‘It’s easy to come up with a contrived adjusted EBITDA’: After a frothy 2021, the pressure is on for newly-public DTC startups to turn a profit

What’s more, as this year’s crop of direct-to-consumer startups prepared their IPO roadshow, they all loaded their S-1s with an array of selective metrics to paint the picture they wanted to potential investors. One such example of these creative terms is adjusted EBITDA. While EBITDA is earnings before interest, taxes, depreciation and amortization, adjusted EBITDA is earnings before whatever else the company wants to tack on to make their financial outlook shine the way they want, with WeWork’s “community-adjusted EBITDA” being one of the most controversial examples. 

“It is easy to come up with a contrived adjusted EBITDA number,” venture capitalist Jason Stoffer said, whose firm Maveron is an investor in Allbirds, among other notable consumer startups. 

Rent the Runway, in its S-1, deducted rental product depreciation in calculating its adjusted EBITDA. “Rent the Runway, to exclude what is arguably its core cost from its EBITDA, doesn’t make much sense to us,” a Financial Times’ columnist wrote. The metric, the company wrote in its S-1, is “a key performance measure used by management to assess our operating performance and the operating leverage of our business.”

But even in a bullish fundraising environment, startups can’t stay unprofitable forever. This year, startups that went public in 2021 will face more pressure to prove that they really, truly, can turn a profit. For those that don’t, mattress brand Casper’s fate serves as a cautionary tale. After going public at the beginning of 2020, Casper announced a deal to go private after failing to turn a profit. 

Startups going public while they are still unprofitable isn’t a phenomenon that’s unique to the e-commerce sector — a line about having a history of losses is commonplace in modern S-1s. Some large tech companies that have now been public for several years, such as Uber and Lyft are still reporting quarterly losses. 

“What analysts are looking for is: can you deliver the growth that you promised?,” Stoffer said. “I think the trend line is more important than the snapshot with this,” he added.

A DTC reckoning that never came 

The tune e-commerce startups are singing these days about profitability is different than the one at the beginning of 2020. 

Two years ago, startups that were previously lauded as brand-building geniuses started to become pariahs for their failure to turn a profit. Ty Haney stepped down as CEO of Outdoor Voices as the company was reportedly bleeding $2 million per month. Casper had a lackluster IPO at the beginning of 2020 after losing $67 million the year prior, and as a result, failed to hit the same valuation on the private markets as it did on the public markets. 

Then, the pandemic hit, which caused investors and executives to reconsider the profitability and growth calculus. 

“Throughout the pandemic, there was a huge push for profitability, and I think that is because people’s tolerance for risk in what felt like a volatile moment in time, went down,” Ashley Merrill, founder of sleepwear brands Lunya and Lahgo said. 

But despite the warnings, things shook out fairly well for e-commerce startups in 2020 and 2021. The uptick in online sales led some DTC brands to have their best-ever sales years in 2020, only to surpass that number the following year. 

As a result, profitability became less of an imperative. Merrill, for example, said that Lunya was profitable in 2020, but not in 2021. “I am looking at a path to profitability, but I am not stopping growth to try to hit profitability at this stage of the business, because I am very bullish on the space,” she said.

Not everyone believes the profitability-growth calculus has changed all that much for DTC startups. Venture capital, by its nature, has always rewarded companies that have grown more quickly than those who have hit profitability more quickly. 

“We are investing in businesses either pre-launch or shortly after launch, so for us it is more about the quality of the founder, how strong we think the market is, and do we think there is enough dynamic movement where we believe there is potential for a venture-scale outcome to be created?” Maveron’s Stoffer said. 

“As an investor now, profitability is something that I think I look at on a case-by-case basis,” Jaime Schmidt, investor at Color Capital and founder of Schmidt’s Naturals deodorant said. “I think the growth signs are more important,” Schmidt added, citing how many new customers are being acquired over time as one example. “It is more of a formula.” 

Lunya’s Merrill added that another change that she thinks has impacted the growth-profitability equation is more investors getting into the space. Thanks to record numbers of VC financing and IPOs, startups were able to access more cash than ever before. 

“There is a lot of cash with not a lot of places to put it,” she said. “And when the investor market gets frothy, and they get more willing to put money into things that are more speculative. And when that happens they are more willing to sacrifice profitability.”

A new game on the public markets 

Startups may be able to put profitability on the back-burner when they’re private, but when they go public they have to bare their financials — warts and all. 

Wall Street won’t tolerate never-ending losses across all e-commerce startups. It depends on the business — some companies can stay public while remaining unprofitable for years if they can convince analysts that all the cash-burning will lead to them dominating a category.

Wayfair managed to go six years on the public markets without turning a profit — and though it turned its first quarterly profit during the pandemic, it lost $78 million during its most recent quarter. By contrast, Casper lasted less than two years on the public market, during which its stock price dropped from a high of just over $11 per share, to $6.72 a share at the time it announced its deal to go private. 

Stoffer said that, ultimately, analysts want to see a company not only growing year over year, but also gaining some leverage and added benefits from growing so quickly. “Is SG&A [selling, general & administrative expenses] as a percentage of revenue lower each year, is marketing as a percentage of revenue lower each year, is gross margin moving upwards…and are they benefitting from scale or not?” he said. “That’s what makes for a great public company.” 

In the end, come quarterly earnings call, these newly-publicly-traded companies have to rely on a multitude of metrics — not just adjusted EBITDA, but whether or not they made money and sales grew — to win over Wall Street. As Stoffer pointed out, “the best three consumer product IPOs of the year — if you just look at a valuation multiple — were Figs, Olaplex and On Running, [and] all three of those are generating significant cash flow.”

The question is whether DTC startups — from those who just went public, to those waiting in the wings to do so — can adapt to meet Wall Street’s expectations. 

“The expectations [on] an entrepreneur shifts with the marketplace, but businesses don’t necessarily shift that quickly,” said Merrill.