“Why are you focusing only on consumer product and retail companies at CircleUp—won’t your investors miss out on the next Twitter or LinkedIn?”
Alas, living in Silicon Valley, I hear this question often. Here, tech investing isn’t a sub-category of early-stage investing—it is early stage investing. The numbers don’t lie: according to PricewaterhouseCoopers’ and the National Venture Capital Association’s MoneyTree Report, nearly 60% of the $29 billion of venture financing in 2013 went to the tech industry (including biotech).
Meanwhile only 4% of venture capital dollars went into Consumer Products in 2013—even though Consumer accounts for more than 15% of GDP, and Kaufmann Foundation data (PDF) shows that angel investments in consumer companies produce average returns of 3.6x invested capital over 4.4 years.
We see an enormous disconnect here—and believe bridging it creates exciting opportunities for investors considering diversifying into private Consumer. Here’s why:
- Growth in all economic cycles
- Low capital intensity
- Recurring revenue
- Transparency
- Avoiding adverse selection
Growth in All Economic Cycles
Since November 2007, the Dow Jones U.S. Consumer Goods Index is up 57% and the Dow Jones Retail Index is up 85%—each of these indexes, which are proxies for growth in the consumer, have significantly outperformed the S&P 500 (up 31%). While consumer spending on durable items like cars or expensive electronics may decline in a recession, calorie intake, for example, does not. At-home food expenditures often grow in tough times. A consumer may forgo a weekend at the spa, but she will substitute a luxury hair care product for a fraction of the cost.
Low Capital Intensity
In consumer products, brand is a company’s most important revenue generating asset; not expensive, depreciable assets. Consequently, many consumer companies outsource capital intensive functions of their business. Manufacturing for example. This makes consumer businesses less capital intensive than other industries.
Low capital expenditures (“CAPEX”) coupled with high gross margins lead to strong cash flow and more cash available early on to invest in sales and marketing. So while a Tech company may be on their Series F funding and still measure success by minimizing their “cash burn rate” or maximizing “eyeballs”, the conversation in consumer can turn to EBITDA and free cash flow much sooner.
Recurring Revenue
The re-purchase cycle for products in some industries is very slow, or even non-existent. (Think of how often you buy a mattress, car or washing machine.) However, many consumer products like food, beverage, pet products and cosmetics are consumed habitually, and lend themselves to being re-purchased quarterly, monthly or weekly.
This repeat purchase dynamic is incredibly beneficial as companies do not need to worry as much about investing a ton of marketing dollars to replace their customer base every year. Recurring revenue streams provide stability, and also help investors identify early winners—companies with strong repeat purchase performance. It’s valuable to find products that the same customers want to buy again and again.
Transparency
| “Never invest in a business you can’t understand.” – Warren Buffett
While the venture capitalists whose careers depend on their ability to pick winners in the cloud computing SaaS or enterprise software space understand these businesses well, most investors do not. On the contrary, it’s easy to understand how a granola company makes money and how it’s performing. As a consumer, you can walk into your local grocery store and see the product for yourself—touch it, feel it, taste it.
And when gauging sales health and trends, there are great third-party data sources that track retail sell-thru data for individual brands, such as SPINS (whom we have a partnership with at CircleUp).
Avoiding Adverse Selection
If you’ve taken a microeconomics course you’ve probably heard of some variation of the lemon problem, whereby information asymmetry in the marketplace leads to only the worst cars being sold at a market clearing price. In the world of online marketplaces, I believe the lemon problem exists, but the lemons are not cars—they are the tech companies that were passed over by the thousands of tech VC firms and tech angels in the country.
Given the robust VC and angel markets for tech companies today—the market is awash with capital— a great tech company should be able to raise capital. If they can’t tap the $50 billion+ of VC & Angel dollars heading tech’s way, then that company probably isn’t an attractive investment opportunity.
Contrast this with consumer and retail, where the equity markets for small businesses are incredibly inefficient, particularly in the sub-$10 million revenue space. Look around—you’ll be hard-pressed to find any private equity firms investing in growing, but small, consumer companies—their cost structures simply can’t support investments as small as $1M, let alone $250,000. Operating online—and capturing all of the efficiencies the internet offers—we are able to support these investments and we believe there are tremendous opportunities for investors to potentially earn great risk-adjusted returns investing in these underserved companies.
It’s still very early days for online investment marketplaces, CircleUp included. The reasons listed above are why I think consumer is the right place to start. That said, realize that these investments are risky, illiquid, long-term investments. The actual returns for investors for these platforms, CircleUp included, are not yet determined.