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Why the next Warby Parker or Allbirds might not be backed by VC

VCs used to be happy to write sizable checks to companies that sold branded apparel, mattresses, suitcases, beauty products and other goods online. Now they’re getting far more selective.

VCs who backed direct-to-consumer specialists Warby Parker and Allbirds have something to celebrate.

Shares of sneaker maker Allbirds soared 90% in its Wall Street debut last week, giving the company a valuation of about $4.1 billion, far above the $1.7 billion value it garnered during its last private round a year ago. Warby Parker, the eyewear brand that went public through a direct listing in September, now trades at a market cap of around $6 billion, double the $3 billion valuation that was reportedly assigned to the retailer in its Series G round in August 2020.

Successful public offerings in a particular sector are often followed by a wave of venture investments into similar types of startups. But this is unlikely to be the case for DTC companies.

Up until several years ago, VCs were happy to write sizable checks to companies that sold branded apparel, mattresses, suitcases, beauty products and other goods online. These startups’ purported advantage is that by cutting out the middleman and saving money on physical retail space, they could offer consumers higher-quality, less expensive products.

But more recently, it became increasingly apparent to venture capitalists that the DTC business model isn’t as cost-effective and scalable as initially thought. With few barriers to entry, other startups and incumbent retailers started copying the successful brands. In the process, they drove up the cost of acquiring customers via ads on Google, Facebook and Instagram.

Additionally, VCs encouraged many of these companies to grow at any cost, resulting in a number of high-profile disasters.

“Direct-to-consumer is a really saturated market. I think it is hard for these startups to generate strong returns relative to enterprise companies,” said Michael Kim, founder of Cendana Capital, a fund-of-funds that backs Lerer Hippeau, the VC firm that led Allbirds’ seed round and participated in Warby Parker’s Series A.

By comparison, Kim said Cendana’s portfolio managers are more excited about SaaS enterprise deals, which have seen revenue valuation multiples generally about five times higher than those of DTC startups.

VCs’ recent reluctance to invest in the so-called digital-first brands isn’t only about their less attractive top-line valuations. It turns out that increasing sales and building a defensible online brand are very difficult to do.

“You need a highly experienced customer acquisition specialist combined with a strong product person to create a great DTC company,” said Yash Patel, general partner with Telstra Ventures. “I think that there are just too few people that have that DNA.”

Eric Liaw, a general partner with IVP and a board member at Glossier, a DTC skincare brand, acknowledged that venture investment into direct-to-consumer companies has slowed down recently.

“I think some of these companies are efficient earlier on and are not raising much venture money,” Liaw said. He pointed to Our Place, a cookware retailer that raised only $10 million since its founding in 2018, as an example of a startup managing to use capital efficiently.

Another notable example is the athleisure brand Vuori. The California company balked at the grow-at-all-costs approach and instead was laser-focused on reaching profitability early without relying on a lot of VC funding. Vouri’s near-bootstrapped approach appears to be working. In October, it raised $400 million in expansion capital from SoftBank at a valuation of $4 billion.

The emphasis on financial efficiency is not a surprise. Venture capitalists have been criticized for overfunding some DTC companies and, in turn, pressuring them to scale at unattainable speed.

IVP backed Casper, an online mattress retailer that raised a total of $340 million in VC funding and was last privately valued at $1.1 billion in early 2019. But when the company priced its IPO less than a year later, public investors thought the company was worth under $500 million. Casper now trades at under $200 million.

But the mattress brand wasn’t the only high-profile, VC-backed DTC company that flopped while trying to keep up with high-growth expectations. Brandless, an online house goods store that collected $240 million from VCs, including $100 million from SoftBank, shut down right before the pandemic. And Outdoor Voices, an athleisure startup, was having such a hard time that investors slashed its valuation from $150 million to $65 million in February of last year.

While there were a few early winners in the DTC space, like Dollar Shave Club, a personal care company that sold to Unilever for a reported $1 billion, “not every category is suitable for this kind of success,” said David Blumberg, founder and managing partner at Blumberg Capital. “When there are many competitors, you start to say, ‘Wait a minute, there’s not a lot of differentiation between this tennis shoe company and that tennis shoe company.’ They become commodities.”

More tellingly, Forerunner Ventures’ Kirsten Green, who has made a name for her firm backing Warby Parker and Dollar Shave, has distanced herself from the original DTC business model. “We’ve been investing in more B2B type business,” she told the Newcomer newsletter.

When asked if she would invest in a Dollar Shave Club or Warby Parker again today if they were in a new category, Green told Newcomer that she “was pitched every version of that” and that she would not invest. Green declined to be interviewed for this article.

In the meantime, many founders in this space are no longer actively trying to be funded by venture capital. “I think DTC companies are also saying maybe I should do this without VC and use another kind of funding or bootstrap to success,” Blumberg said.

Time will tell if Allbirds and Warby Parker will continue to distinguish themselves with consumers, but don’t expect many newly founded VC-backed companies to follow in their footsteps.

“Investing in this space is really about a brand, and a brand can be quite fickle,” Blumberg said. “Some brands have been enduring, like Nike and Gap, but others have come and gone.”

Featured image by the_burtons/Getty Images

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