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December 2, 2021
An estimated 80% of consumer-packaged goods startups fail—and that was before the COVID-19 pandemic put most small businesses through the wringer. In the notoriously competitive natural products space, the failure rate for new brands is likely even higher.
So why do so many CPG startups go under? Certainly, some miss the mark on product, launching a dietary supplement or natural food, beverage or personal care item that isn’t compelling enough to succeed in the marketplace. Others underwhelm with branding or marketing, or simply price their products too high.
But for many of the startups that fail, the problem is none of the above—it’s that they make some all-too-common missteps on the financial end. They might have a delicious organic snack unlike anything else out there, but because they don’t truly understand their numbers or know how to manage their money, the business ultimately falters.
Below are seven common financial mistakes that CPG startups make.
Entrepreneurs often want to launch and grow their businesses without outside capital or expertise. While this may be a noble goal, it can also be limiting.
“Of course, entrepreneurs want to try to bootstrap and generate product-market fit cost effectively,” says Lorne Noble, founder of Simple Startup, a Boulder, Colorado-based firm that helps entrepreneurs understand and make better management decisions around finances. “However, there comes a time when, if they continue to ‘always bootstrap, they will miss opportunities to find the right services and the right people to help scale their business.”
In other words, entrepreneurs shouldn’t shun outside funding or experience just because they come at a cost. “To be clear, I am not saying they shouldn’t always be very careful with financial management,” Noble adds. “But don’t always push for the bottom of the barrel in terms of costs.”
Startups often think topline growth and raising capital are way more important than solid financial health. Noble says this is a big fat myth.
“People say you can be either a growth-first or a profit-first company, but I believe there is potential to be a balance of the two,” he explains. “The challenge with always chasing topline growth is you lose track of your plan to achieve some bottom-line success. I don’t think entrepreneurs should always focus on growth and raising capital at the expense of always raising debt.”
Lots of CPG brands work with co-packers, especially when just starting out. Then, at some point along their growth trajectory, they may want to bring manufacturing in-house in order to improve margins. In some cases, building a production facility may indeed be a smart investment—but it isn’t always, and certainly not at any cost. Yet entrepreneurs sometimes jump too quickly into these projects without fully understanding the potential downsides to the business.
“This decision requires careful consideration,” Noble says. “It can become a distraction to the growth of business when the owner or CEO concentrates on building own their own plant for the sake of improving margins. The difference you get in gross margin can be sizable, but it’s often not worth the distraction to the company’s growth.”
For any company to survive, it is critical to know how much cash is moving in and out of the business currently and to forecast inflow and outflow in the near future. Sadly, many CPGs don’t realize the importance of cash flow management, and before they know it, they land in hot water.
“If you don’t have the cash to pay for things, then you don’t have much of a business,” Noble says. “Cash is king, so cash flow management is paramount.”
Simple Startup helps clients manage cash flow by breaking it into two parts: technical cash flow and strategic cash flow. “Technical cash flow is making sure that, month in and month out, week in and week out, and sometimes day in and day out, they are tactically managing the cash in their business,” Noble says. “Each 90- or 120-day period, we determine what is happening with cash: Who is paying us? Are we collecting fast enough? Are we paying vendors as slowly as we can? Are we expanding the efficiency of our cash as much as possible?”
Strategic cash flow means looking at the bigger picture. “What do the next couple of years look like?” Noble says. “When, approximately, will we run out of cash? Therefore, how many months in advance do we need to raise capital to ensure we build enough contingency to hit our business milestones? All of these cash-management plays increase a startup’s probability of success.”
“Many startups don’t spend money on areas that can get them money,” Noble says. One such area, he notes, is chargeback management, which requires paying for software or other tools that help recover revenue lost to chargebacks while preventing future chargebacks from happening.
“Unfortunately, distributors put a fair amount of effort into deducting payments off their clients’ invoices,” Noble explains. “A young CPG looking to expand into conventional through a distributor may not feel that it can afford the resources to contest this.”
However, Noble insists that spending money on chargeback management can make up that money and then some. “Plus, as soon as you tell the distributor you ‘know how this works so don’t pull the wool over our eyes,’ then you’ll suddenly see the number of deductions on invoices reduce.”
It’s challenging for young CPG companies to grow to a stage that entices venture capitalists and other institutional investors to jump in. “There is this period before reaching about $2 million in annual sales that younger companies struggle to find capital because they are small and not creditworthy,” Noble says. “But since there are usually more expenses coming in than income, companies have to fund their business somehow.”
Many end up taking on equity-style investment, often in the form of a convertible note. “This tool is designed to make it easy for both the investor and entrepreneur to raise early-stage capital by avoiding the valuation debate,” Noble explains. “It says ‘we, the investor, will start off as debt, meaning we don’t have to valuate your company now. We can wait until you have more of a track record and milestones for someone else to valuate. Then we will jump in, and the debt will convert to equity at whatever price they say is appropriate—but with a discount.’”
The problem is that when companies raise a lot of money—say, more than $2 million—through convertible notes, it can hinder their next investment round by driving their share prices down. “To the second round of investors, it looks like the business is not doing as well,” Noble says. “We see companies raising a lot of convertible notes without the knowledge that, if they are not carefully managed, they can impact their fundraising strategy negatively.”
Typically, natural products entrepreneurs launch businesses because they are passionate about their products or brand mission, not because they’re financial wizards. Some figure it out and do just fine, but many others, because they don’t know what they don’t know, end up tanking their companies.
Instead of trying to navigate it all themselves, entrepreneurs should consider consulting with professionals. For example, Simple Startup’s finance, accounting and tax pros can help startups with a wide range of needs and teach them the skills to make solid choices regarding money, whether they are just launching a business or prepping to sell the company for a big payday.
Melaina Juntti is a longtime freelance journalist, copy editor and marketing professional. With nearly two decades of experience in the natural products industry, she is a frequent contributor to Nutrition Business Journal, Natural Foods Merchandiser and NewHope.com. Melaina is based in Madison, Wisconsin, and is passionate about hiking, camping, fishing and live music.
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