New DTC toolkit   //   August 28, 2019

As DTC brands mature, private equity takes on an increasingly important role

As the direct-to-consumer space matures, private equity brands are starting to play an increasingly heavy hand in picking category winners and losers.

One of the most active private equity investors in the DTC space is L Catterton, which announced on Monday that it had taken a $100 million investment in bedding brand Boll & Branch.  L Catterton has also taken investments in Mizzen + Main, Third Love, and Peloton, which on Tuesday released its S-1 filing as it prepares to go public. During its most recent fiscal year, Peloton said that it did $915 million in revenue, while incurring losses of nearly $196 million.

Other private equity firms that have dipped their toes into the private equity space include Great Hill Partners, which has invested in Bombas, Wayfair and TheRealReal after historically focusing on the software and healthcare sector, and JH Partners, which invested in DTC sneaker brand Greats and was recently acquired by Steve Madden.

Some of these DTC brands are taking on private equity because they believe it allows them to grow at a more manageable pace than if they were to take on venture capital money. Others, like Peloton initially took on venture capital funding, but took on private equity as they got older and required more growth capital.

Many of the DTC brands that have taken on private equity are still young — Boll & Branch for example, is only five years old and has only opened one retail store to-date. But depending on how many of them go public or end up being acquired compared to their venture-backed counterparts, it will set the tone for how receptive the next generation of DTC brands will be to private equity.

While the amount of equity any two private equity firms can take in a company may vary, there are typically a few key differences between private equity funds and venture capital funds. First, while venture capital funds may invest at any time during a company’s lifecycle — some venture capital funds invest at the seed stage, while the company has yet to sell a product, while others typically invest at the late stage when the company has a set timeline to go public — private equity funds only invest during later stages. Additionally, while venture capital funds only inject equity capital into a company, private equity funds may invest a mix of equity and debt. And, private equity funds can take a majority stake in a company, while venture funds typically do not.

Web Smith, former chief marketing officer of Mizzen + Main and founder of 2pm Inc., an e-commerce research and consultancy firm said in an email that “for the brands who’ve grown with proper mechanics and sustainable, blended customer acquisition costs,” private equity “can provide strategic capital with a slightly longer time horizon than what’s typically the case in venture capital.”

The private equity boom in DTC can be explained by the fact that as that DTC brands have gotten older, there are simply more of them who may qualify for private equity investment. Michael Kumin, the managing partner at Great Hill Partners, told Digiday in April that it only invests in companies when “the business model and unit economics are clearly established because we focus on businesses that are either making money or have a clear path to be profitable.”

“You had venture fuel the first five or so years of the boom, and then you started to have private equity come in which is used to a little bit lower multiples, has a lot more cash on hand, a lot more strategic relationships and can bring debt into the equation,” said Richie Siegel, founder and lead analyst of consumer advisory firm Loose Threads.

Kevin Lavelle, the former CEO of Mizzen + Main, told Digiday in April that his company decided to take on private equity funding from L Catterton instead of venture funding after speaking to one venture capitalist who declined to invest in his company because “she couldn’t see how we could [make] 10 times our revenue over the next 12-18 months.”

“She was absolutely right. There’s no way we could do that,” Lavelle added. “I know of a lot of founders who ended up losing control of their company because they were chasing wild growth [due to VC pressure].”

Private equity investors typically operate under a longer time horizon, and don’t expect companies to multiply their revenues as quickly as venture capital investors do. However, private equity investments come with its own set of challenges.

According to Siegel, while some private equity investors take a longer-term outcome on their investments, there are others that do look to generate more profit in the short-term by “putting a lot of debt into companies and use it to pay themselves fees, and kind of pull cash out of the company.”

Additionally, given that many private equity firms are looking to invest when these companies have a clear path to becoming profitable, the pressure can be greater for a firm to be acquired or to go public. While venture capitalists may be making investments in companies with the expectation that only one or two will generate the necessary returns for the fund, private equity firms are “investing for the vast majority [of their companies] to make money,” Siegel said.

“Taking on large sums of institutional capital will always limit outcomes,” said Smith. “Private equity will [still] require a much larger exit than what you’d find in brands who’ve taken on smaller investments.”