Shoe closet

Update: The companies have since confirmed this transaction, calling it a “merger.” Additional details are available in our follow-up post, here.

After months of rumors, we hear that negotiations between two of LA’s subscription fashion ecommerce leaders are ending, and JustFab will soon be the proud owner of ShoeDazzle.

The companies have been in steady negotiations for several months, but multiple sources close to the transaction say that the deal is done and likely to be announced within days, possible as early as tomorrow.

As always, things could change at the last minute, but this deal is one that has appeared imminent for some time. Emails to Adam Goldenberg and Brian Lee, founders of JustFab and Shoedazzle respectively, and to ShoeDazzle investors Andreessen Horowitz and Lightspeed Venture Partners requesting comment on the transaction were not returned prior to publishing. Representatives from both companies have acknowledged in the past that such a tie-up was being considered. (Disclosure: Andreessen Horowitz partners Marc Andreessen, Jeff Jordan, and Chris Dixon are investors in PandoDaily.)

The transaction would mark a somber end to a tumultuous 24 months in which ShoeDazzle went from the category leader under founder and CEO Brian Lee to a sinking ship under replacement CEO Bill Strauss, and then most recently to a stable but slow growing shadow of its former self upon Lee’s return.

Making the deal either more poetic or bittersweet, there’s a long history between Lee and Goldenberg. Depending on who’s telling the story the details change, but the gist is that Goldenberg offered to invest in or acquire ShoeDazzle before it ever really got going. Goldenberg, who had already founded Dermstore and Sensa under the Intelligent Beauty parent, claims to have told Lee at the time, effectively, I want to sell shoes online, either with or without you. When the deal fell apart – again for reasons that change depending on the storyteller – JustFab was born and the “LA shoe wars” began.

There are a lot of metaphors people close to the company use about Lee’s CEO redux. Perhaps the most fitting is that he pulled the plane out of a tailspin and kept it from crashing in flames. While impressive – miraculous, even, given the damage done – that’s not the same as soaring. One source close to ShoeDazzle recently confirmed the talks, characterizing the company’s current state as “not great.”

In the approximately one year since returning, Lee has taken an iterative, “everything but the kitchen sink” approach to reinventing ShoeDazzle, pioneering some clever strategies – like a one-touch mobile shopping experience – to get women to come back to the site and start buying again. For all the promise, however, multiple sources say that ShoeDazzle was running low on cash and would need to raise new capital.

It’s been a bruising year for Lee and he’d planned to take August off with his family – a rare founder vacation. Instead, he’s spent the month negotiating with his cross-town rival.

According to three sources, the transaction is structured as an all stock deal. The final valuation is unclear, although we heard from one source roughly two weeks ago that negotiations were such that ShoeDazzle’s shareholders would end up with approximately 4 percent ownership of JustFab.

Obviously, there’s a lot of variability with how private companies are valued, but the deal is likely worth under $40 million, possibly well south of that. The phrase “face saving” has been thrown around by several investors in the LA ecosystem. For instance, if JustFab is valued at $250 million, ShoeDazzle would be valued at $10 million under the 4 percent scenario; if JustFab is worth $750 million – a stretch but not out of the realm of possibilities – ShoeDazzle would be worth $30 million.

This also ignores any other possible deal considerations like the assumption of debt, management earnouts, and the likelihood that ShoeDazzle shareholders received common stock, rather than the preferred stock typically held by venture investors.

Whatever the final valuation, sources described it as a pretty disappointing outcome for ShoeDazzle, given that it raised a total of $66 million across three rounds, with its May 2011 Series C financing reportedly coming in at a valuation north of $200 million. The company was the category leader at the time, and by all accounts had the revenue and growth metrics to justify the hefty price tag. Neither is true today.

Sources inside ShoeDazzle tell us that JustFab’s was not the only deal on the table. We’re hearing that the company had a termsheet for approximately $36 million in new financing in recent months. But such a deal would have almost certainly been a significant down round. It would also have meant management committing to several more years of rebuilding with the only acceptable outcome being building a huge company

Lee has earned props from his employees, board of directors, and others in the industry for the stabilizing effect he’s had on ShoeDazzle since returning and arresting its mid-2012 freefall. But with Lee’s next company, Honest, in the midst of its own hockey stick growth, it’s unsurprising that continuing to run both companies was deemed an unattractive and unsustainable option.

