complicated concepts

Investing in D2C/consumer-goods companies

Today’s topic: investing in D2C/consumer-goods companies

It’s not uncommon for VC firms to specialize in a specific vertical. But there are a few industries that most VCs won’t touch. And one of those is consumer goods: CPG / D2C (consumer packaged goods and direct-to-consumer). But this doesn’t mean the category is un-investible. There are angels and even VC funds that will take the risk on a D2C brand.  

I wanted to learn more about what it takes to make smart bets in this category, and what a realistic outcome is for the brands that can get to an exit. For that, I interviewed Jamie Melzer, active angel investor and managing partner at Hustle Fund Scale. Here are my big takeaways.

D2C is hard because of CAC

There are several reasons D2C is a tough category. One is CAC.

Back in 2010-ish, going direct-to-consumer was a novel concept. Brands that arrived early to the trend (Warby Parker, Dollar Shave Club, Casper, Mejuri) thrived. They cut out the middleman, which allowed them to offer super competitive pricing to consumers. Retention was high because the brands owned all their customer data. And customer acquisition costs were low because there were so few brands going D2C.

Life was good.

But because the barrier to entry for D2C was so low, it was only a matter of time before D2C became the norm. Now there are many D2C brands across every category – jewelry, skincare, clothing, accessories… even vitamins. And they’re all competing with each other for customers.

To be clear: these D2C companies aren’t just competing with other brands in their category. They’re competing with every other product that’s marketing to the same customer.  

So the jewelry brands are competing with the clothing brands are competing with the accessories brands… and so on. With so much competition and noise, retention is hard, which means that most of these brands are continuously increasing ad spend to generate growth.

D2C is hard because of TAM

Reason number 2 that D2C is hard: TAM. It tends to be smaller than most SaaS companies.

For example: the TAM for a U.S. DTC swimwear brand is ~$22B. The TAM for a fintech SaaS company could be 10x that. This is a big reason early-stage VCs don’t invest in D2C. Early stage VCs need that 100x return (more on that below), and consumer brands often aren't big enough to get the $1B exits that VCs need to invest at the early stage.

D2C is hard because of the growth model

Another reason D2C is tough? Growth is linear … if you’re lucky.  

SaaS businesses are different. A SaaS company will spend $X to acquire a customer, and then see recurring revenue from that customer via a subscription model. The cost to keep a SaaS product running is pretty much the same whether you have 1 customer or 10.

This is why SaaS companies can grow exponentially. They can 10x their revenue without 10xing their costs. Even if they go from 10x to 100x growth, a SaaS company’s costs will only increase incrementally. This is why they can command higher exit multiples.

But consumer goods companies work differently. A D2C company that wants to 10x their revenue has to 10x their costs. And because consumer goods are often manufactured months before they are sold, the businesses require a lot of working capital to grow.

(To be fair, as D2C brands grow, they manufacture larger batches of their product, and their cost-per-good goes down. This helps with the margins somewhat, but it can take a while to get there. And they need to have enough working capital upfront to cover the cost of those orders).

So, a parent company might acquire a SaaS business for 20x-50x the current revenue of the SaaS business because the parent company can continue exponential growth without exponentially increasing expenses. But if a parent company wants to acquire a D2C brand, it needs to allocate considerable budget towards keeping that business alive. It’ll need to continue to fund the creation, marketing, and distribution of the product. Like, forever.  

D2C isn’t un-investible, though

It’s pretty clear why early-stage VCs tend to stay away from e-commerce or CPG or D2C companies. Pre-seed funds invest in 100 companies knowing that only 1 or 2 of them will return the entire fund. This is why pre-seed funds need to focus on those 100x returns. But the category isn’t un-investible. D2C tends to be popular for angel investors ... especially if the angel investor has a personal affinity for the product/brand.  

Later-stage funds can also be good candidates for D2C brands if the company has been de-risked in some way. These funds often aim for a higher stake in the business and lower multiples in the return.

For late-stage (think established, multi-billion dollar companies) the risk of failure is comparable to public mid-cap equities. And a 2x return in a 3-year period (to IPO) generates a 30%+ gross IRR, which is above most venture fund returns.

(Can you tell I stole that line directly from Jamie’s mouth?)

For Series B or C (also known as the “growth stage”), investors are likely looking for a 5x-10x return. This could also feasibly get the fund to 30% IRR, depending on the time to exit.

And there are always exceptions

As with any industry, there are unique snowflakes that play by their own rules. comes to mind.

Technically Ancestry’s DNA test is a D2C product. But its technical component and strong network effects make it hard for other brands to compete.  

Fertility is a growing consumer industry that could have strong outcomes, according to Jamie. The pain point is massive, the market is big, and the margins are high. And that’s a trifecta most investors can rally around.