This Fashion Startup Is At The Center Of A $500 Million Fraud Crisis

Axios reported earlier this week that fashion tech company Caastle is virtually broke and its founder, Christine Hunsicker, is being accused of financial misconduct, according to Axios’ anonymous sources.

Axios says the company told prospective investors that it generated $519 million in 2023 revenue and that the actual number was $15.7 million.

If you haven’t heard of Caastle, it presented as one of the most interesting startups in the fashion business. Here’s how it worked:

One of the biggest problems in retail fashion is markdowns. You get people into your store by showing them flashy fashion products. But when they come in and shop, they mostly buy basics. That leaves retailers with the need to create products that get attention, but those items often get left on the shelf.

Caastle had an answer. It took control of unsold inventory and rented it out. After all, you might want an eye-catching garment for an event but you are less likely to want to wear that outfit on a regular basis. Caastle maintained that it could make a profit on the rented garments where the retailer would otherwise have had a loss.

It had arrangements with Express, Ann Taylor, Bloomingdale’s and other brands and retailers.

The Wall Street Journal reports that investors included Peter Thiel, Bill Ackman and Henry Kravis. According to the Journal, Caastle sent a letter to its shareholders recently that said Hunsicker had “provided certain investors with misstated financial statements and falsified audit opinions” and that the company was “facing a severe and immediate liquidity problem.”

When I asked Caastle about the accusations, they told me this: “The Board is deeply disappointed by the conduct that has led to this moment. Our immediate focus is on addressing the company’s challenges, supporting our employees, and preserving the value of our technology and business operations. We regret having to temporarily furlough our employees, but we believe this will best position the company to successfully recover from our current situation.”

Axios said all Caastle employees have been furloughed for two weeks starting this week.

According to Pitchbook, it also had over $180 million of investors’ capital and was valued at an estimated $596 million.

How Can This Happen?

In hindsight, it’s always easy to see that something was heading down a bad road. So how could sophisticated investors allow their money to go down the drain like that and be associated with such a big fraud and failure?

If you’ve ever seen the deck for a startup, they’re not long on financial details. A potential investor has to dig and ask a lot of questions in order to get into the weeds on the financials.

Founders are often not so well versed in the financials, they are more commonly focused on building and the mission. It’s easy to get caught up in their enthusiasm.

Cash Never Lies

One thing is almost always true about startups: having a lot of cash doesn’t ensure success. But the opposite, not having enough cash, will ensure failure.

It’s often compelling to fuel a dream with more cash and listening to a founder that’s driven to do something hard can be inspiring. So it’s tempting to make an investment in a company with a mission.

One thing that is puzzling about startups is that while they almost always predict eventual profitability, it can often be pushed further and further into the future. Investors are often tolerant of this approach because the payoff is so big.

What we see in our merger and acquisitions business is that one of the most important things to watch is the cash inside a company. When you see companies reporting big profits but their borrowings are increasing, it’s a sign that something might not be right, the company may be investing in assets that aren’t performing or it may have losses it’s not recognizing.

Because the operations of startups are so often threadbare, reporting may not be up to snuff and it may be hard to get information. And just because cash is burning every month, it doesn’t necessarily mean there’s a fraud happening.

But cash is always a source of truth. If you watch where the cash went, it usually reveals the condition of the company.

In Amazon’s early days, it burned an enormous amount of cash, many billions. And the company would say that profitability is eventually coming. Investors at that time were of two minds: one said you gotta believe. The other said, how big does a company need to get before you say they’re never going to be profitable.

Founders look at Amazon’s story and it gives them inspiration. It also helps investors to have faith.

I can’t say what happened at Caastle and whether the allegations are true or not. Axios and The Wall Street Journal allege that the financials did not reflect the actual performance and condition of the company.

But I know this: if the uses of cash had been better understood during the years in which Caastle was in business, a fraud is a lot less likely to happen. It’s understandable that investors and board members can find it uncomfortable to press on issues when founders and staff are short of time. Due diligence is always annoying.

Questions like those arising around Caastle point out that getting into details about where cash goes, is never a wasted effort.