Last Monday, I told you that NowRx was going out of business. Today, I’m going to share some more thoughts on why it happened.
The company says it was because of the deteriorating economy. But there’s a lot more to it than that. And there’s a lot more to it than merely running out of money.
Running out of money was a problem. But what caused the problem in the first place? Why did this problem turn lethal?
And was this ending inevitable?
These are the questions I’m going to address today.
There are two reasons a startup runs out of money. One is if it spends too much. This is only meaningful if it has the option of spending less.
The second reason is if it doesn’t have enough money in the first place. That could be the result of bad planning or coming up short in its efforts to create a viable war chest.
Let’s address the second reason first.
NowRx raised $27 million in its recent funding round. To me (and, I imagine, most investors), that seemed pretty good. But NowRx founder and CEO Cary Breese had a different perspective. He originally expected to raise $40 million. And he hoped he could raise up to the $75 million ceiling this round had.
Not only did Cary expect to raise $40 million, he needed to raise at least that amount. To understand why, you need to understand that when NowRx began its fundraise last November, its cash position was less than ideal (and worse than I thought).
According to its SEC-filed statement for the raise, it had nearly $9 million in the bank. But that was old information based on financial statements that ended in December 2020. With a monthly burn rate of $1.5 million, that amount was down to an insignificant number by the time the raise began.
Based on the report NowRx filed for the first half of 2021, cash was already down to $2.7 million by June. By the time the round started in November, the company’s cash position was dire. During the raise itself, NowRx took advantage of its closing opportunities every couple of weeks to cash out its raise in order to fund its current operations. It also had to pay for raise-related fees and marketing along the way.
By the time NowRx closed out its raise in June, only $8 million was left. At its current burn rate, that money could be expected to last a little more than five months.
And that’s how it turned out.
The company ran out of money in December. Its cash position was much more tenuous than outsiders had reason to believe. And that brings us to the first reason for running out of money: spending too much.
Could the company have spent less?
I asked Cary that very question. He answered with an unambiguous no. I mentioned in my email to you on Monday that “the nature of the pharmacy business is that startups have to spend cash to become viable.” Here’s what I meant by that.
Margins in the pharmacy business are much smaller than in most industries. And the smaller a pharmacy company like NowRx is, the more that large wholesalers charge it for the drugs it provides to its customers. Supply chain issues put even more pressure on thin margins.
The imperative to expand is not just driven by seeking more revenue but also by the enormous cost benefits that scaling brings. Cost of goods sold goes down as scaling proceeds. Delivery routes become more efficient. Margins increase. The ability to compete on price improves — as it must.
But, of course, scaling takes money. The imperative to scale quickly turns into the imperative to raise capital. NowRx took on that challenge willingly. But might it have adapted its expansion plans to account for a difficult fundraising environment?
In hindsight, it’s tempting to say yes. If we do, though, we have to ask if that’s realistic. Startups that can’t show growth can’t attract capital. Asking for money without showing growth would have been a surer path to capital starvation than the path Cary chose: acquiring capital to fuel expansion. And demonstrating expansion to attract capital.
It’s a proven startup strategy. And NowRx had more reason than most startups to pursue it.
But why was running out of money a death sentence? It’s not for many startups. Determined founders can and do find ways to survive. But NowRx’s options were limited for three reasons:
- Legal strictures. Running out of money and paring down to a skeletal staff triggered regulatory consequences. In such circumstances, a company is no longer considered able to service its patients, and a distressed transfer of the patient files becomes necessary. Legally, NowRx had no choice.
- Inability to raise more money. On the face of it, this is perplexing. NowRx’s upside was intact. Its management team was proven. It was one of the leading disruptors in the space. Why couldn’t it get somebody — anybody — to step up to the plate? What really hurt its chances was that the investing group most able to help them — the venture capital (VC) community — was just not interested. From the very beginning, NowRx decided against potential VC investment in favor of using crowdfunding. It was the right decision at the time. But it left the company with no VC insiders to champion its cause. So NowRx’s best option to capture quick funding became a non-option.
- The competitive environment. When I first saw NowRx, it was one of the earliest movers in the online pharmacy space. But today, it has competition — well-funded competition. Capsule recently raised $300 million. Alto Pharmacy recently raised $200 million. The competitive environment is formidable. Unless you spent time looking under NowRx’s hood, the investment opportunity NowRx represented had lost some of its shine.
Was NowRx’s downfall inevitable? I don’t think so. With the benefit of hindsight, different choices might have made a difference. Expansion plans could have been scaled back. Spending (on things apart from expansion) also could have been cut.
Alas, there are no mulligans in the business world. We make the best decisions we can in real time based on the information available to us. NowRx made no obvious bad decisions.
But did we as investors? What did we miss that we shouldn’t have?
The one thing that stands out is the funding risk. Frankly, it was much greater than I thought it was. I will be paying more attention to funding risk and burn rate in the future.
At the end of the day, NowRx was not a victim of bad decisions. Rather, its victimization is explained by a well-known Wall Street maxim: Sometimes, bad things happen to good companies and through no fault of their own.