Zappos exit was partially driven by fears of a cash flow crunch

image Many of you will remember Amazon’s acquisition of Zappos last August for what turned out to be a $1.2bn deal based on Amazon’s stock price on the day of completion (it was an all share deal and the increase in Amazon’s share price between the when the deal was announced and completed took the value up 30%+ from the original $900m).  Since completion Zappos has been operating as an independent brand and business unit within Amazon and doing very well with sales up 50% in the first quarter of 2010.

Last week Tony Tsieh, the CEO of Zappos, published an excerpt from his new book Delivering Happiness: A Path to Profits, Passion, and Purpose describing why he sold Zappos.  Surprisingly for me, and of interest to ecommerce businesses everywhere the main reason was fear of a cash flow crunch.

In 2008 Zappos’ revenues were over $1bn and they had raised tens of millions of dollars from outside investors, including $48m from Sequoia Capital, and in addition they had working capital facilities from a group of banks.  Tony used the following words to describe his financial situation in early 2009:

At the time, Zappos relied on a revolving line of credit of $100 million to buy inventory. But our lending agreements required us to hit projected revenue and profitability targets each month. If we missed our numbers even by a small amount, the banks had the right to walk away from the loans, creating a possible cash-flow crisis that might theoretically bankrupt us. In early 2009, there weren’t a lot of banks eager to give out $100 million to a business in our situation.

That wasn’t our only potential cash-flow problem. Our line of credit was "asset backed," meaning that we could borrow between 50 percent and 60 percent of the value of our inventory. But the value of our inventory wasn’t based on what we’d paid. It was based on the amount of money we could reasonably collect if the company were liquidated. As the economy deteriorated, the appraised value of our inventory began to fall, which meant that even if we hit our numbers, we might eventually find ourselves without enough cash to buy inventory.

If a business backed by Sequoia and with $1bn in turnover faces these sorts of problems you can bet that other ecommerce businesses will too, which is why I thought this news was interesting to post.

The Zappos case was unusual for a couple of reasons, most notably their strong customer service ethos which led to greater expenses and a high returns rate than most ecommerce companies.  In the excerpt Tony talks about the tension between high levels of customer service and short term profitability and how his board wanted to focus on profitability to reduce the cash flow risk, and how he was reluctant to do so because he thought it would undermine Zappos’ long term prospects – a tension most businesses in this space avoid by not offering the same levels of service.

That said, both the fact that Zappos was a forced seller due to cash flow concerns and the fact that what made them different was an expensive strategy of good customer service, talk to the importance of keeping expenses lean in ecommerce companies and having a very clear picture of how scaling the business will turn cash flows positive.

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  • dwax

    Another great post. I wonder if they had choosen to sell the company before the economy cratered would they have commanded a higher price? (not that their exit was bad, quite the contrary). What's really impressive is his ability to negotiate a great exit during a time he truly thought the company was on verge of serious cash flow issues. amazing. david waxman, co-founder, http://www.VITAband.net

  • Yes – there is a lot to admire about Tony Tsieh

  • rhhfla

    Hard to believe that Sequoia could not help structure a line with better terms. Maybe the entrepreneurs did not want to take more equity and the line described was the best they could get without help from the VCs.

  • That depends on how bad the situation was