D2C investing from the point of view of our Associate - Siddharth Shah
As a predominantly angel investor operating in the tech & tech-enabled spaces in India, I rarely focus on D2C or Consumer-focused themes. The way I look at things - venture capital is more suitable for tech-enabled or digital-first companies that can scale rapidly, earn exceptionally high return on capital, and has a very high terminal value. As an angel investor, I like to focus on companies that can reach 50 cr in revenue in 5 years without burning (and effectively raising) a ton of money.
My experience in the public equity markets shows me that companies that have been able to create value for their investors are mostly companies that are:
Asset light
Have a strong moat
Have a long runway for growth
The key issue when I look at consumer brands or D2C companies as a tech investor with a public equity background is that I feel D2C does not fit the bill in venture capital.
There are large players in the market that own distribution
There is zero to low brand loyalty which means constant value add + rediscovering
Lack of scale in D2C translates to poor ROI on these investments
The biggest issue being the last point
Early-stage D2C investments that come in with large fundings at a high valuation distorts the chances of the entrepreneurs chance at a successful exit
Out of the handful of D2C deals I’ve pitched to our investment team, I’ve received feedback like:
a) How many energy bars can you sell?
b) What if Kellogs gets into that segment once it becomes big enough?
c) We haven’t seen a single consumer company going big!
But my pushback is - India is a country with 1.3 billion (and counting), consumer wallets are becoming fatter, and they are becoming more conscious about what they are consuming.
Most investment thesis revolves around tech investing, digital trends, enterprise software, but in reality, consumer is probably bigger than all of them combined. So when someone asks me ‘Is the market large enough?’ I don’t doubt their question, but I know the real question is ‘Is the market large enough for Coca-Cola or Pepsico to enter?’.
By far, consumer has been underserved due to the hype surrounding tech-led investments that return the entire fund!
Tech & consumer investments arent alike and the investment thesis shouldn’t be alike either. We love quoting BCGs Rule of 3 & 4, and that is true to a certain extent, however, consumer mindsets are changing. How you may ask?
Consumers today prefer, and favour unique and targeted products that cater to their personal preferences. Today, if a mother is looking for baby products, J&J is no longer the only option in the market. Today we have companies like MamaEarth & Chicco that have gained more targetted usage. Does a mother trust a large conglomerate like J&J to be able to provide soothing relief to her child more or someone who gives it their all to be the best product their child can use?
By default, these companies have products that are inherently smaller in scale - are never intended to be mass market as a J&J - yet these are the same companies that can be quickly absorbed by larger conglomerates.
Giving too high valuations, and shoving cash down the throat of a D2C company with the hope that it will rule the market is not only unrealistic but also counterproductive. Large fundraises at obscene valuations only force entrepreneurs to pick that path of least resistance i.e. GROW AT ANY COST!
Growing at any cost in software is much different than growing at any cost in consumer. Weren’t you operating in a niche? So you’re telling me your space is now mainstream where you can potentially grow 10x a year for 10 years? Hmm…
The more capital a D2C company raises, the more it is forced to grow at any cost, which leads to expansion into unrelated adjacencies, which leads to higher cash burn, which leads to more funding. In a slim chance, someone wants to acquire the company, the high liquidation preference, last round valuation come into the picture and they’d rather the company shut shop.
The beauty of consumer companies is that it does not need to raise a large amount of capital to grow. These companies can typically raise 3-10 cr, and get to 10+ cr in revenue quickly, at which point they can be profitable. Now to go from 10 cr to 50 cr is a matter of:
a) Growing patiently
b) Growing profitably
When it’s proven that customers want its product, the company has up to 1,000 loyal customers, and now wants to invest some resources to grow from 1,000 to 10,000. This is typically the stage where the company has under 2-3 cr in revenue, maybe operating a breakeven to a minimal EBITDA loss, and now needs capital to get to more customers, and more channels. This typically means capital is invested equally into inventory, distribution, marketing. With some investment, these companies can get to that 10 cr in revenue, run profitably and grow patiently & profitably.
The company’s been growing profitably for a while in a niche, customers like its product, products are present in a few channels, and customers want the company to be accessible more widely, with more offerings. By now, if the company has not been acquired for a handsome figure already, this is a good signal that it’s time to grow! Internally generated free cash won’t get you too far, and this is where you go out and raise a large round. This round can be as small as 50 cr or as big as 500 cr depending on the product suite, industry, current run rate, growth opportunities. This is round that takes the company from a niche, class offering to a mainstream, mass offering - something that has the potential to be scaled up rapidly. And more often than not, this is the round that is a while before an IPO in an ideal world.
