Editor's Note: This story is part of a package on DTC exit strategies. Find the rest of the stories here.
The direct-to-consumer model has surged in popularity over the last decade, led by DTC darlings aiming to disrupt their respective spaces. But now, many of those brands have grown up.
At a certain stage in its life a brand begins to eye its next move. The brand at that stage is generally between five and 10 years old and has seen revenue materialize, to at least $40 million in annual revenue, according to Alex Song, CEO of DojoMojo.
"I think that gives both investors and strategic acquirers more confidence that your brand is legitimate and scaled to a place that it has longevity," he added.
Profitability, or a clear path to reach that point, is also a good sign a company is ready for that next step — though, as some recent exits have proven, it's not a requirement.
The founders or brand leaders realize that in order for the brand to level up to the next stage of growth — and access more money — they need to bring in professional management or expertise, generally through an exit or other capital infusion.
"It's just human nature. People want to be rewarded for their hard work," said Hemant Kalbag, a managing director at Alvarez & Marsal. "We have generated a lot of millionaires and multimillionaires and billionaires for startup companies over the last 20 years. So, it is very natural that as an entrepreneur, or someone with an idea that has a startup, to be thinking of how they can create value out of their idea. An exit is typically the monetizing moment for an entrepreneur."
Historically, brands had two major options when forming an exit strategy: selling shares on the public market through an initial public offering or direct listing, or selling to another company.
Over the last decade, acquisitions by a corporate or strategic buyer have been the most popular option among direct-to-consumer brand exits, hitting above 100 every year from 2016 to 2020, according to data provided by PitchBook.
"Up until probably the last year or so, M&A was the main kind of exit. It was a way to exit and get bought by a bigger brand or conglomerate or a big CPG company," said Andrea Hippeau, a partner at Lerer Hippeau, a venture capital fund that has invested in some of the biggest DTCs, like Casper, Allbirds and Warby Parker. "But now, with SPACs and the IPO market, we're really seeing that as an even better exit strategy sometimes."
Top DTC mergers and acquisitions, by deal value
|Company name||Close date||Deal value ($B)|
|Supreme New York||12/28/20||$2.1|
|Dollar Shave Club||8/10/16||$1|
The next most common exit options were IPOs, then de-SPACs, which is when a SPAC — or special purpose acquisition company — completes a merger with a target company in order for that company to become publicly traded. That form of going public, however, hasn't been particularly popular across industries, let alone retail, up until recently. So far in 2021, 66 brands have been acquired, 38 experienced a buyout and 19 filed for an IPO, bringing the total exits, as of Aug. 3, to 123, the data found.Buyouts from private equity were the second most popular exit, according to Pitchbook. Though buyouts and leveraged buyouts are forms of acquisitions, by Pitchbook's definition, this category is a private equity transaction where a firm acquires all, or a significant amount, of equity in a company. A firm will generally use a mix of cash and debt to acquire equity in a buyout, whereas in an acquisition, the transaction can be achieved through cash or stock.
Acquisitions have remained the most popular exit
Total exits among DTCs reached their highest point in 2018 with 202 and have remained close to those levels in the years since.
Now, alternative avenues have gained steam, particularly SPAC deals. So far in 2021, 412 companies across industries have gone public through the method, up from just 59 in 2019, according to SPAC Insider.
But as the methods expand, so does scrutiny from outside forces, complicating DTC brands' exits. The Federal Trade Commission, for example, works to block anticompetitive mergers and business practices in order to protect consumers. As a result, a number of deals have fallen apart following FTC actions, notably those of razor brands Harry's and Billie. Schick maker Edgewell was set to acquire Harry's for $1.37 billion, while Procter & Gamble was going to buy Billie for an undisclosed amount. Both deals ultimately were called off following separate lawsuits.
And SPACs face increased scrutiny from the Securities and Exchange Commission, potentially muddling the exit path.
Brands now need to think critically about the state of their business and where they want it to go next when determining an exit plan.
But why exactly does a brand need an exit strategy?
An exit should be a natural next step in a brand's life when it realizes it needs more funds or resources to continue serving customers effectively, according to Rebekah Kondrat, founder of Kondrat Retail, a retail consultancy that helps direct-to-consumer brands build stores.
"The hope is that a company, a brand creates a product that fills a need for customers," she said. "And the acquisition or IPO — whatever that process is — is just kind of a naturally occurring thing because the brand needs more capital, it needs additional support to continue to service its customers and service its constituency."
But that's not always the case. Some companies build a brand with an exit in mind from the very beginning — sometimes before their products even hit the market. "That's just the rules. You always start by figuring out what you want to be when you grow up because it helps drive your strategy," Paula Rosenblum, co-founder and managing partner at RSR Research, told Retail Dive in an interview.
When this happens, however, it creates this "insatiable desire to get to the exit point," Kondrat said. This can result in the customer getting left behind and the products ending up subpar.
"It's not good for anyone in the equation: the brand, the customer or the bankers, frankly," she added. "But it's still a thing that happens. People look for a 'whitespace,' and they want to build a brand with an eye on exit. It doesn't seem like those are the ones that become the unicorns, if you will."
