Lily Kanter says a rescue deal made it impossible for Serena & Lily to raise another dollar

Luxury crib bedding is not supposed to come with courtroom drama and capital stack shrapnel. Lily Kanter says the rescue financing Serena & Lily took to buy out a hostile investor carried a 2x participating preference so ugly that she told the board they would never raise another dollar for the company.

That is the real lesson hiding inside this How I Built This episode, not the tasteful wallpaper, not the catalog magic, not even the Hamptons store glow up. Serena & Lily became a beautiful brand by selling a feeling. It nearly got trapped by selling too much of its future to people with different clocks.

Kanter and Serena Dugan tell Guy Raz that the company began almost accidentally, with Dugan’s painterly textiles and Kanter’s Mill Valley baby boutique. A first catalog landed at the exact moment a major premium crib bedding competitor moved to Babies R Us, leaving independent stores scrambling. Orders came in before the founders had inventory. Very startup. Very charming. Also, very broke.

we have $100,000 in orders

They solved that first cash problem the scrappy way, by asking retailers for 50 percent deposits. Later problems were less adorable. The company grew from wholesale baby bedding into a direct to consumer home brand, going from $5 million to $10 million to $20 million in three years, according to Kanter. Growth like that sounds like champagne until you remember someone has to pay for fabric, furniture, catalogs, payroll, shipping, stores, and all the other nouns that make investors reach for protective terms.

The bad money looked helpful at first

Before the really gnarly deal, there was a warning flare. Kanter says a private equity firm offered to write a $1.5 million check when she and Dugan were trying to raise a friends and family round. Easy money, right up until a lawyer read the term sheet.

I forbid you to do this deal. You’re not doing this deal.

The attorney’s objection, Kanter says, was that the firm wanted control for 17 percent of the equity. The founders walked. They raised the $1.5 million from friends, family, and, wonderfully, Kanter’s rabbi, in a 17 day sprint. That is a nice founder myth. The kind with fleece vests and panic.

But the later financing mess is nastier because it doesn’t present itself as predation. It presents itself as rescue. By around 2010, Kanter says the company had venture investors pushing growth and a family office type investor pushing profitability. Here is the twist, Kanter now thinks the profitability crowd had a point.

That admission keeps this from becoming a simple villain story. The private equity style investor may have been strategically right and still relationally disastrous. Kanter says the investor sued for irreparable harm of his investment. She got on a plane and told him the lawsuit could take the company down. The settlement, by her telling, meant buying him out for his original investment plus a 50 percent return after roughly a year.

there’s good money and there’s bad money

The cure poisoned the cap table

To fund that buyout, another major investor put in more capital. This is where the episode stops being a founder fairy tale and becomes a term sheet horror movie. Kanter describes the security in the kind of language that makes finance people sit up and normal people look for a beverage.

They actually put the money into the company on top of our cap stack on top of the capital chart at a very heavy duty preference of a 2x preferred participating very gnarly security

The plain English version, as Raz lays it out, is brutal. That investor would get double its money back first, plus its ownership share, before founders, employees, or other investors saw their returns. In venture capital, preference stacks can turn a headline valuation into decorative fiction. Everyone owns a piece. Not everyone gets paid like it.

I said to him we will never be able to raise another dollar for this company

My verdict, credible and slightly self-protective. Credible because the mechanics she describes are exactly the kind of thing that can scare off new money. Slightly self-protective because founders often discover the horror of investor preferences only after the preferences are the thing keeping the company alive. Kanter knows this. She says she wishes she had pounded the table harder. She also says the board chair told them they didn’t have a choice.

The company eventually found a cleaner path through a majority shareholder deal that let investors cash out or convert, and the brand survived without its founders. That part matters. Serena & Lily didn’t implode. It became the sort of store Kanter still visits, introducing herself to employees like a proud ghost in a very expensive coastal living room.

For anyone building a company, the stake is less poetic. The check that saves you in January can own your July, your exit, and your next round. Sometimes the most expensive money is the money that arrives right on time.