying for it. Nasty Gal likely wound down the spending in 2013 and 2014 after burning through most of its venture money, and the nightmare scenario about paid acquisition came true: its customers weren't sticking.
Some attribute this harsh reality to the mediocre quality of the company's products. While this was likely true, Nasty Gal had a bigger problem, which is arguably the biggest reason to doubt the company: it lives in a trend-driven category. This meant it had to constantly keep up by designing, producing and selling new products almost daily. This is very hard to do profitably, and Nasty Gal couldn't figure it out as it scaled.
Even if Nasty Gal could have made it to, say, a few hundred million dollars in revenue, it was on a collision course with two giants: Zara and H&M, who practically owned this category and had mastered the operational acumen needed to thrive in it sustainably. More telling, Zara had over $22 billion in sales in 2015 and the company has never advertised. Instead, the company has plowed that money into becoming operationally unrivaled, realizing that selling fast fashion is a commodities game, where scale, speed, real estate and free cash flow matter most. Nasty Gal, which had a reportedly bad culture, was not seemingly good at any of these things.
From the bankruptcy filing:
Nasty Gal experienced difficulties, however, in managing its business to keep pace with this incredible growth, including adjusting its product mix and merchandise offerings for a booming customer base and developing internal systems to manage and control the business.
It was, and would remain, a mere rounding error to these behemoths. Even if the company could figure out a way to sustain the growth without spending excessively, and figure out a path towards coexistence in fast fashion, it would still need to be very well managed. Unfortunately, it wasn't.
One of its biggest blunders was running its own 500,000 square foot warehouse in Kentucky, a wildly expensive endeavor when there was no need to reinvent the wheel. People pay other people to do things for one reason: focus. If a company is really good at designing products, it should likely let someone else sell them, and vise versa. Companies, like people, can only be good at so many things.
A brand-driven ecommerce company trying to run its own warehouse is as much of a disaster as it sounds. There are plenty of third-party logistics providers Nasty Gal could have worked with, chief among them Amazon, who has probably the best logistics in the world. But Nasty Gal insisted on going it alone, which likely sucked up an immense amount of focus and capital, for something that provided no differentiation whatsoever. As Business of Fashion pointed out, companies much bigger than Nasty Gal successfully work with third-party providers.
This lack of focus took its toll. The last few years featured a range of departures from retail veterans at the company, which the bankruptcy filing frankly referred to as the departures of "highly valuable employees throughout critical areas of its business." That's never good.
The brand at scale
The Nasty Gal brand itself sought out young women in California, and it's questionable if Nasty Gal hit the ceiling on this market. There is simply a limit to how many girls want what Nasty Gal was selling, and my bet is that the company hit this peak in 2012. One of the most interesting parts of Zara is that the brand means nothing besides "now." It's just an entity to sell trendy product through. This malleability allows it to move with the trends and keep its customers along the way. Zara's brand is meant to operate at scale. Nasty Gal, by being so defined, might have limited its growth. Its brand meant something so specific that it constrained its relevancy.
In 2015, Lululemon-veteran Sheree Waterson replaced Amoruso as CEO, and put in place a strategy that would seek out higher priced brands and products that offered higher margins, possibly moving out of the fast fashion price point where Nasty Gal made its name. The move quickly backfired, as it alienated its loyal customer base and cut into sales, as Business of Fashion reported. The Nasty Gal brand might have never been scaleable.
Beyond this, there was a foundational problem with Nasty Gal's business: it was poorly architected. From the bankruptcy filing.
While these rounds of financing provided continued runway to the business, they did not provide a fundamental solution to the Debtor’s continued operating and liquidity challenges. The Debtor continued to lack sufficient liquidity to finance inventory, pay rent and pay certain other operating expenses.
Nasty Gal, as a business, was fundamentally flawed. It was unable to sustainably finance its growth. 87% of its revenues came from online sales, as its two Los Angeles stores did not do as well as anticipated. Half of the company's sales came from its top 20% of customers and the company had a 20% monthly return rate. Although this return rate is relatively in-line with other ecommerce companies, it hurts even more at scale.