There are investors who are primarily tech investors who feel D2C is tech-enabled and has similar characteristics as any other tech business. These are the ones who should stay farthest away from D2C as possible.
D2C is not a tech business. D2C is just another channel that brands use. Just as modern trade or general trade. D2C has its pros and cons. Some VCs feel D2C is cheaper than traditional channels but with the growing customer acquisition costs over the years, this is far from the truth. Consumer companies also do not have better margins just because they are marketed as D2C, because if they did, companies like Rawpressery or Soulful would be profitable, and not have raised a lot of money.
Fundamentally, a consumer company needs to focus on product differentiation, branding, margins, and distribution. Not very different from a traditional company eh?
I do not know about consumer investing as much as others in my field. However, I disagree with those who say consumer investing is a cash burn business that never gets to scale - if you are sensible in the way you raise less, less often, and aim to grow profitably in a niche - you only need venture capital twice in the first 10 years of a consumer business. And that translates to spectacular returns as an early-stage investor!
This post originally appeared here.
Continuing our quest for busting VC jargon for founders, we bring part 3. VC jargon is the defacto manner in which investors talk all the time. It makes them look and feel cool, however, it's usually the first time founders, or interns, or doe-eyed analysts who may not understand all the terms fully, and get super confused.
Today, we are adding to a list of jargons (in alphabetical order) to help you understand some of the VC slang in plain English!
In case you have a better or simpler explanation or would like to add some to the list, ping me at ss@malpaniventures.com
You can check out part 1 & part 2.
A cap table (or capitalization table) is a document (usually an excel spreadsheet) that shows who the shareholders in a company are, how many shares each shareholder holds, and what each shareholder paid to attain that ownership. In addition to the total number of shares issued by the company, the cap table also shows for each financing round the class of the shares issued (e.g. series A preferred shares), any options granted, e.g. under an ESOP, and other equity instruments e.g. convertible loans, as well as the amount of investment, received in each case.
When a venture capital fund has decided that it would like to invest in a startup, it will approach its own investors in order to draw down the money to be invested. The investors in the venture capital fund have promised to make a certain contribution to the fund but the capital call (also referred to as capital drawdown, drawdown, or takedown) is the actual act of transferring the money so that it reaches the startup
Every investor in a venture capital fund commits to investing a specified sum of money in the fund partnership over a specified period of time. The fund records this as the limited partnership's capital commitment. The sum of capital commitments is equal to the size of the fund. The actual transfer of the money is made in a capital call.
When an asset is sold for more than the initial purchase cost, the profit is known as the capital gain. This is the opposite of capital loss, which occurs when an asset is sold for less than the initial purchase price. Capital gain refers strictly to the gain achieved once an asset has been sold – an unrealized capital gain refers to an asset that could potentially produce a gain if it was sold (sometimes also referred to as hidden reserves - because they are not shown on the company's balance sheet and are, therefore "hidden"). An investor will not necessarily receive the full value of the capital gain – capital gains are often taxed; the exact amount will depend on the specific tax regime.
A captive firm is a private equity firm that is tied to a larger organization, typically a bank, insurance company, or corporate group
Carried interest (also simply referred to as carry) is the share of profits that the manager of venture capital or private equity fund receives once the fund has returned the cost of investment to the fund investors. Carried interest is normally expressed as a percentage of the total profits of the fund. The industry norm is 20 %. The manager of a venture capital fund will normally, therefore, receive 20 % of the profits generated by the fund and distribute the remaining 80 % of the profits to investors of the fund.
A change of control occurs when (a) a majority stake is acquired by a party that held no or a minority interest before the acquisition, (b) a company is merged into another entity, or (c) a majority of the voting power of a company changes hands
The churn rate (a.k.a. rate of attrition), is the percentage of customers or subscribers to a service who cut ties with the service or company during a given time period. These customers have “churned.”
In the context of a financing round, the term closing usually describes the final event to complete the investment, at which time all the legal documents are signed, the closing conditions are fulfilled and the funds are transferred. In the context of setting up a venture capital fund, the term closing can have a different meaning. E.g. when a venture capital fund announces it has reached its first or second closing, that does not mean that it is not seeking further investment but that it is ready to make a capital call for the money raised so far so that it can start investing. A venture capital fund may have many closings, but the usual number is around three. Only when a fund announces a final closing is it no longer open to new investors.
