LOS ANGELES, United States — When news broke last week that Los Angeles-based apparel brand Nasty Gal was filing for Chapter 11 bankruptcy protection, the retail and tech communities were not particularly surprised. There had long been rumblings that, after raising $65 million in venture capital funding, Nasty Gal was on the block.

Chief architect Sophia Amoruso had already distanced herself from the company she founded as a vintage eBay shop in 2006, focusing instead on the #Girlboss media platform created in response to the success of her 2014 memoir of the same name, which is currently being adapted into a Netflix series set to premiere in 2017.

But Nasty Gal, which sells trendy wares with an edge to Gen Z and millennials, said in a release that filing for bankruptcy protection would not result in any immediate changes to the company’s day-to-day operations. “Our decision to initiate a court-supervised restructuring will enable us to address our immediate liquidity issues, restructure our balance sheet and correct structural issues including reducing our high occupancy costs and restoring compliance with our debt covenants,” said Sheree Waterson, Nasty Gal’s chief executive officer.

Many of Nasty Gal’s vendors were owed several thousands of dollars in back payments. Some were owed more than $100,000. Ashley Glasson, director of Los Angeles-based contemporary label LNA, which has sold its artfully draped t-shirts to the retailer for about a year, knew something was wrong when the orders Nasty Gal was placing were not being approved by factors, who provide invoice financing services.

“They were placing really large orders up front, and seemed to be really behind the brand, with a great team of people working on the buying side,” Glasson explains. “We were having great sell-throughs, then getting paid just turned into a non-existent process.”

As the bills stacked up — with a balance into the six figures — Glasson became reluctant to ship goods. A few weeks ago, LNA received a call saying that Nasty Gal was “holding off” on its latest order. “That’s when you can tell,” Glasson says. “Unfortunately this isn’t the first time this has happened to us.” The situation echoed that of Scoop NYC, the contemporary retail chain that was forced to close all 17 locations in May 2016.

We were having great sell-throughs, then the process of getting paid just turned into a non-existent process.

Indeed, Nasty Gal is just one of several apparel retailers in the past two years to face financial turmoil resulting in bankruptcy or an outright shuttering. American Apparel, Delia’s, Aeropostale, Pacific Sunwear, Quiksilver, and Wet Seal — all trend-driven and youth-targeted — have all filed for bankruptcy protection. Reports indicate that fast fashion pioneer Forever 21 has had difficulty paying some of its vendors, while Gap Inc. recently announced that it would close its Banana Republic business in the UK. Within the last week, Kenneth Cole announced that it would close 63 outlet stores in the US, leaving just two full-price stores.

But Nasty Gal’s circumstances are also reflective of the strained relationship between some fashion startups and their venture capital investors, who can sometimes be uninformed about the challenges of scaling a business focused on making and selling physical products.

So what, specifically, went wrong at Nasty Gal?

By the time Nasty Gal had raised $16 million in its final round of funding in February 2015, led by former JCPenney head and Apple veteran Ron Johnson, Amoruso had already stepped down from her role as chief executive of the company.

But as Nasty Gal’s public face and founder, Amoruso was still heavily involved in the fundraising of that Series C round, which amounted to significantly less than the $40 million the company had raised in 2012, led by Index Ventures. In pitch meetings, Amoruso said she aimed to rebalance Nasty Gal’s business so that 80 percent of the company's sales would come from its in-house line. The new strategy followed a model that looked more like J.Crew or Urban Outfitters, the latter of which had been in serious talks to acquire Nasty Gal in 2013, according to sources privy to the conversations. Shifting to direct retail would help Nasty Gal to drive healthier margins of up to 70 percent or more, versus the 43 to 45 percent the company could earn from working with wholesalers.

The Nasty Gal-branded product would capitalise on Amoruso’s vision and taste, which had a distinctively LA flavour: sexpot, hipster and badass rolled into one. For a certain slice of millennials and Gen Z, Amoruso’s aesthetic — and personality — were intoxicating, and she believed they would buy even more heavily into Nasty Gal-branded clothing.

In January 2015, Lululemon-veteran Waterson replaced Amoruso as chief executive. It was thought that Waterson and Johnson’s experience, combined with Amoruso’s distinct creative vision, would help propel the brand forward.

But Nasty Gal had taken several missteps that made it difficult to turn things around. When the company raised its $40 million round in 2012, spurred by a jump in sales from a reported $28 million in 2011 to $128 million in 2012, it invested heavily in fulfilment and logistics. This included renting a 500,000-square-foot warehouse in Kentucky. But many startups use third-party logistics providers for years before taking over this part of the business. For instance, Warby Parker, which operates 40 stores and is valued at over $1 billion, still uses a third-party logistics provider.

Nasty Gal also invested heavily in paid e-commerce acquisition, an expensive way of attracting customers. With thousands of brands vying for eyes on Facebook and Google, paid acquisition works best when advertising something very targeted — like a subscription service for razors — or something that has a very high margin, like mattresses or couches.

“Messages and products that are easy to grasp are more likely to result in conversion,” explains Kirsten Green, founder and managing director of Forerunner Ventures, an early-stage venture capital firm with interests in several physical product-driven brands, including Glossier and Dollar Shave Club. “A hero product or message can be instrumental in getting a foundation set … over time it is obviously important to deliberately broaden your offering as driving repeat transactions is a must."

