Member Exclusive   //   September 6, 2022  ■  6 min read

DTC Briefing: Founders are ‘battening down the hatches’ as M&A cools

This is the latest installment of the DTC Briefing, a weekly Modern Retail+ column about the biggest challenges and trends facing the volatile direct-to-consumer startup world. More from the series →

This is the latest installment of the DTC Briefing, a weekly Modern Retail column about the biggest challenges and trends facing the volatile direct-to-consumer startup world. To receive it in your inbox every week, sign up here.

The summer slowdown has reared its head, and it seems even more pronounced than in other years.  

Last year was a record period for acquisitions and so, unsurprisingly, mergers and acquisitions across most industries are down year-over-year. A June analysis from PwC found that globally, M&A activity had reverted back to pre-pandemic levels

That’s not to say that there are no deals to be done. Acquisitions remain hot in so-called recession-proof sectors, and startups that are profitable yet fast-growing remain highly sought after. Just before this newsletter went out, Church & Dwight announced it was acquiring Hero Cosmetics for $630 million.

But rather, industry observers say that direct-to-consumer brands are in a holding pattern right now; founders aren’t looking to sell if they can help it. That’s because as the stock prices of hot consumer startups crater and VC funding dries up, many DTC brands are now holding out hope that next year will be a more favorable environment for them to sell when they can, hopefully, get a higher valuation.

The job of private equity and holding firms, then, is to get some of the more desirable acquisition targets — those with double-digit growth rates along with solid gross margins — off of the sidelines. They’re looking to convince brands that in fact, now might be the time to sell as inflation and supply chain challenges make running an independent, bootstrapped brand more difficult than ever before. 

“I consider what’s happening now maybe more like a mild cold than the severe flu or pneumonia that we saw in 2008, 2009 or in March of 2020 where there was just a complete stop,” Arash Farin, managing director at The Sage Group, said. Farin’s firm has advised consumer brands like Bombas, Pura Vida and MeUndies on exploring acquisitions and other strategic financing options. 

Farin said “everyone’s open for business, everyone’s looking to do transactions. But a lot of the private equity firms are saying, ‘do your clients realize that valuations are different than before?’” 

“If you’re a financial sponsor or growth equity firm, you do tend to pull back in these [economic] environments, because you kind of want to see how these brands are going to fare,” Eric Satler, president of holding company Win Brands Group told me. “For Win, we’re still active.” 

Nick Ling, CEO of home goods-focused holding company Pattern Brands, said that he would characterize DTC acquisition targets as falling into one of the three categories right now. The first group, he said, are brands that are profitable and growing. The second group is startups that aren’t doing well, but feel like they have enough of a financial runway to make it through the next 12 to 18 months, after which point they hope markets will improve. 

“They don’t want to exit right now, because it wouldn’t make sense from a numbers point of view,” Ling said. “They’re almost battening down the hatches until they can see improved performance.” 

The last group, Ling said, consists of brands that immediately need to get a sale done because they are running out of cash. 

It’s the first group, of course, that Pattern Brands and other holding companies are most interested in engaging with. And Ling said that he believes that the economic uncertainty does make some of the founders of these startups more willing to, at the very least, engage in acquisition conversations. 

Pattern Brands most recently announced two acquisitions in July: Poketo, a stationary brand founded in 2003, and Yield Design Co, a ten-year-old home goods that sells glassware and other tabletop accessories. Terms of the deal were not disclosed.

Pattern Brands targets founders of bootstrapped brands in the home goods space. The company pivoted into a holding company model last year, after previously attempting to launch brands of its own. The Pattern Brands team also previously worked with brands like Harry’s and Sweetgreen through the design agency Gin Lane. 

Part of Pattern Brands’ pitch to founders is that there’s no other “platform aggregator who has a track record of building brands like we do,” Ling said, referring to his team’s work through Gin Lane as well as now launching brands of its own. 

Win Brands Group is similarly focused on home goods brands, as well as the wellness and outdoor spaces. Its pitch to founders is that has a playbook to help brands successfully scale beyond DTC, and into channels like Amazon and mass retail. Win Brands Group owns candle brand Homesick as well as a company that sells silicone rings called Qalo.

Earlier this month it acquired MiHigh, an infrared sauna blanket that it will sell through its other weighted blanket brand, Gravity. Terms of the deal were not disclosed. 

“Things are getting more expensive, supply chains are getting tighter — it’s a difficult time to be an independent company,” Satler said. “I think it makes a really good case for why founders and brands should think about partnering with Win, and take that weight off their shoulders.” 

For larger, venture-backed startups looking to sell right now, they essentially have two options: sell a majority stake to a private equity firm, or to a strategic like a larger retailer. 

“There’s some strategics that are really getting hammered right now,” The Sage Group’s Farin said, referring to the fact that many publicly-traded retailers are facing an inflation-induced slowdown in sales right now, and dedicating cash to clearing out their inventory gut. 

He said that acquisitions are likely going to be the main driver of growth for many brick-and-mortar reliant retailers going forward, But there are certain distressed retailers — Bed Bath & Beyond for one — that simply don’t have enough cash on hand to consider acquisitions right now.

For startups looking to sell to a private equity firm, EBITDA is more important than ever, as I discussed in my newsletter a few weeks ago. And that is what is going to help determine valuations. 

When Warby Parker went public during the IPO boom of 2021, it debuted with a market value of roughly $4.5 billion in adjusted EBITDA of $7.7 million during its most recent fiscal year. But those days are over: Warby Parker’s market cap has since dropped to under $1.45 billion. 

And in the private markets, valuations have similarly fallen. Farin said that some of the best companies can still get valuations that equate to a high single-digit or low double-digit multiple of EBITDA. 

The Hero Cosmetics acquisition is an example of this; in its press release, Church & Dwight said that Hero Cosmetics did $115 million in sales and generated $45 million in EBITDA over a 12-month period ending June 30, 2022. Given the price tag of the acquisition, Church & Dwight acquired Hero Cosmetics at a valuation of roughly 14 times EBITDA.

But ultimately, unless a founder needs liquidity, many of them are saying, “there’s no reason going to market right now,” according to Farin. “There’s no magic to [selling in] 2022 versus 2023.” 

What I’m reading

  • Insider’s quarterly report on the 25 fastest-growing DTC brands based on web traffic, according to SimilarWeb data. Startups that reported the biggest traffic bumps during the second quarter include Thousand Fell, Better Booch and Simulate
  • In time for the U.S. Open, Thingtesting looks at how some brands like Rothy’s and Palmes are targeting tennis enthusiasts
  • Retail Brew has a roundup of the most important C-suite announcements from August, including Gopuff naming a CFO, and a couple of notable CEO shakeups in the footwear space.

What we’ve covered

  • Member exclusive: Why zero-sugar beverage brand Swoon decided to use Amazon to fulfill all of its online orders, as building a DTC channel has become more expensive. 
  • One year ago, Bravo Sierra – a personal care brand with military roots – stopped advertising on Facebook and Instagram altogether. Here’s how the company’s marketing strategy has changed since then.
  • Founders of food and beverage brands like Seed + Mill and Supernatural sound off on what Amazon could be doing better to grow its grocery business.