A Grave Financial Error Sank A Startup And Contributed To Its Founder's Suicide

Last month, we published a behind-the-scenes report on a failed e-commerce startup, Ecomom, and its founder who committed suicide, Jody Sherman.

Sherman shot and killed himself at the end of January. Two weeks later, the company, which sold affordable goods to parents and was loved by its customers, abruptly entered into Assignment for Benefit of Creditors, an alternative to filing for bankruptcy. Today, the company updated its Facebook page and website and announced that it had been acquired by etailz, Inc in late March and would be relaunching this summer.

The fact that Ecomom ran out of money, shut down, and was then acquired is startling. The company had raised $5 million just six months earlier and more than $12 million total. Sherman left no note explaining his actions.

One of the questions the article tried to answer was, what happened to the startup's cash late last year?

There were three people with intimate knowledge of the company's financials. One was an outside accountant named Darin Marinov, who declined to comment for the article through lawyers. Another was Jody Sherman. The third was an internal controller who was hired in October, just three months before the company collapsed.

His name is Philip Prentiss, and he's written a detailed account of the company's financial state those final months. According to Prentiss, the company's aggressive discount culture and Sherman's lack of financial knowledge dwindled away the company's account to nothing.

We've left his account unedited and posted it on Scribd. You can read it in its entirety below, but here are the highlights.

Please note, the following merely summarizes Prentiss' document; it is not the opinion of Business Insider.

• Prentiss joined Ecomom in October 2012 as the company's first controller. It never had a CFO. He was the first person, other than Sherman and the outside accountant, to handle invoices, income statements, and finances.
• Ecomom never had a profitable month.
• For the first month, things at Ecomom seemed fine despite the company losing half a million dollars. The October 2012 Income statement looked like this:
• ($000's)
• Revenue: 322
• Cost of Goods: 173
• Gross Margin: 46%
• Selling: 288
• G&A: 102
• Operations: 169
• IT: 87
• Customer Service: 24
• Net Profit (Loss): (548)
• "A half million dollar loss wasn't great, but the company just received $4.8 million in financing the previous month and a number of selling and operational expenses were due to one time website development fees," Prentiss writes. "More importantly, black Friday was just around the corner. We anticipated sales of over $1 million for November and without the one time costs there seemed an outside chance we might actually reach the break even point."
• While sales were an all-time high on Black Friday, that day marked the beginning of the end for Ecomom, according to Prentiss. The company generated $1.1 million in November, but it also lost $860,000. Prentiss shows why in a breakdown of the November 2012 income statement.
• ($000's)
• Revenue: 1089
• Variable Costs*:
• Cost of Goods: 548
• Discounts: 751
• Warehousing: 152
• Freight Out: 134
• Contribution Margin: -48%
• Fixed Costs:
• Employees: 141
• Consultants: 111
• Advertising: 44
• Overhead: 41
• Net Profit (Loss): (864)
• "Our discounts are meant to be one time only, but we can't limit them by customer so every order ends up sold 50% off," Prentiss explains. "Said another way, for every additional $60 average order shipped our variable cost is $89 and we lose $29. Said another way, the more we sell, the more we lose. Said another way, if we cut all our sales to zero and sat around and played ping pong all day we could continue to pay ourselves handsomely for two more years while at the current sales rate we'll be out of cash in three months. Said another way, now would be a very good time to pull the fire alarm."
• After that $864,000 loss, Prentiss says Sherman finally realized there was a problem, but it was too late to right the sinking ship.
• Sherman held a management meeting and made some big changes, but somehow, the grave financial situation was never discussed. "I can tell you for sure the word 'margin' and the word 'profit' were never mentioned," Prentiss writes of that meeting. "Jody was a master marketer and led a management meeting that focused on an awesome feel good marketing plan."
• Sherman told the executives at that meeting he'd bring in additional financing of $2 million, possibly from one of the current investors, People Fund (Note: PeopleFund disputes this claim, saying that they were not considering investing more in the company at that time.)
• November closed with $2.2 million in the bank.
• After November, Ecomom did away with the discount strategy. The GM and VP of Sales departed. But without the discounts, Prentiss says sales dropped off and Ecomom got stuck with inventory it couldn't sell.
• Sherman never got that $2 million from People Fund or anyone else, but he did try hard to raise more money. "I never had a close relationship with Jody but I did sit right across from him in the office and overheard a large number of unsuccessful fund raising calls," Prentiss recalls. "I remember him quite clearly ending one with 'well, I'm not really in love with this conversation either.'"
• A large problem was Sherman did not understand some basic business principles. "I would bring the financial statements to Jody who would glance at them so cursorily and wave me away with 'no one can understand this without extensive analysis,' Prentiss writes. "Critically, he did not understand margin. At the end of December when things were getting truly desperate, he said to me, 'Phil, just bring me a forecast that shows how much we need to sell to break even.' He did not understand, after three years of negative margin, that increased sales resulted in increased losses. He had built his house by raising money and when times got tough he went with what he knew."
• One week before Sherman's death, Sherman asked Prentiss to draw up a forecast of what the company's financial situation would look like with half the staff laid off and inventory filling the empty space instead of sitting in a warehouse.
• Prentiss remembers the last few meetings with Sherman. It included Sherman making "morose comments" such as "if you want to fire me that's ok" and "I'm too old to start over." Prentiss also says Sherman drew up a will one week before he died and gave it to his secretary.
• "On my very last weekend, January 26-27, 2013, I drew up multiple different forecasts at Jody's request. Some were 2013 P&L forecasts at different levels of revenue, and some were detailed expense forecasts with spending cut to an absolute minimum. I speculate Jody was either trying one final time to raise capital or preparing for severe downsizing otherwise," writes Prentiss.
• On January 28, Sherman ended his life. On February 15, Ecomom entered into Assignment for benefit of Creditors.

Ecomom Post Mortem

*Prentiss clarified how the variable expenses in the income statement were defined via email:

• Discounts: We contracted with 3rd party discount companies such as Plum District to advertise our products. For example the customer would pay Plum District $20 and receive a $40 coupon to be used on our site. We would ship $40 of retail value and receive nothing from the customer, but eventually receive $20 (less some service charge) from Plum District. This worked phenomenally well to drive traffic to our site, but of course was also extremely expensive. In this particular example revenue would be $40 and discounts would be $20. On a technical accounting note, this should have been booked as "discounts." However, because it rolled up under the VP of Marketing, it had always been booked as "advertising expense" and thus remained hidden.
• Freight Out: FedEx charges for shipping out. We offered free shipping to the customer.
• Warehouse: invoices from our third party warehouse service in La Brea, California. I can't remember the name.
• Consulting: large parts of our IT were outsourced. Most expensive was our tech support for our computer systems OMX and Magneto. Second most expensive was website design for various specials and promotions and general technical trouble. All these people charged around $100 per hour and we used them intermittently - but usually averaging 100 hours a month or more every month. I used to work at Mattel and Medtronic, in comparison the IT system at Ecomom was versatile, robust, and generally first class.