What's more, because the company’s product minimums were low to start out, Nasty Gal’s choice of factories was limited, creating product that, even when priced cheaply, did not look as good in real life as it did on the screen. For many years, Nasty Gal had no trouble getting a customer to convert once, but the perceived low quality and value of the product made it hard to get her to return.

And then there was also the matter of Amoruso, who had emerged out of the publication of #Girlboss not as a merchant princess, but a Hollywood personality, complete with her own agent and personal publicist. While the #Girlboss brand was inspiring female entrepreneurs to launch businesses, Amoruso’s own company was struggling to stay afloat. A “toxic” work environment, as several former employees have described it, did not help — and resulted in several wrongful termination lawsuits.

According to one executive, the publication of Amoruso’s memoir was the “nail in the coffin” for Nasty Gal, as it marked the founder’s own pivot away from the company she started. “She was savvy, and she saw the writing on the wall,” the person said. The term “#Girlboss” became more ubiquitous than Nasty Gal itself, and Amoruso’s book promotion did not correlate to sales, according to another former executive.

Amoruso was savvy, and she saw the writing on the wall.

Industry sources suggest this roadblock — the founder turning into a celebrity — is germane and particular to Los Angeles, where actual celebrities have used their brand power to launch venture-backed businesses. The difference with someone like Amoruso, of course, is that her celebrity was born out of the brand, not vice versa.

Amoruso did not respond to BoF’s requests for comment, but she did speak at a conference in Australia on November 11. “Things that I would have freaked out about two years ago I can handle now,” she said. “Hopefully that is how I feel two years from now about this. It was my first business. I got really far.”

But it could be argued that Amoruso’s extracurricular activities did not make or break Nasty Gal. Instead, the company’s demise reflects Silicon Valley’s complicated relationship with product-driven businesses, which typically cannot scale at the same rate as a technology-enabled platform.

“There is a mismatch between the modus operandi of the venture capital community and the reality of the apparel and fashion business, which can be very monotonous. It takes years to acquire customers, opening one capital-intensive store at a time,” says Ari Bloom, an investor in early-stage fashion startups and chief executive at San Francisco-based fashion software company Avametric. “A lot of investors who have gotten into the game see something great at the micro level. But micro communities, while they might be really into these brands, are often only one or two degrees removed from friends and family.”

While the success rates for startups are already low, even the most successful apparel companies rarely break $1 billion. Old Navy, which reached $1 billion in sales in a record four years, is a rare success case — an outlier. It also had the infrastructure of Gap, Inc. and the leadership of merchandising veteran Mickey Drexler. In 2015, more than 20 years after it was founded, Old Navy generated $6.7 billion.

According to sources familiar with Nasty Gal’s financials, revenue remained healthy until 2014, but began to decline thereafter. The two physical retail stores did not perform well, particularly the second, 6,500-square-foot location in Santa Monica that opened in March 2015. A shift in strategy implemented by Waterson, in which the buying team was instructed to seek out higher-priced brands in order to increase margins, shrunk the customer base and backfired sales-wise.

And while there were more retail veterans involved than had been in the past, there were also few company advisors with e-commerce backgrounds. (Former president Deborah Benton, who had more than a decade of e-commerce experience under her belt, departed in February 2014.)

The thing that made the brand was that not everybody knew about it. How do you maintain that cool, counterculture element and scale?

“Venture capitalists like things that they can get into early and that have gigantic exit potential,” Bloom says. “They’re generally not in the business of hitting doubles.” They’re also not generally in the business of pushing for profitability, but instead high valuations.

“Five years ago, companies were getting valued as tech stocks, but they were never tech companies,” one investor said. In such a capital-intensive business like apparel production, a business needs to be liquid or least be able to pay back its creditors quickly.

In the technology space, companies will go for years on end without being profitable in exchange for scale, which is hard for apparel companies, that must create loyalty and repeat customers, not quick hits, in order to pay up front for physical inventory.

Company boards and VCs alike have also got into the habit of allowing founders to cash out early on, creating a sense that their work is done. “They’re letting founders take $3 million, $4 million, $5 million off the table before the businesses are even profitable,” Bloom notes. “In my opinion, it reduces motivation and removes the magic.”

Certain VC firms are now better educated in how physical-product brands are built and run than they were a half-decade ago. Industry observers also expect to see more retail veterans investing in apparel startups, and the boards of those startups populated with more operators and merchants. Private equity firms, too, are “coming way downstream,” investing in smaller companies that manage to pass due diligence. (Stripes Group’s investment in Reformation, a direct competitor to Nasty Gal, is one example.)

As for Nasty Gal, it has filed for bankruptcy protection, but that does not necessarily mean that the brand is done. Johnson, who has been a proponent of Amoruso and her vision, may look to partner with a more traditional retail investor who has the time, patience and knowhow to help grow it properly. Sources familiar with the company’s financials are convinced that there is a buyer waiting in the wings, willing to scoop it up for a bargain once its debts have been settled.

But Nasty Gal is a brand predicated on cool, and cool is ephemeral. “The thing that made the brand was that not everybody knew about it,” says an executive close to the company who wished not to be named. “How do you maintain that cool, counterculture element and scale?”

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