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.