What Silicon Valley tech VCs get wrong about consumer investing

Once I began finance for CircleUp six years back, I encountered many investors whose eyes will glaze over when I mentioned “customer. ”

These investors would fidget uncomfortably or drop their gaze once I explained that our platform will just supply funds to small CPG businesses. I would frequently hear that the cynical comments, such as, “an energy bar company may’t get that big,” “infant food isn’t scalable,” and my personal favourite, “I can’t title one customer business” (real quote by a VC).

Today, needless to say, the tone is much different. Scroll through tech information and also you’ll see everything from Greylock Partners singing the praises of CPG startups, Sequoia’s Michael Moritz joining the board of Charlotte Tilbury, to Lightspeed Ventures coinvesting with VMG Partners, a top mid-market customer firm.

Alongside blockchain and AI, “technology-enabled” CPG startups are now a bona fide craze for Silicon Valley VCs. The uptick in technology VC dollars going to the CPG market is partly because technology investing is brutally competitive and saturated, and mostly because these VCs are stirring to the strong historical returns in CPG, especially with the tendency leaning towards little brands stealing market share.

Consumer is a massive market — roughly 3x the size of technology, as noticed below.

Regardless of the size of this current market, the early-stage has historically been underserved by shareholders due to market inefficiencies such as the geographic dispersion of brands and a lack of structured data sources (i.e. there is no Silicon Valley for customer, and surely no Crunchbase equivalents — yet). In concept, the current trend of VC dollars going to fill a funding difference in CPG should result in a win-win. In effect, lots of the VC investments into customer are misguided, and at times dangerous. Investors may lose cash, but entrepreneurs may lose businesses theyrsquo;ve spent lives building.

There are a few things that VC investors should keep in mind to make certain they invest in a manner that benefits both the entrepreneurs they utilize.

One firm won’t rule its economy

The heart of the issue with technology investors in CPG is that they operate under the premise that one CPG participant can rule its market. They believe that because in technology, it’s mostly true. When you look at Uber and Airbnb, it’s likely that one or 2 players could own 70% of their respective markets. Holding this premise in the CPG space, nevertheless, in fundamentally flawed.

There has been a secular shift over the last 5-10 years where individuals now prefer unique, targeted products catering to personal tastes. Today, even the action of selecting a beer or hand cream is a form of self-expression. The outcome is a fragmentation with several manufacturers which are more targeted at their offering. A number of these products are inherently smaller in scale and never mean to be mass market–yet do frequently get gobbled up by people consumer conglomerates. The M&A in consumer and retail was over $300 billion in 2017 according to PWC, vs. $170b for technology.

Though the market grows increasingly more fragmented with little to mid-sized brands offering products that are accessible, we’re moving far away from the belief that one condiments or infant products manufacturer can own 70% of its category.

Too-high valuations and big raises are harmful, not encouraging

Relatedly, placing too high a valuation on a CPG business and theorizing it might rule its economy is both counterproductive and unrealistic. It compels the entrepreneur to unnatural and dangerous tactics to fulfill this valuation, or to eventually fundraise again at a lower valuation — or at a higher valuation from anything out-of-tune investor they can find to do — then badly struggle to depart. Some of the spiraling is obvious, such as inflated marketing campaigns which induce growth, often long before the product is prepared, and a few are less obvious, such as inflated amounts in investor decks behind the scenes.    

Ask anyone educated in customer about why Unilever bought Seventh Generation rather than the similar, but much more trendy Honest Company. It’s mainly because of valuation. By every account, the VCs involved Honest Company place a valuation in preceding rounds which made no sense relative to core metrics. Consumer businesses shouldn’t raise $30m in equity to increase, let alone $300m. The consequence: Honest Company couldn’t get the exit it desired,’d to decrease costs, and allegedly faced enormous unrest among employees who had been upset about the way the company was heading.

Ultimately, CPG manufacturers don’t want that much cash to grow. Capital efficiency is among the beauties of CPG. Consumer companies can typically raise $4-8m to get to $10m in revenue, where they’re often rewarding. Tech companies typically raise $40-50m to get to the exact same revenue range, and frequently fail to produce a profit even at that point. SkinnyPop, RXBar, Sir Kensington’s and Native Deodorant are great examples of this lean operations characteristic of CPG.

An Excellent brand isn’t as simple as a D2C design and a sleek website

In the past year I’ve had 10-20 technician VCs phone me and say a few variation with this: “we want to get into customer, but it needs to be technician enabled, since we advised our LPs we’d invest in technology companies. ” This over concentrate on D2C leads VCs to place too much cash into the business at too high a valuation.

D2C is a station. The same as the convenience store channel (i.e. 7/11), club (Costco), mass (Walmart) and grocery (Safeway). Like these other channels, DTC has pros and cons. It is not a Holy Grail. Too frequently, we see inexperienced VCs talk about D2C as “lower price” if in reality the average D2C brand raises 10-30x that the amount of brands on the offline world with massive overvaluations. Tell a D2C entrepreneur that their station is cheaper than offline, and she will quickly explain to you that the Client Acquisition Costs in the previous 3-5 years have made that no longer true. If D2C is better earnings, why did Bonobos raise $127m, Dollar reluctantly Club raise $164m and Casper raise $240m?

D2C is a station, but it does not change the underlying fundamentals of what makes a successful CPG business. Those fundamentals, besides team and margins, are manufacturer, supply and product differentiation. Item differentiation in customer is essential, but not sufficient, for achievement. The item must be unique relative to other offerings, and in ways that matters to individuals. Kind Bar appeared like actual food comparative to Clif Bar, 5 Hour Energy was the only energy beverage fit for on-the-go, and Halo Top gave you permission to eat an entire pint in one sitting. If these seem absurd, they’re all billions-dollar businesses that every increased much less than the normal tech firm, thus with less dilution.

How forward

Consumer is an amazing market with massive depth and presents a wonderful opportunity for investors to help build the dreams of entrepreneurs together. If VCs truly need to be successful in this current market, they will need to take the time to understand the fundamentals of customer investing. I hope that more investors grab on to this so that wonderful consumer entrepreneurs may continue to get the capital and resources that they need to thrive.

Read: https://techcrunch.com

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