As the term suggests, closing conditions are conditions that must be satisfied (or waived) before the closing of a financing can occur (e.g. before the investors transfer their investments to a startup). The closing conditions can vary depending on the individual situation of the startup and the financing round; common examples of closing conditions include legal opinions, the completion of certain milestones by the startup, or passing shareholders' resolutions (e.g. for changing the articles of association).
Closing date is the date when a transaction is brought to completion, i.e. the date on which the closing happens
The term is sometimes used to describe any two parties that invest alongside each other in the same startup, however, when referring to limited partners in a venture capital fund, this term has a special meaning: If a limited partner in a fund has co-investment rights, it can invest directly in a startup that is also backed by the venture capital fund. The investor, therefore, ends up with two separate stakes in the venture - one indirectly through the fund and one directly in the startup.
Common shares are shares that represent ownership rights in a company. Usually, founders, members of the management, and employees or a startup own common stock while investors own preferred shares. In the event of a liquidation of the company, the claims of secured and unsecured creditors, bondholders, and holders of preferred shares take precedence over common shareholders.
A company buy-back is a process by which a company buys back the stake held by a financial investor, such as a private equity firm. A company buy-back is one possible exit route for private equity funds, it extremely rare in the venture capital environment.
Rights on an investor or shareholder relating to control over the company's affairs. Control rights typically relate to voting or designation of board seats, voting, certain actions like debt, promoter salaries, which require consent
Conditions precedent are tasks that must be completed before an investment occurs, an acquisition is closed, an option can be exercised, and so on
Conditions subsequent are tasks that must be completed within a certain period of time after completion of an investment or acquisition. Failure to fulfill the conditions subsequent will usually trigger contractual rights or an automatic mechanism (in the worst case the recission of the transaction).
Convertible loans (sometimes also referred to as convertible notes) are often used by business angels who provide financing to a startup without an explicit valuation of the business. Convertible notes are structured like a loan when the financing is granted but can convert into equity (meaning shares in the startup) when certain events occur, e.g. an equity financing in which a venture capital firm invests in the startup
The rate at which the loan amount is converted into equity (the conversion rate) usually matches the conditions of the equity financing less a discount (usually in the range of 10 to 25%).
Corporate venture capital or corporate venturing refers to large corporations making venture capital investments. Usually, this is done for strategic reasons (so-called strategic investments). However, there are also corporate venture capital funds that stress their independence from their parent company. Corporate venture capitalists sometimes provide access to the existing customer base and know-how of their parent which can be of benefit for startups.
A covenant is a legal promise to do or not do a certain thing. For example, in a financing arrangement, company management may agree to a negative covenant, whereby it promises not to incur additional debt. The penalties for violation of a covenant may vary from repairing the mistake to losing control of the company.
Also known as Break Even Point
CRM is short for Customer Relationship Management. CRM is a strategic approach in which internal procedures are focused on the interaction with a customer (rather than merely the product) with the goal to establish a lasting customer relationship.
Where a private equity/venture capital firm invests in the same company at different times from different funds, i.e. uses its current fund towards a financing round in a company which forms part of the portfolio of one of its earlier funds.
And we're back with part 2. VC jargon is the defacto manner in which investors talk all the time. It makes them look and feel cool, however, it's usually the first time founders, or interns, or doe-eyed analysts who may not understand all the terms fully, and get super confused.
Today, we are adding to a list of jargons (in alphabetical order) to help you understand some of the VC slang in plain English!
In case you have a better or simpler explanation or would like to add some to the list, ping me at ss@malpaniventures.com
Adding some that we missed in Part 1
Average revenue per user. If the company has revenue of Rs 1 lac, and 1000 users, the ARPU = Total revenue divided by Total users. In this case, 1,00,000/1,000 = 100
Annualized run rate. If the company has a revenue of Rs 1 lac in a month, the ARR of the company is Rs 1 lac x 12 months = 12 lacs
Allocation is the size of the round that is set aside for an investor or a group of investors who have usually committed verbally (soft commitment)
B2B means Business to Business. This means the model is for a business to sell its goods or services to another business
B2C means Business to Consumer. This means the model is for a business to sell its goods or services to end users or individual customers
Barriers to entry mean obstacles that a company can face while entering a market. This can be created because of the existence of other companies, brands, patents, exclusivity, monopoly, large investments required to get started, etc.