It's a problem that stems in part from how most startups raise funds early on: venture capital. From 2015 to 2019, VC firms made, on average, 121 investments in the internet retail space per year, according to data from PitchBook. Compared to other sectors of retail, internet retail has them beat out in terms of VC interest: In 2019, internet retail accounted for $2.5 billion of retail's VC funding, while specialty retail notched $682 million.
"There was, at one point, a very strong push to infuse a brand with a ton of capital, performance market the crap out of it, and then push it to exit, whether that's through IPO or acquisition."
Founder of Kondrat Retail
But venture capitalists generally have a short time frame for when they want to get their money back on an investment, usually between two and five years. "For them, I think having money tied up any longer than that doesn't fit their business model," Kalbag said.
"That's definitely the model, which is: You invest early and in some ways you exit early," he added. "And to be able to do that, you have to think about the value that you're creating and an exit strategy pretty early in the cycle."
Before a VC invests in a brand, it's important to understand what its long-term goals are and what direction it expects the brand to head, according to Hippeau. This is why DTC brands map out their exit strategies years before actually reaching that point.
"It's important to understand what the North Star is and what you're working towards," Hippeau said. "If you're going to raise venture money, then your investors are looking for venture-style returns, and so you need to kind of be thinking about what your options are for an exit."
In the past, this pushed many brands to adopt a grow-at-all-costs mentality.
"There was, at one point, a very strong push to infuse a brand with a ton of capital, performance market the crap out of it, and then push it to exit, whether that's through IPO or acquisition," Kondrat said.
This was evidenced when Casper filed its IPO documents in early 2020. The DTC brand at the time reported that while its net revenue reached $358 million in 2018, its operating loss was $92 million, as was its net loss. Meanwhile, its sales and marketing expenses were $126.2 million, of which $116.8 million was for advertising. It became clear to investors that the brand was unprofitable and the likelihood of it reaching profitability soon was slim, resulting in a less-than-stellar public debut, according to analysts.
Now, however, there's a movement away from this fast-growth model, and more brand-friendly VC firms have popped up that help brands grow at a more sustainable pace.
"There will always be a push for return on investment for any investor, but now I think it has slowed down — growing slower, but growing better if you will," Kondrat added. "Growing more sustainably is much more favorable than pumping a bunch of money into a brand, buying up all of the Facebook and SEO just to get its gross revenue to a certain point where it looks good for an exit, and then the brand kind of crumbles under its own weight."
Part of this is fueled by the fact that larger companies no longer have an appetite to acquire unprofitable businesses and investors keep a closer eye on a company's profits in the public market.
"It used to be that bigger brands would buy unprofitable smaller, high-growth companies just to get the growth velocity. I think that has changed, where these bigger companies are looking for businesses that could be stand-alone businesses within their bigger company. They don't want to take on a company that's burning a ton of cash," Hippeau said. "New founders, who are starting companies today, understand that, and I think are much more realistic about where you need to be in that respect to get an exit."
Is there a right way to exit?
There are many things a brand needs to have in place before plotting an exit, including "having a clear value proposition for your customers and delivering relentlessly against that value proposition," Kalbag said.
But when the time comes to actually make moves toward an exit, there's no one-size-fits-all option. There are a number of questions brands need to consider when determining the avenue that meets their needs. "Does it have the legs to be freestanding? Or is it better off being acquired?" Rosenblum said.
"Everything is so unpredictable that I would just stand pat. I wouldn't exit now. I wouldn't exit unless I was out of money. I wouldn't let myself be bought. I wouldn't go public. I would just wait."
Co-founder and managing partner at RSR Research
It also really depends on what the brand needs. For example, a brand like Schmidt's Naturals may seek the infrastructure of a larger company, therefore an acquisition may make the most sense for it, Kondrat said. Or, as in the case of Eloquii, Walmart was able to provide the brand with immense marketing power and allow it to reach more customers. And SPACs, Kondrat said, can sometimes be "used in place of the later rounds of capital raising," when a brand wants to avoid raising more money from investors, but isn't yet profitable enough to plan a successful IPO.
And the pandemic, which rattled much of the retail industry, is also complicating the timing of when a brand pursues an exit.
"Everything is so unpredictable that I would just stand pat," Rosenblum said. "I wouldn't exit now. I wouldn't exit unless I was out of money. I wouldn't let myself be bought. I wouldn't go public. I would just wait."
Brands, ultimately, should be focused on their business in the here and now, and work on growing sustainably, without putting too much emphasis on a carefully crafted exit plan that may have been put in place years ago.
"The goal should not be to find the right exit strategy," Kalbag said. "The goal should be how to build a healthy, robust and productive business. And I think an exit is a consequence of that, but it shouldn't be the North Star that guides your strategy."
Editor's Note: This story is part of our ongoing coverage of the direct-to-consumer space. Sign up for our weekly newsletter, Retail Dive: DTC, here.