How direct-to-consumer brands can avoid startup purgatory

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We are entering into a new phase where the smartest direct-to-consumer companies are figuring out there is a better path to growth than relying strictly on venture capital funding. Over the last few years, we’ve seen fewer than a handful of exits in the the direct-to-consumer (DTC) category that could be deemed successful. The majority find themselves stuck in startup purgatory, waiting to enter the gates of liquidity.

Don’t get me wrong; venture capital has been a tremendous asset to many DTC brands. Products that feel tangible gain access to initial friends and family investors, as well as angels who make up the top level of the VC funnel. Less than a decade ago, a plethora of DTC companies came onto the scene with significant early revenue traction, big rounds of venture capital, and high impact growth acquisition through the use of social paid marketing. Think Bonobos, Casper, Warby Parker, The Honest Company, and Birchbox, to name a few.

But within a few years, the market became overly saturated, and social media acquisition channels became less effective at facilitating capital efficiency. Nonetheless, these companies had to keep raising funds at higher valuations to keep their existing investors happy. The problem was that funding was contingent on the promise of continued revenue growth which, in turn, created pressure on businesses to prioritize growth at any cost.

Of course, when a company’s sole focus is to maximize shareholder returns through scale and speed, it develops undisciplined operational habits and is unable to build a sustainable and profitable business.

Which brings us to the present day landscape — one where many of the largest DTC startups are sitting on significant capital raises with no exit in sight. Companies that started off strong, like Casper and Warby Parker, are now stuck in “purgatory.” The main problem these VC-backed brands are facing is that they’ve raised too much capital to slow down revenue growth in their current business model. Acquisition isn’t a viable option because the valuation expectations are too inflated for an acquisition to happen at a price that makes sense to a strategic buyer. Furthermore, their reliance on their direct distribution channels and differentiated supply chains means there are limited cost synergies or vertical integration opportunities that a transaction requires. The irony is that the same distribution channels that were the reason for rapid success now block strategic exits.

Need for new approaches

None of this is to say that consumer brands are losing their appeal. Consumer tastes continue to be subjective and ever-changing, providing tremendous opportunities for new brands to enter the market. The difference now is that the most typical approach has failed, bringing us to an important crossroads as DTC companies formulate new approaches to building and scaling their brands. They can continue to try to accelerate revenue growth to drive up valuations, even at the cost of being able to build a sustainable long-term business, or they can slow down growth to focus on building a long-term sustainable business model.

One approach that is seeing success is a Holding Company model, where companies build a portfolio of product lines to create shared cost efficiencies internally. Harry’s Ventures and Glossier are two great examples of this, both recognizing this model as an opportunity to avoid purgatory and create a sustainable standalone business. In February 2018, popular shaving company Harry’s raised $112 million to move beyond shaving. It went from competing with Gillette in the razor industry to taking on Procter & Gamble through strategic venture capital investments. Similarly, Glossier, a digital-first beauty brand, launched Glossier Play on the road to becoming the next big beauty conglomerate. Harry’s was acquired by Edgwell for $1.37 billion in May 2019, and it’s likely Glossier will be the next brand in line for a big payday given its attractive portfolio approach.

Another common tactic we’re seeing is brands testing wholesale in the hopes of acquiring more customers. A few examples of this are Allbirds and Reformation selling through Nordstrom, and Bevel selling on Amazon. In each case, these brands used Nordstrom and Amazon as a marketing funnel, helping them get in front of a new set of consumers more efficiently.

These newer approaches minimize the need for significant VC, allowing companies to focus on profitability instead. And while many DTC brands have had to suffer in stasis to demonstrate the necessity of a new model, I’m certain many of the companies that currently find themselves struggling for an exit could have been in a very different position today had they raised less capital and focused on capital efficient growth early on. To that end, it’s my prediction that the tides are changing and that we’re on the precipice of a new era of DTC growth — an era with less reliance on VC and more focus on innovative growth tactics. Only then can companies avoid joining the ever-growing population within startup purgatory.

Alex Song is founder and CEO of Innovation Department.