Is the worst time the best time to invest in D2C?

“Buy high, sell low.” Is that right?

I’ve often discussed why venture-backed, as well as why most D2C businesses have struggled over the past few years. Whether it’s the burden of expensive operational stacks, mounting agency fees, acquiring customers at premiums to fuel growth, or the relentless chase for an IPO, many have faced corruptive challenges.

At the same time, we saw the revival of the aggregator model, with roll-ups fundraising in hopes of selling consolidated portfolios to PE firms or larger conglomerates at higher multiples. Unfortunately, most have failed and only those that acquired strong, resilient businesses have endured.

Survival of the fittest in e-commerce

The reality is, sometimes re-evaluations or market corrections can be the best thing for longer term sustainability. It flushes out the crappy businesses that have inefficiencies, forces companies to cull unnecessary fat and reveals not only strong businesses but unveils new opportunities for start-ups.

Through my work at Igloo, I’ve spoken to nearly 700 businesses at every stage of growth - from scrappy bootstrapped businesses and venture-backed startups to, on rare occasions, publicly traded companies. Many are on the brink of collapse, others are experiencing top-line growth but remain unprofitable, and most are likely flat or slightly declining in the last 3 years.

However, occasionally there’s a golden nugget in the cookie dough. This is a business that’s not only profitable (net, not just gross) but also operates without an over-leveraged team, maintains a healthy cash reserve, and consistently delivers organic growth - even in the face of the e-commerce downturn. Most critically, it’s a brand with strong equity and exceptional customer retention, arguably the most important KPI in my opinion.

The resilience metrics and importance of organic LTV

Once in a while, I get asked: “Would you ever start a D2C business again?” While it’s an unlikely scenario, it hasn’t stopped me from thinking about it. If I looked at this inversely, I’d start by asking myself: “What D2C categories would I most certainly NOT invest in?” This way, I’d work my way up from the more vulnerable sectors to businesses that seem less exposed to the uncontrollable.

In my opinion, the key requirements for investing in a business shouldn’t just focus on growth potential but also on safeguarding the brand's downside in times of turmoil. It's crucial to balance expansion with risk. Some of these would probably be similar to the below:

Andrew’s very wise investment requirements:

The brand must be a private label. This is a vital requirement, as resellers have very little leverage over the brands they represent.

The brand must have excellent customer experience and brand equity, which are among the most important factors driving organic growth.

The brand would ideally be premium. Expensive products often push greater margins and have the power to create cult followings that entice consumers to spend more. It also allows greater flexibility in testing price sensitivity among consumers.

The brand must have an LTV greater than 3x. Boutique fashion, high-end jewelry, subscription businesses, etc., often show longer-term value due to their product retention rates. There’s no point in building a brand if there’s no long-term organic value.

Paid advertising must not exceed more than 50% of the revenue generated by the brand, alongside organic growth in sales over time.

The brand needs to be net profitable even if paid ads are turned off. This prevents their fixed costs from becoming too inflated and keeps operational costs as a small percentage of net income.

The brand should be mid-sized ($3 million in revenue per year or more) and at least 3 years old.

The brand must have a net income of 15% or greater as a percentage of revenue, after dividend distributions to founders, ensuring excess cash reserves for reinvestment.

The brand should show growth in the bottom line as a percentage of revenue, ideally over a 3-year period, along with an increase in organic sales as a percentage of revenue.

You can spend all day adding to a list of requirements before acquiring a business, but the key is ensuring that performance and growth metrics are also evaluated as a percentage of net income. This highlights whether improvements are truly benefiting the company's bottom line.

It’s crucial to focus on metrics that demonstrate resilience in the face of adversity. A brand with strong fundamentals that support organic growth will always be a more secure investment than one heavily reliant on real estate leased from Meta or Google.

Why are D2C investors on the sidelines?

Downturns are truly the best exposure for brands that are actually successful, growing businesses. So, I’d argue that when a sector is at its weakest, or close to it, it’s one of the best times to hunt for prospective acquisitions. Is this the best time to start a D2C roll-up? Why not?

However, for an investor in a hurry, riding the wave to grab another win often exposes you to your blindside, or so it seems. We’ve seen this with tech multiple times in the past, just as we’ve seen pricing corrections in oil and gas markets, crypto (does anyone know what happened to NFTs?), D2C, and without a doubt, at some point, we’ll see the same in AI.

As a result, investors often fast-forward through a lot of the important factors outside of plain financials that focus on the resilience of a business. They focus too much on the primary KPIs that drive immediate value (EBITDA or revenue).

The problem is that while funding can be the engine that powers growth behind a brand, it can also be the Achilles' heel for brands not operationally prepared for turmoil. Chasing growth will forever be most investors' kryptonite and a reason why the portfolio value for most investors will fail to exceed the compounded value of simply investing in the index.

If investors gave equal weight to long-term stability and the ability to weather downturns, rather than just chasing short-term expansion, the overall resilience of these investments would improve significantly.

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