Lee emphasized how doable running both companies was at our May PandoMonthly. But we’ve heard since that squeezing two very full time jobs into one day has been taking its toll. Lee takes his legacy seriously. Plenty of people will characterize this as “he wanted out” – indeed, we’ve heard those reports in the LA ecosystem as well. That’s a huge oversimplification of what has no doubt been a harrowing decision for the company he once started for his shoe-obsessed wife. Lee is intensely competitive. Failure is tough for him.

Indeed, the toughest thing for all involved might be that ShoeDazzle’s fall was almost entirely self-inflicted. From the beginning three things made ShoeDazzle stand out: It’s early use of celebrity, social, and subscription. Lee’s successor, Strauss, didn’t understand any of these strategies and cut resources for each almost immediately. Meanwhile, he bloated the company tremendously, adding management layers it didn’t need and greenlighting TV ad campaigns that made accountants cry and made Lee want to gouge out his eyes.

Of one of Strauss’ commercials, Lee told us in January, “I almost shot myself when I saw that. If I wasn’t laughing, I’d be crying right now.”

Beyond that, ShoeDazzle’s costs of customer acquisition and shoe production increased dramatically over time, Lee confirmed during his PandoMonthly interview. Customer acquisition costs and customer lifetime value have become the two defining metrics of the ecommerce 2.0 era. While some companies have been guilty of buying revenue and “traction” in unsustainable ways, others – like JustFab – have been able to balance that equation and approach profitability with greater economies of scale.

JustFab, under Adam Goldenberg and co-founder Don Ressler, has proven itself adept at both online customer acquisition and operating a global production and fulfillment operation at scale. Both are areas that appear to have hampered ShoeDazzle’s pursuit of profitability, as they have with fellow competitor BeachMint (by way of its ShoeMint and StyleMint subsidiaries). While Lee may be described as a product visionary, Goldenberg is a classic ruthless operator.

Given the backstory between Lee and Goldenberg, and the (mostly) friendly competition that ensued, it’s unlikely that Lee would have chosen JustFab as the ultimate destination for ShoeDazzle. And there are rumors that other acquirers took more than a passing look. But ultimately, in a world where Yahoo is buying headscratchers like Qwiki, this is just one of those deals that makes complete sense – sad as it may be for the early ShoeDazzle team and investors.

First and foremost, JustFab is likely to be the only acquirer that wouldn’t lock up Lee in a multi-year contract as a condition of closing. Also, it’s one of the only companies with the expertise in the fast fashion subscription ecommerce market necessary to extract the latent value remaining within ShoeDazzle. Traditional brands like Steve Madden or ecommerce 1.0 giants like Zappos just aren’t built for this rapid product cycle business. In some way, Lee’s legacy can continue with this deal, rather than selling to a larger brand that might neglect or shutter the whole model.

ShoeDazzle offers JustFab a strong brand that it will likely continue to operate, giving the company the ability to target multiple demographics, geographic markets, price points, and possibly even business models. And with the second largest competitor out of the market, JustFab’s cost of customer acquisition is likely to drop going forward. From all our discussions with sources in the last few weeks, there seems to be an optimism that this transaction will lead to a stronger combined company.

The seemingly imminent acquisition also represents a necessary contraction of the category. Shoes have proven to be one of the most attractive categories within the ecommerce space, but they have also proven an incredibly difficult and costly mountain to summit. It’s a category in which being a number two or number three player is a tough position to find yourself, and one that is as unforgiving as any in terms of operational efficiency.

Through a combination of superior execution and just plain dumb luck, JustFab won the war. It handily outmaneuvered ShoeDazzle as soon as Strauss took the reins and is now several times its size in terms of traffic, members, and revenue, by all accounts. Whatever the reasons, to the victor goes the spoils.

If anyone is going to prove that women’s footwear and apparel fast fashion is a multi-billion-dollar online opportunity, it’s going to be the new JustFab.

Update: An Andreessen Horowitz spokesperson responded to our email following publication, saying, “We have no comment.”

[Image via TheShoeGirl]

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