In 2013, Nasty Gal launched its own private label clothing, adding another discipline the company needed to master. This only compounded Nasty Gal's struggle to finance the cash flow nightmare that's often the result of selling and making physical products.
This weekend I finished reading "Shoe Dog," the autobiography from Nike founder Phil Knight. It's probably the best illustration of the litany of liquidity issues for companies selling physical products. The basic problem is that a brand or retailer needs to buy products and pay for them before it can sell them, thus the idea of "the float." A bank lends a company money at shorter term interest rates and once the order lands or the product sells, the company pays the bank back. For the first 20 years, Nike was so highly leveraged that multiple banks refused to take its business because it kept next to nothing in its bank account, plowing all of the money back into the business. (Banks like to lend to companies with assets, not low balances.) That said, Phil Knight was trained as an accountant, and was able to maneuver the balance sheet better than most.
Nasty Gal, however, was less prudent with its cash flow and debt. It had $20 million in debt most recently, composed of a late 2015 loan for $15 million at a 13% interest rate, and the remaining $5 million as a convertible note granted that same year with a 3x liquidation preference, meaning it when converted it's worth $15 million. Although Nasty Gal is current on its big loan, the monthly interest likely ate into its cash flow.
The company also had a complex capital structure, with both common and preferred stock, the latter of which there were three classes A, B and C. This complexity likely held off potential suitors, including Urban Outfitters which contacted the company in 2013 about a potential acquisition. Nasty Gal's bankruptcy filing acknowledges this much, in addition to a bad report with its vendors:
Additionally, efforts at selling or merging the company have been hindered by a complex capital structure, the significant aging of Nasty Gal’s existing accounts payable, strained vendor relationships that have disrupted the normal flow of merchandise and the need to further right-size its staff and facilities.
Business of Fashion also reported that the company had tenuous relationships with its vendors, owing some of them hundreds of thousands of dollars. More recently, factoring firms stopped approving applications for Nasty Gal orders, a telling sign of a retailer's creditworthiness.
If everything outlined above was not enough, Amoruso published her book #GIRLBOSS in 2014, part memoir, part call to action. Less than a year later she stepped back as CEO, and slowly reduced her role at the company. She launched the GIRLBOSS Foundation, and, most recently, optioned the book into a Netflix series that she's an executive producer on. All of these pursuits are noble, especially empowering young women to be entrepreneurial. But the debut of #GIRLBOSS marked the beginning of Amoruso's focus shifting from Nasty Gal to her own personal brand, which would now be independent of Nasty Gal.
From Business of Fashion:
According to one executive, the publication of Amoruso’s memoir was the “nail in the coffin” for Nasty Gal, as it marked the founder’s own pivot away from the company she started. “She was savvy, and she saw the writing on the wall,” the person said.
It seems that Amoruso saw the flailing trajectory of the business and wanted a path out. That's understandable, but the timing makes it look like a captain abandoning her ship as it's sinking, or even before, knowing it is about to sink. Anyone is free to live how he or she pleases, but there's something unsettling about abandoning the thing you built (and built your own brand on) at a such a precarious time. It's unclear if Amoruso sold any of her stock when the company raised each round of fundraising, but the "savvy" comment from the executive in the Business of Fashion article makes it plausible. This is never a good sign, as entrepreneurs should always be incentivized to succeed—and fail—directly in line with their business. Changing these incentives does not end well.
Although Nasty Gal plans to continue operating, its future is highly uncertain. Even as it reorganizes its finances and business structure, it remains on an undifferentiated course to run into fast fashion's two biggest players. Even with 40% gross margins, it is unprofitable. It has a brand that means increasingly less to increasingly fewer people. And it's seen a revolving door of leaders and critical executives that have no interest in sticking around. Nasty Gal might have been a good business for Amoruso to run by herself or with a small team. But today, especially with Amoruso only tangentially involved, its unclear what Nasty Gal is worth to its creditors and its customers.