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September 12, 2022

Mehtab Bhogal of Karta Ventures: How To Transform Distressed DTC Brands Into Profitable Ecommerce Businesses

Written by: Satta Sarmah Hightower
"We really compete on speed, flexibility, and value-add. We aren't going to beat out a room full of Wharton MBAs. It's just not going to happen … There [are] too many middle-market and lower middle-market players that can outbid us there, but where we can beat them is speed when running diligence in a turnaround situation." — Mehtab Bhogal, Co-Founder, Karta Ventures

While most venture capital and private equity firms focus on accelerating the growth of already successful businesses, Mehtab Bhogal, co-founder of Karta Ventures, has no problem running toward companies these firms likely would never touch.

Karta Ventures specializes in turning around distressed direct-to-consumer (DTC) brands, seeking to transform each of them into a profitable ecommerce business. Though the firm isn’t afraid to tackle operational complexity within its portfolio companies, the DTC landscape is changing in ways that will simultaneously present more challenges and opportunities in this space.

Bhogal joined a recent episode of the "Unpacking the Digital Shelf" podcast, "A Roadmap to DTC Turnaround," to share his perspective on the unique challenges facing DTC brands today, how to overcome them, and how Karta works with DTC and ecommerce companies to execute successful turnarounds.

Headwinds Facing DTC Brands

In a cheap money environment, DTC brands have been flush with cash, which they could deploy to drive growth. However, supply chain issues and changes in digital advertising are creating a less favorable environment for DTC companies, especially those that were already struggling.

Bhogal says container prices have jumped from $3,500 each to more than $20,000, leading to higher shipping costs and lower margins for DTC brands.

"The second big change was the iOS update, which hammered the efficacy of digital advertising," Bhogal says, adding that many DTC brands have shifted their spending away from Facebook to TikTok, paid search, and programmatic advertising.

The Impact of Rising Inflation

Brands also face a tighter credit market. In recent years, DTC companies have had greater access to unsecured credit, and some were even 60–80% levered for every dollar in revenue they produced, Bhogal says.

"We saw a lot of that — a lot of leveraging during 2020 and 2021," he says. "That's coming to the table now, where some of these companies are tightening up credit requirements and underwriting."

On top of these changing dynamics, DTC brands face inherent challenges, including high customer acquisition costs. At the same time, these companies often have a deeper connection with their customers than brands that primarily sell on retail channels and marketplaces.

With its unique model and turnaround process, Karta Ventures tries to tap into these advantages while optimizing operations and lowering costs for DTC brands it identifies as prime investing opportunities.

A New Approach to Private Equity Investing

Karta takes pride in being a different kind of investment firm.

It focuses on brands that largely sell directly to consumers through their own websites, rather than through marketplaces or other retailers. Its bread and butter are distressed, lower-middle market DTC and ecommerce companies that earn below $100 million in revenue. Karta’s team includes experienced entrepreneurs and operators that use their experience and financial resources to revive and grow these businesses.

"We really compete on speed, flexibility, and value-add. We aren't going to beat out a room full of Wharton MBAs. It's just not going to happen if we're bidding on a vanilla-leveraged buyout," Bhogal says. "There [are] too many middle-market and lower middle-market players that can outbid us there, but where we can beat them is speed when running diligence in a turnaround situation."

For example, whereas another firm may have to rely on third-party consultants to optimize digital advertising, Karta already has this knowledge and expertise in-house. It uses this expertise to tackle a diverse array of challenges its portfolio companies face and accelerate their path to becoming profitable ecommerce businesses.

Executing a DTC Turnaround Strategy

Bhogal says building the right team is one of the main challenges Karta’s portfolio companies face.

"Most of the time, the company is not failing because the people are great. There's something critically wrong. It's almost always traceable back to management or a few bad apples."            — Mehtab Bhogal, Co-Founder, Karta Ventures

Karta executes a multi-faceted turnaround strategy to turn each portfolio company into a profitable ecommerce business, which typically begins with management and staffing changes.

Management and Staffing Changes

Making staff cuts is one of the first things Karta does as part of its turnaround process. However, the firm interviews everyone at the company first to identify high and low performers.

"What I’ve found is a lot of the same people will pop up in a good way and a bad way," Bhogal says, adding that retaining employees that are really operationally competent and passionate about the brand actually improves overall productivity and performance.

Containing Costs

Karta also focuses on streamlining each company’s costs. These efforts often include creditor and vendor negotiations, where the firm details the operational and leadership changes it has made, as well as implements a 13-week cash flow model.

"That tends to buy us anywhere from three to 10 months, right off the bat,” Bhogal says. "We've had landlords tell us, 'Don't pay rent for the next six months. You guys seem like you know what you're doing,' and we'll make [the landlords] whole."

Increasing Marketing Efficiency

Because Karta primarily deals with DTC and ecommerce brands, improving each company’s digital marketing execution is also part of the firm’s turnaround approach.

Bhogal says Karta "lean[s] harder into channels like email and simple notification service (SNS) to try and juice more out of the existing customer base."

The firm also implements a multi-touch attribution solution, and then does holdout tests and lift analysis to verify that what it’s seeing from an advertising return on investment (ROI) perspective is correct. It’ll also quickly deploy new channels to increase revenue.

"In a turnaround situation, it's probably not the best time to worry about a brand. You see a lot of people being concerned about their brand and what marketplaces it's on, but if you're hemorrhaging money, I feel like [the] brand is the last thing you should be really concerned about," Bhogal says. "I don't think it's a big deal if you pop up on a few marketplaces or discount sites, so you can move some bad inventory very quickly."

Implementing a SKU Strategy

Bhogal says it's common to see companies use a lot of materials for only a small number of SKUs. Rationalizing SKUs can cut costs and increase working capital.

"Entrepreneurs get very obsessed with offering width when there's no proven correlation to offering width with revenue," Bhogal says. "The fastest way to test this is to change the collection levels, the collection pages, and the products displayed in each collection. Very rarely do we find that there's a strong correlation with offering more width and revenue."

Managing Cadence

On the operation side, Karta focuses on managing cadence.

It uses four core systems, including Lean Six Sigma — a common manufacturing method for big enterprises not frequently used among lower-middle market companies. Bhogal says one advantage of implementing this approach is that many states subsidize the cost of Lean Six Sigma training, allowing companies to access the knowledge of highly trained professionals for a fraction of the cost.

Bhogal says that along with driving operational improvements, leveraging training to improve operational cadence upskills employees, empowers everyone on the team, increases their productivity, and leads to greater retention.

"We had one portfolio company that had about 120 or 130 people there. It was turning through that workforce essentially every two or three months, which is crazy. With Lean implemented, that was significantly reduced," he says.

Creating the Pathway for a Profitable Ecommerce Business

So far, Karta’s approach appears to be working. The firm has saved four companies from bankruptcy and created or saved more than 200 jobs in the U.S. alone.

Along with continuing to convert distressed DTC brands into profitable ecommerce businesses, Bhogal says the firm intends to look for new investment opportunities, particularly with larger retailers.

"For us, going up-market [and] tackling some of these brands that aren't necessarily digitally native and making them more digitally native or accelerating that process, and at the same time taking advantage of their omnichannel infrastructure, is really exciting," Bhogal says.

If Karta’s track record with DTC brands is any indication, it stands a good chance of propelling the same kind of ecommerce transformation for larger retailers, too.

To hear more of Bhogal’s perspective on the DTC landscape, check out the full episode of "Unpacking the Digital Shelf."