CPG v ChatGPT: A billion reasons to invest & build in consumer

In looking at the portfolio recently, I was surprised to see that our DTC portfolio – ranging from baby toys to cat food, furniture, skin care, and more – will do over a billion dollars in sales this year. A billion in sales!

These include Whoop, Lovevery, Caba Design, Hawthorne, Smalls, Bird & Be, Baublebar, Bookbub, Shellworks, Levels Health, Jones, and many others. Just under 10% of our portfolio has a consumer good component to their business. And their success isn’t an anomaly – some examples outside the portfolio include Oli Pop and Liquid Death, both valued over $1B. Stanley Tumblers have 10X’d their salesin the last five years. Despite these eye-popping valuations and traction, consumer goods companies aren’t celebrated as they once were.

The DTC category has been in the VC doghouse for years. Over the last decade, a bunch of overfunded consumer products brands raised huge amounts of venture capital and failed to live up to their valuation, souring people’s perceptions. It has become common wisdom that physical products, without any tether to the internet, are a bad place to invest. However, this hasn’t been the case in our portfolio.

Conventional VC logic is that software companies are easier to build, easier to scale, and will ultimately be much more valuable. However, that’s a gross oversimplification, especially given the competitive landscape, labor costs, and platform changes that typical VC-backed software companies face.

More surprising than the quantity of their revenue is the quality. With limited access to venture capital, these consumer companies have built incredibly well-instrumented businesses. They know their contribution margin and have found creative, capital efficient ways to find their customers. Many are recurring revenue subscriptions much like their revered SaaS counterparts and, in some cases, with even more sticky revenue.

As Brooks Powell, portfolio founder of Cheers, says, “You can never replace the physical world.” LLMs may be eating the world, but they’ll never replace the burrito!

The problem wasn’t DTC itself, but how VCs approached it.

The failure of many first wave D2C brands had much less to do with the intrinsic nature of the businesses and more with flaws in the VC model. Overcapitalization kills startups no matter if they sell B2B software or boxes of groceries. The fatal flaw wasn’t small markets or low willingness to pay, but oversized funds that assumed they could get scale economics from consumer products by applying a software mindset. The trajectory of consumer companies is much less linear – they can be seasonal, and winning big channels (like Target or Walmart) is lumpy. Consumer companies need to go slow before they go fast.

So why are so many consumer companies thriving in a market where VCs have soured? I spoke with a few and most had a variation on a theme that when the venture capital tap ran dry, it forced them to become more resourceful and careful with their funds. It was painful medicine, but most of these companies would not have survived without it.

Why are consumer businesses good, potentially great investments?

They aren’t necessarily winner take all

There can be many multi-billion dollar brands in a category. There’s a belief in tech that the winner should take most. This is less true in CPG. It’s ok to carve out a niche and grow a business without feeling like every quarter is existential.

Single decision maker

B2B software often involves a multi-stage, multi-stakeholder decision making process. Consumers, while very fickle, are often a single decision maker who can simply put in a credit card. These “rails” can lend themselves to fast adoption.

Rapid & relentless customer feedback

Roderick Morris, founder of Lovevery, commented that there is a unique level of rapid and relentless customer feedback you get in these businesses, which for the right founding team presents an opportunity to outlisten and outperform legacy and new competitors.

AI won’t replace athleisure

Technology is getting increasingly easy to clone, but your favorite skincare brand won’t be replaced by a foundation model. Brands are stickier. They’re hard to build, but so are most software businesses. Taste and brands are becoming more valued in a market where everything else seems to be online – from education to Zoom meetings.

The infrastructure exists now

Shopify and the myriad tools built around its ecosystem have made it easier than ever to run the back office of these businesses. That allows these founders to focus on their products and distribution, much like you see in software.

Some founders have that special something

At Founder Collective we believe the “who” beats the “what” in early stage ventures, every time. Jessica Rolph and Rod Morris are a dynamic duo but also have an insight into what modern parents want for their young kids. Other consumer founders came from different spaces but have a passion and vision to build something for an end-consumer. These founders can build a culture and a tribe around their brand that’s hard to replicate in any other arena.

But are these investments venture scale?

The million dollar question is whether CPG businesses can generate venture scale returns. The answer to that is “yes!” Sort of. But you have to think differently.

How do you make VC work for D2C?

Start lean, stay lean

I’ve watched founders like Ryan Babenzian start Jolie and bootstrap his way to significant growth. Mike Salguero bootstrapped ButcherBox to $600M+ in sales without a dollar of venture capital. I’ve seen others in our portfolio get to market with only $1-2M to test product-market fit, pricing, and channels before scaling quickly. Sometimes these are smaller regional tests, or single SKU launches before branching out. There’s a lot of trial and error in the consumer market in the early days, so staying lean helps founders find what works – without burning as much capital while they’re figuring it out.

If you want to build a big brand, you need a small fund

Consumer products businesses have lower multiples on average. Most “big” exits probably will be in the low-single digit billions. Most CPG categories are bought out by large companies and tend to be high hundreds of millions, or single digit billions. So they’re not a great fit for funds with tens of billions of assets under management, trying to find the next Google. But for funds that stay small, there’s ample opportunity.

Startup brands need to think like startups, not brands

The old, capital intensive model of buying customers isn’t going to work. The days of plastering the C train with ads is over. In order to win, you need to have a creative approach to acquisition and the patience to build a business brick by brick.

Patient capital (and founders) is key

Ben Parsa of furniture-maker Caba wrote to me, “you need patient capital.” So many investors were in a rush, but it takes time to build a brand, a hard good, positive customer reviews, multiple channels, etc. Not only that, VCs are fickle. At times they were too happy to fund D2C startups, hoping they found the next Dollar Shave Club. But a few years later the winds had shifted and they were out of that category entirely, forcing founders to find and impress a new wave of backers. This draws focus from the hard work of consistently growing a brand.

Follow the CPG Mafia

You hear a lot of the “Paypal Mafia,” and for good reason. But in consumer there are many examples of founders that have repeatedly built successful consumer businesses. Take Eric Ryan for example. He’s a 5x consumer product founder, including the founder of Method Products. Or John Osher, who founded the Dr John’s Spin Brush which was ultimately sold to P&G – who then leveraged the same insight to successfully launch the Spin Pop, a Spin Mop, and various other kids toys.

Eyes wide open on multiples

There’s a fair bit of public data from various transactions that shows a clear increase in multiples based on channels. If you’re just selling on Amazon, prepare to get 2-3x EBIDTA. Growing fast multi-channel, you can achieve 2-3x revenue and, if there’s a strategic buyer in your category, 4x or more. The 10x+ exits are rare and while they are more common in software / hardware, the playbook to build value and exit is more clear (and potentially less risky). So the key is to build and diversify channels.

Founder Collective is open to consumer

Our approach is to treat all markets and founders with the same open mind (and checkbook!). We look for people with unique insights, comparative advantages, and well-articulated approaches to large markets, and we try to help them with the business of company building.

In the end, building any business is hard. Moreover, building a “venture scale” one is exceptionally rare. But the market has swung too far and convinced a generation of investors and founders that the consumer markets are impossible and software is comparatively easy. I take the other side, which is that the same fundamental truths apply to both. Start-ups need to identify a unique market insight, test and execute carefully and cost efficiently, and find channels that are unique. As everyone is focused on AI, now’s the time to build… in consumer!