An acquisition offer that is so attractive that the company's management & board must accept it, if it does not want to risk the shareholder's ire
Book runner is the lead investment bank that manages the entire process of equity or debt financing including documentation, introductions, syndication, pricing, allocation & closing
A bootstrapped company is a company that is funded by the entrepreneurs own capital or personal resources or the company's revenues
The Break-even point is the point at which the company starts to show positive operating results. A breakeven point is a point where the company's expenses are totally met from the company's revenues, and the company is neither loss-making nor profitable
A bridge is a short-term financing option that can be either equity or debt, or both, which can be used to fund the company until it can find a more comprehensive long-term financing option
Burn rate is the rate at which a company consumes capital to cover expenses. This is typically expressed on a monthly basis. A company with a high burn can not operate for long without growing revenues, or raising capital.
A business plan is a summary that captures the key attention of the investor. It gives us a synopsis of the business concept, history, industry, market, competition, management, marketing plan, a financial plan for the future.
VC jargon is the defacto manner in which investors talk all the time. It makes them look and feel cool, however, it's usually the first time founders, or interns, or doe-eyed analysts who may not understand all the terms fully, and get super confused.
So today, we are creating a list of jargons (in alphabetical order) to help you understand some of the VC slang in plain English!
In case you have a better or simpler explanation or would like to add some to the list, ping me at ss@malpaniventures.com
Now, onto simplifying complex words! Today, starting with the Letter 'A'
Accelerated vesting is a form of vesting that takes place at a faster rate than the initial vesting schedule. This allows the option holder to receive the monetary benefit from the option much sooner. The conditions or events upon which accelerated vesting occurs are usually determined in the shareholders’ agreement. Typically, accelerated vesting is triggered by an exit, but an involuntary termination of employment can also be a trigger event.
Accelerators are institutions aimed at promoting and accelerating the development of startups by providing to the startups coaching, various support functions, and facilities (e.g. office space, infrastructure) for a fixed period of time. In return, the accelerator usually receives an equity stake in the startup. For example, Upekkha is a SaaS Accelerator.
A program that is run by an accelerator. Usually, accelerator programs are structured and the more prestigious and successful an accelerator program is, the more rigorous the selection process can be.
An acqui-hire is when a company acquires a startup to obtain the startup's team, rather than to own its products or technology, which it often kills after the purchase. It has become an increasingly popular hiring method, especially to gain access to talents that are not on the job market.
The process of taking over a controlling interest in another company is called an acquisition. The term also describes any deal where the bidder ends up with 50 % or more of the company taken over.
Artificial Intelligence
The first limited partner to commit to a fund is sometimes called the anchor investor.
An angel investor is a person who provides a small amount of capital to a startup for a stake in the company. Such an angel investment typically precedes a seed round or angel round and usually happens when the startup is in its infancy. Although angel investors are rarely involved in the management of the startup, they often add value through their contacts and expertise. Malpani Ventures is an angel investing firm.
Anti-dilution provisions are provisions in the shareholders’ agreement that are intended to protect the investor by preventing a subsequent issue of shares from being made at a lower price than the investor originally paid. This protects the original investment or value from being diluted. Examples of commonly-used anti-dilution protection include broad-based weighted average ratchet, narrow-based weighted average ratchet, and full ratchet anti-dilution. We prefer a broad-based weighted average.
An asset deal is an acquisition in which the buyer acquires from a company (essentially) all assets of the business or a part of its business. This usually happens before an acqui-hire, where the acquiring company buys all the IP of the target company for a nominal sum before shutting it down.
At Malpani Ventures, we believe that our success lies in the success of the founders whose startups we invest in. In today's growth at any cost investment ecosystem, where companies are encouraged to focus only on revenues, we want to explore the road less traveled by supporting founders that want to create profitable, sustainable businesses at scale.
Startups need capital to grow, and while larger organizations have the liberty of using internal accruals, debt, or equity to fund their growth, startups do not. Even if they are profitable. Their P&L is not strong enough to support growth. Banks are not willing to lend to smaller companies as they are deemed risky. Venture debt is almost negligible, and whatever exists is predatory. And VCs are not interested in businesses that are not in hyper-growth domains.
For startups that are willing to grow organically, but have limited resources at their disposal, we are willing to extend the option of Revenue Based Financing or RBF. We want to offer growth capital to startups that can be in the form of revenue or income share agreements. The founder decides how to structure the RBF. All we are looking for is a 35% IRR that makes it worth our while.
Timely infusion of funds can help founders grow their businesses faster, and everyone in the ecosystem benefits. We focus on unit economics and helping the founder grow their business frugally.
