What’s Really At Stake

By Jamie Valenti-Jordan, CEO of Catapult Commercialization Services

Early in the life span of a CPG company, a vital decision must be made: will they partner with a contract manufacturer (co-man), and if so, what will this relationship look like? This decision can have major implications on the brand’s future success. We hear a lot of questions from founders about co-man relationships, so we asked an expert to explain equity-based arrangements. Jamie Valenti-Jordan of Catapult Commercialization Services offers his insights into the often complicated financial relationship between these two parties -- and why “equity” and “strategic partnerships” are not always synonymous.

CONTRACT MANUFACTURING RELATIONSHIPS

To understand the nuanced relationship between a company and a co-man, it is necessary to first understand the key differences between these parties’ goals.

The brand needs the product to cost a certain amount on shelf and has to pay a lot of people to get it there. The brand makes money when the product is sold and consumed over and over again. The brand must have the flexibility to respond to their market forces of competitive products, cost pressures, demand spikes, seasonal category cycles, target consumer optimizations in product attributes or quality, etc. These are not always things that co-mans are built to respond to directly. The contract manufacturer’s business model, on the other hand, is to make product to a specification from the brand - not necessarily to make a brand succeed. The co-man has to get paid and make their margins for product produced in order to stay in operation. When input costs change (a function of their market forces), they have to be able to charge for them. When they reach a physical limitation (24 hours in a day, square feet of production space, power limitations, municipal waste limits, etc), they necessarily must halt growth until something changes.

When a co-man puts equity on the table to form a “strategic partnership,” the brand may assume that by sharing the equity, they can change the business model for the co-man; they cannot. The co-man will always focus on production and cost problems, which means the brand won’t feel like they have a partner in their equity-based co-man when they are facing sales challenges. Contract manufacturers do not care about the equity; it is a calculated play to double-dip into the work and success of the brand. They will continue to charge enough to cover their costs and still make a margin on top.

WHAT DOES THIS LOOK LIKE IN PRACTICE?

Let’s say the brand does well and has a difficult-to-make product. The co-man has 90% utilization and really is just trying to make a profit, takes the equity, and starts producing in their remaining time. The brand grows and starts projecting needing 20% of the line time. They have efficient, easy-to-make products that take up 90% of the line time and they can count on continued sales of that product. They will always prioritize that over the difficult-to-make, riskier products. So the brand outgrows the co-man and looks for another partner to manufacture with. Obviously the next coman doesn’t get equity, but they aren’t going to get the scaling efficiencies that the first co-man developed for the brand (co-man’s IP) so it will cost more initially to produce at the second co-man. Assuming that can be overcome, the first co-man loses all its volume, doesn’t have to do anything, and still owns a portion of the brand.

A Case Study (Based on a real client)

Company X gave away 20% of their company in order to have a large manufacturer. Eventually, the brand’s primary investor tried to recoup their costs - but they couldn’t sell their share of the company because they didn’t own 20% of their own company due to supermajority requirements. Additionally, the co-man had essentially locked them out and said they won’t make the product anymore because they have other products that made a better margin, so the value of the brand tanked. The co-man no longer saw a future for Company X, so they decided not to prioritize scheduling their products, because they had already agreed to lower their margin in exchange for the equity.

Company X then had to change comans, which proved nearly impossible - the previous co-man still owned 20% of their company. They ended up having to undersell to the industry board to recoup the ownership of their own company and sell that 20% to another third party. That’s the nightmare scenario; you don’t have the freedom to leave a co-man, and the coman won’t run your product for you.

SO WHAT SHOULD YOU LOOK FOR IN A CO-MAN?

In early conversations with a contract manufacturer, the brand should be paying keen attention to what the co-man is asking them. A good sign of a good future partner is a co-man who asks things like “what does your brand stand for?”, “how quickly do you want to grow?”, and “what resources do you have to execute sales?”. These questions are a sign that the co-man is thinking about a future partnership, and that they have an interest in your success. If they’re not asking these questions and are focused solely on numbers (ie. cost to run), they are not going to be your partner, just an agent of production. Of course, this partnership is a two-way street. The brand should also be asking questions like “how can I make my product work more effectively on your systems?” that will gain buy-in from the co-mans early on.

Universally, equity should be exchanged for support now and ongoing support as you grow. It should not be transactional, but rather a commitment that that partner has value as you scale and grow and pivot for years to come. Most of the time they end in threats of litigation due to hurt feelings and mismanaged expectations, but rarely do they end up being litigated.

If a brand truly thinks they have a forever co-man, and that co-man is asking for equity, ask for some in return. If you truly think your business plans are so well aligned, then swap equity, don’t just share it.

Jamie Valenti-Jordan, CFS, CEO of Catapult Commercialization Services, has 15 years of experience with early stage startups through Fortune 500 food companies. He has a BS in Chemical Engineering from Georgia Tech and a MS in Food Science from UW-Madison. His career has led him through the successful launch of over 500 products, the installation of $50M in capital equipment, and savings projects totalling more than $200M annually. He currently manages a team of 45 professionals spread throughout the US and EU to launch new companies and products around the world.

To learn more about co-manufacturers, check out our past blog post by Matt Suggs of Partner Slate.