When Walker & Company, the direct-to-consumer men and women’s health and beauty brand (formerly Bevel), sold to P&G this month, it was bittersweet.

The company will now have the distribution network, budget and resources of one of the industry’s biggest corporations, elevating a brand designated for people of color to much more mass exposure. But after raising $33.3 million in four rounds of venture funding, Walker & Company is said to have sold to P&G at a price that earned its investors the majority, but not all, of their money back, according to Recode.

In the history of the DTC era, there haven’t been enough exits, successful or not, to gauge whether or not the category is a good investment. Bonobos sold for $310 million after raising $128 million, but it was to Walmart, a move that made fans of the brand cringe. The Honest Company, which has raised a staggering total of $500 million in venture capital, has been said to be exploring both a sale or an IPO but has been held back by a number of lawsuits over product claims. Dollar Shave Club did hit the jackpot, by selling early: It sold to Unilever after five years in business for $1 billion, nearly 10 times the amount it raised, in 2016.

For Walker & Company, the underwhelming payout was due, at least in part, to the fact that brand has never been profitable. Thanks to a newfound interest in consumer brands and large pools of capital due in part to low interest rates, venture capital has flooded the space at an unprecedented volume: According to CB Insights, $3 billion in venture funding has gone to DTC brands since 2012. More than $1 billion of that investment was made this year.

With that, top-line growth has been the priority — profitability could come later. But more and more, that engine is running out of fuel. Companies now operating on borrowed cash are facing disappointing payouts. VCs aren’t shutting off the pipes, but they are looking for more proof that a business is viable before they invest money.

“You used to be able to get through multiple rounds of funding losing money, and that’s how you were supposed to do it. Now the main concern is how we can get to profitable growth,” said Andrew Dudum, the CEO of telemedicine DTC startup Hims. “Investors we’re talking to, they’re asking different questions now with different expectations.”

The gold rush
According to Adam Winters, CEO of Merchant Financial Group, a finance company that backs small and medium-sized consumer businesses, it’s not the fact that young, well-funded consumer brands are unprofitable — many consumer businesses, as they invest in growth, don’t automatically achieve profitability. It’s the misalignment of expectations between investors and founders that causes trouble. Investors want big returns, relatively quickly; founders typically want growth, of course, but also long-term sustainability.

“We’re now looking at the tricky situation where tech multiples applied to consumer-driven businesses is not an equation that always works out in everyone’s best interest,” said JB Osborne, co-founder of the agency Red Antler, that specializes in digital branding. “Maybe some brands can grow fast enough and get to scale and exit at the pace of tech companies, but many of them can’t, and shouldn’t. For most consumer brands, VC pressure erodes what was special about the business in the first place.”

With millions in investment funding, brands like Casper, Hims and Thinx have made a lot of noise in the form of subway takeover ads and performance marketing. With increased competition, the cost of customer acquisition has skyrocketed, so the path to profitability has become even harrier. If a brand spends more to recruit a customer one time than the customer spends in that one purchase, it’s doing so on the faith that the customer will love the brand so much, they’ll buy again, and again, and then tell a few friends about it. That’s the only way the math adds up.

But that’s a gamble that doesn’t always work out.

“You can be unprofitable with a healthy business. If you’re not turning a profit on every single order, you can make up for that with customer profitability — the lifetime value of customers is profitable. You’re not spending more on getting customers than customers are spending on you,” said Richie Siegel, the founder of retail advisory company Loose Threads. “It can be OK to make bets that customers will eventually become profitable, but what typically happens is investors and founders get stuck. They sprint, then they don’t notice they’re out of gas until the motor stops running. Then they have nothing to do but sell off what’s left of the motor.”

The risk of spending big to earn profitability down the line is a riskier bet for different product categories. Casper sells mattresses, which people don’t typically purchase more than one of. The company declines to share if it’s profitable. Meanwhile, Hims, which has raised $97 million in funding, is profitable, according to Dudum, but the brand is built on a retention-driving subscription model, selling products like anti-hair-loss shampoos that customers return to time and again.

But even subscription brands in highly replenished categories like tampons have trouble striking the balance between what’s best for the business vs. what’s best for the customer. Jordana Kier, the founder of women’s care brand Lola, wouldn’t share whether or not her company is profitable but said that prioritizing customer engagement and loyalty at the same time it needs to build a smart business for her investors (Lola has raised $35 million) are two things that don’t always align.

“You have to make those trade-offs — what’s right for the business vs. the customer. Ideally, they align and we’ve been able to make it work,” said Kier. “But without a loyal and engaged fan base and customer base you’re nothing.”

The anti-DTC playbook
Rothy’s, the footwear brand that makes flats and sneakers out of recycled bottles, shared this month that it’s set to earn $140 million in revenue this year. On top of that, it’s profitable, said Kerry Cooper, the brand’s president and COO. And on top of that, every order is profitable, meaning it’s not losing money on customer acquisition, she said.

Rothy’s represents a more buttoned-up version of the DTC brand, one that has investors but also practices restraint. You won’t see the brand papering the ad space on the New York City subway, even when there’s pressure from investors to do so. That can be frustrating, said Cooper, but at the end of the day “we know our financials and what we can do, and nothing else,” she said.

The brand’s ability to raise money, now $42 million worth, came about from timing. It raised its first round in 2018, a year that it sold 1 million pairs of shoes.

“It’s a different conversation than we would have had in 2016. More than anything, we’re profitable, so our destiny is in our control. When you’re losing money, you have to prove that you can grow more only by raising more, and then you’re on a treadmill,” said Cooper. “There is risk involved with investors and setting expectations around growth too early — you may have to change your brand or expand in ways that you wouldn’t otherwise choose. But because we’re profitable, that investment doesn’t change where we want to go.”

Other brands have cited restrained fundraising in order to grow their brands on their own terms, including AYR, Modern Citizen, Boll and Branch and Buffy, a line of down comforters launched last year. For these companies, prioritizing profitability is key so that they’re not running on the fumes of VC funding. As a result, growth looks different.

“A lot of companies today don’t care about being profitable; they just care about growing. We are a profitable company; we don’t run off debt,” said Buffy vp of brand Paul Shaked. “For us profitability is really important. We don’t want to just grow with no kind of end in sight for when losing money is no longer part of the company’s story. It makes no sense for us to be preaching that we’re a worthwhile product when we’re hemorrhaging money.”

Investors aren’t likely to shun the DTC category entirely. But they are asking different questions, meaning the sheer volume of brands that blast into the market off of a new $50 million round will shrink.

“We’re seeing it already: Unless you’re a serial founder, you’re having a much harder time raising money. There was a moment where everyone could get funded and it got a little crazy. Now, every category and every channel is more competitive,” said Osborne. “There’s no guaranteed recipe for success, but you have to have the right team, the right priorities and a plan for viable growth in place. It’s requiring people to be much more thoughtful about proving success. It’s a good thing — it feels more like reality.”

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