DTC can be hard. Founders pour their passion into building a brand that can last. For this post, I went back to reading the bankruptcy filing of Lunya from this summer. The filing is a few months old now, but the lessons can be applied to any DTC brand.
I plan to capture highlights from the filing, lessons that can be learned, and what I would do if I were CEO. My intention – as with all of my writing – is to learn, get clarity, and share them with you.
The facts:
- Lunya was founded in 2012, launched in 2014 and filed for chapter 11 case on June 16, 2023.
- Lunya was based out of LA and had three sales channels: DTC via Shopify, seven retail stores, and some wholesale. It controlled its leases but also worked with Leap.
- Lunya’s top-selling product was the Washable Silk Tee Set
- Lunya had 40 employees
- 2022 revenue was ~ $35M. Split between 83% DTC, 8% retail stores and 8% wholesale.
- Lunya did not have secured funded debt when they filed for Chapter 11
- Lunya had $6M of unsecured debt; mainly trade and credit card debt
- Lunya did have a 3PL in California that it owed $500K
What led to the bankruptcy filing:
- Lunya exclusively focused on DTC growth first 5 years. When COVID hit, growth expanded further. By 2021, Lunya was doing $50M in gross revenue.
- The growth was fueled by COVID-19 spike (demand increase in sleepwear and online shopping and strong customer acquisition tactics).
- Demand forecasts were bullish. Lunya ordered finished goods 9-12 months in advance of delivery against their latest forecast. The company ordered 60% more inventory than optimal 2021 levels.
- Company struggled to drive demand with iOS 14.5 changes, CAC increased significantly, and growth slowed dramatically.
- Working capital management became overwhelming. Books were not being closed monthly. Finance and Ops teams were not managing cash forecasts properly… there was a lack of financial discipline. The retail channel was losing $135K per month, on average, over the last 12 months.
What I would do as CEO:
Start with cost control. To do this, let’s build:
- Balance sheet ratios to understand our current liquidity, solvency, working capital efficiency and cash conversion cycle. Set targets for the team and align programming goals with stakeholders.
- 13-week cash flow forecast that can help serve as a precision tool
- Re-forecast forward-looking 12 months against cost control initiatives below
- Build a KPI dashboard where I can track my CEO metrics daily
Then, I would break down the larger problem into single components.
Cost control:
- Get a grip on gross margin, contribution margin, operating margin and net margin. Set monthly and quarterly targets for each.
- Since 83% of gross revenue is tied to DTC, focus all of the energy on reducing fixed costs and managing variable costs. For DTC brands, COGS and marketing should be the largest expense. Other OPEX categories should never exceed those two cost centers.
- First-order profitability on DTC: take a scalpel tool approach to demand generation. Every order has to drive profitability. Yes, this means pulling back on variable spend dramatically and lean into other tactics. Here’s what every DTC brand needs to know: Marketing drives revenue → Revenue helps influence inventory buying decisions → Inventory helps account for working capital management → Which helps brands manage their balance sheet.
- Get rid of any expense that isn’t driving top line or improving bottom line. I mean literally. Go down to the user-level on all software. If you have 19 employees, you shouldn’t be paying for a software product at 20 seats. That $15/month account is worth $180/year.
- RIF: least favorite part of the job. There’s no reason a $50M DTC company should have 40+ employees unless you’re doing your own manufacturing. Systemize and automate. Hire quality vendors to help you on a project basis if needed.
Working capital:
Chapter 11 filing shows that Lunya once had 66 weeks of supply in its inventory account. The goal should be to have 13-16 weeks of supply on hand. As such, design a liquidation strategy. This dilutes the brand, but it opens up cash from operations. Additionally:
- Negotiate AP with critical vendors and suppliers. This will help increase your cash conversion cycle.
- Dial in product strategy. Product assortment is a big problem in DTC. Retail expects variety, but DTC product strategy has to remain focused. As such, push the hero product to all first-time customers. Allow yourself to become a lifestyle brand after the initial transaction is complete.
Restructure and re-grow:
Take 1 step back to take 2 steps forward. DTC is a terrific channel when you’re first building the brand. You get to own your customer, control messaging and visuals, expand margin, toggle ads on/off as you see fit and more.
The natural evolution of DTC is that it eventually leads to marginal diminishing returns. Meaning, 1+1 = 2… 2+2 = 4… 3+3 = 5! Imagine an S-curve where we reach the inflection point (you concave up and then down). It’s the physics of DTC. Over time, marketing channels become less efficient, not more.
Brands need to drive growth across the omnichannel. Wholesale is a critical channel to focus on before the brand feels a marginal diminishing return with online demand generation.
Wholesale comes with its own set of challenges and opportunities, though. Margin erosion, lengthy AR cycles, precise inventory management, and more. But it gives you scale and volume which helps drive top line. Growth in sales will typically solve all problems.
Conclusion
This would be the starting point. Then there’s ongoing management of the business during the restructuring process. This shouldn’t be a difficult turnaround. It will come down to:
- Re-think the retail footprint and get out of bad leases.
- Focus on DTC as a key revenue driver with a focus on first-order profitability. Increase LTV/CAC and leverage all organic channels properly.
- Parallel path wholesale expansion; leveraging excess inventory and assets thoughtfully and in a curated capacity.
- Ensure proper working capital management to improve liquidity and solvency.
Lunya could actually become a great bolt-on acquisition play. Potentially from a PE-backed platform. It can become a valuable asset once the restructuring process comes to fruition. The brand can eventually become a $100M revenue business with the right strategy, planning, and management.
I’m cheering for Lunya and am looking forward to seeing where the brand goes from here.