We are actively looking to fund companies in SAAS or eCommerce domain
We want to fund companies with gross margins of more than 50%
We will prefer founders utilize RBF funds in sales & marketing, geographic expansion, or working capital financing
We will partner with founders who want to grow frugal businesses
We have a soft corner for founders from Tier 2 & Tier 3 towns in India
We will prefer mature founders who have a domain experience
Our financial goal is to make a 35% IRR from this instrument
We plan to provide 6-9x of Monthly Revenue Runrate as RBF funds
The variable revenue share can be between 5-10% of monthly revenues
The fixed coupon of the instrument can be as low as 0.01%
We welcome prepayments at any point in time
We will extend a moratorium of up to 6 months after disbursal
We will close the instrument once we receive our expected IRR
In companies where we are not existing equity investors, there will be equity of up to 1% which will be transferred to face value to us at the beginning of the RBF. This will be returned back to founders at face value itself when the instrument closes. This is because Section 73 of The Companies Act does not permit anyone except Shareholders, Directors & Relatives of Directors to extend a loan to a private limited company. Once equity is transferred to us, we can extend the loan as a Shareholder.
If you are a founder whose startup fits our thesis, please reach out to Siddharth at ss@malpaniventures.com with the subject line 'RBF: [Your Startup Name]'
With venture capital funding drying up due to Covid, many startups found themselves on the lookout for alternative funding structures that do not require diluting equity. And rightly so, because equity dilution is expensive in the long run.
And herein came the moment of truth for Revenue Based Financing. Revenue Based Financing (RBF) is a type of revenue share or profit share funding structure that has started gaining traction over the past few years. Unlike equity funding, an RBF is a fixed sum that is repaid over a period of time from the incoming revenue the company generates. Startups receive funds from investors to spend on marketing or working capital or any strategic need, and the funds are returned back to the investors from every sale the company makes.
Allow me to explain very simply
Let's say an eCommerce company is generating Rs 12 lacs in monthly revenue and requires capital to build out their inventory and spend on advertising. With a ROAS (return on ad spends) of 3.5, they can generate Rs 3.5 in revenues for every rupee they spend on ads. This eCommerce company has a healthy 60% gross margin and has fixed costs of Rs 6 lacs.
Equity raise
In case of a regular equity raise, the company may receive a max 10x ARR multiple in terms of valuation. In this case, 12 lacs x 12 = ~1.5 cr ARR, and ARR x 10 = a max valuation of 15 cr. If the founders dilute ~20% then they can raise up to 3 cr.
If they spend 40% of the funds in marketing, at ROAS of 3.5, the company can generate ~5 cr in sales in the coming 12-18 months. With a 60% gross margin, and an inflated fixed cost base of 15 lacs per month [because VCs love it when you experiment (10% funds), grow the team (20% funds) and add new products (10%), and the rest is working capital (30% of funds)], they will be at an MRR of 40-45 lacs and breaking even, and again in need of funds in 18 months.
RBF route
Now, if they would have opted for the RBF route, the company could have received up to 10x MRR or ~1.2 cr in funds from investors. RBF funds are typically for very specific needs of the company like working capital or marketing spends. If this company spends 65% of funds received for marketing and the balance on working capital, it has 70-75 lacs to solely focus on marketing that can potentially take them to ~25-30 lacs in monthly revenues without diluting equity. They pay investors only from the revenues they generate (typically 5-10% of monthly revenue) and retain entire equity with themselves. Say for example the company generates 20 lacs of sales, they pay the investor 20 lacs x 7.5% = 1.5 lacs that month. If they generate 40 lacs, they pay 40 lacs x 7.5% = 3 lacs that month. They pay this revenue-based return back to investors every month until they pay the pre-determined IRR which is usually 25-35%.
VC funding
A couple of years later, with much better traction, they can raise a large round of equity from VCs and pay off the RBF instrument. RBF is kind of a rocket fuel capital infusion that gives founders immediate cash for growth without having to dilute equity. There are also no fees involved typically so the company gets the entirety of the cash.
Our views on RBF
RBF is a growing trend especially for eCommerce and SAAS companies that enjoy healthy gross margins. At Malpani Ventures, we have successfully exited an RBF in a SAAS company generating a 30% IRR in a span of 16 months. During this period the company was able to use funds to grow its marketing initiatives and cross over a million dollars in ARR with founders retaining a good majority of their stakes.
We are always on the lookout to explore RBF opportunities in the eCommerce & SAAS space. Prospective founders are encouraged to read more about our RBF thesis here. Please reach out to us if you think we are the right investors for you! We want to work with founders who can create win-win outcomes for everyone!