Apr 11, 2016 · 7 minutes

Say what you will about Valley VCs. There’s a reason they typically don’t invest in content companies and there’s a reason many of them avoided “ecommerce 2.0.” Or quickly learned their lesson after Gilt, Beachmint, ShoeDazzle, Fab, and other blow ups. If companies haven’t blown up, they’ve stumbled and slowed like NastyGal and OneKingsLane.

Everytime we think it’s different this time, and that someone will build a large defensible stand alone ecommerce company, it eventually stumbles. Even Zulily which made it past all those listed above to hit an IPO then faltered, selling for an unceremonious amount to the decidedly un-hip QVC. As we wrote at the time: “Cursed by an inflated IPO valuation, Zulily ends up where no startup wants to be.”

Well, at least that won’t be the epitaph we write for The Honest Co.-- the latest, greatest hope that maybe all these ecommerce 2.0 mega trends like celebrity co-founders and subscription commerce had real legs.

Reports came out at the end of last week that Honest was switching gears from a planned IPO to consider an acquisition instead. Though many have cautioned that it could still go public, and that companies explore both avenues all the time, it’s certainly a sign that the IPO plans aren’t going as well as hoped. And that matters because of the terms that came with Honest’s private unicorn round. That deal means this isn’t just about getting out, but getting out at the right price if anyone at the company wants to see a dime in returns. (More on that in a bit.)

For years, insiders had been insisting that Honest was going to prove all those thesis that hadn’t yet worked in practice. The value of celebrity done right. The value of multi-channel, using subscription commerce as a jumping off point. The value of designing for a hipster, eco-conscious, GenX audience of parents that huge consumer package goods companies were mostly ignoring to design for a mass audience only.

It wasn’t just a $1.7 billion valuation that made people think Honest was for real; it wasn’t just top ecommerce investors like Kirsten Green telling Vanity Fair it was the one company she wasn’t in that she wished she was. It was the fact that the company had made it to this point (and price) while avoiding the landmines of celebrity and subscription commerce that blew up nearly everyone else.

Even before it started, Honest shouldn’t have worked. I wrote about their launch as one of the first stories we ever did on Pando and I was a new mom at the time, so I was squarely the intended audience. Although I love the products and I’ve been a customer since launch, even I was cautious at the time:

Only 8.2 million moms have babies in diapers in the US. It's a comparatively tiny market for an online retailer. But those 8.2 million babies consume a whopping $8 billion in diapers. Pampers and Huggies split the market almost 50-50, with every other brand getting just small percentages or fractions of a percent.

For a company like Procter & Gamble, Pampers is by far its biggest revenue generator and they aggressively defend it, throwing samples at any gatekeeper for new moms. For instance, we got some Pampers from the hospital and just kept using them. The hospital gave them to us, and they do the job, so why switch? No new parent has the time to agonize over diaper brands.

The Honest Company will have a marketing challenge that its clear value proposition, snazzy patterns and celebrity power may not be enough to overcome. "It's hard to get women to switch brands," [Co-founder Brian Lee] admits. "We need to catch them before they get too addicted to the Luvs and Pampers." That or they need to find more moms like me who think it's well worth the switch for my baby to be in cuter diapers I can trust.

Many believed this hurdle would be insurmountable. But Honest expanded more aggressively in home, bath, beauty goods to widen its market, and in multiple channels to expand its footprint. Alba was absolutely on point as the celebrity co-founder, logging hours at the office every day, as you know if you read the hundreds of profiles on her in every celebrity, fashion, business or general interest magazine done in recent years.

Some have surmised the IPO stumble could have to do with reports that its products have caused skin irritation. Sure, when you promote yourself as purer than pure, this is problematic. But Honest has strongly rebutted the claims, and it’s hardly something that’s dogged Honest for its lifetime. There are plenty of families like me that have used its products for years with no such reports or issues. There are plenty more families that use the diapers for the designs as much as the purity claims. This alone the company could bounce back from. It’s this paired with the valuation. That’s the problem about pricing yourself for perfection.

And that’s a story we’re going to be hearing more and more in coming years.

As we detailed in this story, Honest had some of the more arduous terms designed at downside protection in its unicorn funding round, according to an analysis by Pitchbook. From that story:

Of the group, only Honest and DocuSign have multiple liquidation preferences – meaning investors get more than their money back at the time of exit, before anyone else gets anything. Most everyone has a single liquidation preference, and half of the companies – roughly – had term sheets where late stage investors had senior rights over early stage investors. Pitchbook’s latest unicorn report has a lot of these same details if you want more specifics.

What does this all mean at the end of the day? There are a shitload of Cheggs out there, and it explains the disparity between what the exact same investors will pay in a private deal and an IPO: They are getting all kinds of guarantees to limit the downside in exchange for the lack of liquidity.

Companies that can’t easily meet the agreed on minimums will have a hard choice: A down round they know they can live with as a public company at the risk their deals come with or inflated prices they can’t possibly support.

You can understand the deals came with such strings given the sector and its track record. But no one forced them to stretch for that price.

Honest’s board has to be asking themselves now whether it was worth it. Sure, it was great for press for a while. Each magazine cover talked about Alba as head of a $1 billion company. That number gave her mass market bonafides, and no doubt opened more retail doors and channels for the products.

But watch. As this story unfolds everyone will say a variation of the following: “Given the company’s $1.7 billion…” It’s not that an IPO was impossible at some point at some price. My guess is it’s that it can’t do one right now at the valuation it would need to clear the thresholds of those late stage investors.

We’ve written before that the ease of late stage fundraising in the last few years has absolutely dictated companies’ strategies. (Would Uber be burning $1 billion in a futile China war in any other funding market?) Pretty soon we’re going to see the inverse. Despite the much heralded downturn, there’s only one metric that looks awful across the board: Exits. The lack of them is also going to start dictating companies’ strategies.

As a side note, it has to be bittersweet for co-founder Brian Lee, one of the best entrepreneurs in LA, and yet one that has yet to build a public company. His first venture, LegalZoom, was long rumored to be filing, but eventually sold. ShoeDazzle imploded and then sold for a disappointing amount to copycat rival JustFab. Honest was set to be his big hit-- the culmination of all he’d learned and the network he’d built. He’d finally gotten all the elements right…. Or so the market thought.

It’s a shame that it may be an over-zealous valuation that makes a legitimately impressive company like Honest feel like a disappointment.