What makes a beauty brand worthy of investment in 2018

It doesn’t hurt that beauty at large seems to be having a moment, with U.S. beauty sales rising to $17.7 billion in 2017, a 6 percent increase from the year prior. Skin care accounted for 45 percent of those gains, which is not surprising, given that every media outlet from The New Yorker to New York Magazine has unpacked its current vogue. 

But the consumer stickiness and loyalty the beauty category affords makes it appealing in the long-term, too, according to Sutian Dong, a partner at Female Founders Fund, which has invested in brands like Winky Lux and Manicube.

“That results in very predictable revenue,” she said. “But more and more people are also realizing that it’s a really compelling place to make tremendous margins at scale.”

Buzzy companies like Glossier, Huda Beauty and Charlotte Tilbury have all received recent funding, but new investor cash isn’t just reserved for high-profile brands. Last February, the customizable hair-care company Function of Beauty secured a $9.5 million Series A round led by GGV Capital, while its competitor, Prose Beauty, raised $5.2 million of its own this past December in a Series A round led by Forerunner Ventures.

All in all, the beauty sector saw an all-time-high of more than 149 deals in 2017, according to an April report from CB Insights, representing a 19 percent jump from the year prior.

Even the traditional beauty players left in the wake of these younger brands are catching on to their appeal, which has led to a frenzy of M&A activity over the last few years.

After scooping up Smashbox early in 2010, Estée Lauder purchased Too Faced Cosmetics for $1.45 billion in 2016. The same year, L’Oréal purchased It Cosmetics for $1.2 billion. After Unilever acquired a slew of brands in 2015, including Kate Somerville and Dermalogica, the company continued its buying spree last year, shilling for brands like Carver Korea ($2.7 billion) and Hourglass Cosmetics (for an undisclosed sum).

But the beauty startup space is increasingly crowded, and not all new, digital-first brands meet the mark for investors. What it comes down to is a combination of product efficacy, transparency, innovation and customer connection.

Product is king
In the age of Instagram, good branding matters. But it won’t lead to success in and of itself, especially in the beauty space, where results are key. Evidence that your products work is not just essential to courting consumers, but potential investors, too.

“A company might be able to pull off bad product with good branding at first, but I think it will be short-lived,” said Jonathan Keidan, the founder of Torch Capital, an early stage venture fund.

“You know which products work right away from consumer behavior,” agreed Matt Scanlan, the founder of the seed-stage fund Softmatter Ventures, an investor in True Botanicals. “They create a repeat-purchase behavior that is highly identifiable and profitable, and that leads to healthy, organic growth for the company.”

Clinical trials are also helpful, even if, as Scanlan pointed out, many young brands avoid investing in them for fear of the results or the belief that marketing dollars are better spent elsewhere.

“That’s a mistake — they’re a huge indicator of value,” he said.

Everything that True Botanicals produces, for example, goes through rigorous clinical trials to ensure that its results are top-notch.

Legitimate transparency
Those trials also offer an important reflection of your supply chain, something investors agreed is crucial for beauty brands to be open about today.

“Customers want to know what ingredients are involved and where they’re coming from,” said Keidan. The more natural or organic they are, the better — but only if the products actually work, added Dong: “You can’t rely on natural in and of itself.”

Sustainability, or the assurance that a product’s creation has not had a negative impact on the environment or its producers, is also important.

“It’s a huge category-buster right now,” said Scanlan, whose company considers it the No. 1 factor when investing. “It’s really changing beauty at large.”

He added that sustainability has even reached Sephora, and the retailer will be rolling out a sustainability initiative in most of its store in the coming months. Although Sephora didn’t respond to a request for comment, the retailer has promised in the past to better audit the suppliers it relies on for Sephora Collection.

Of course, many companies today have jumped on the sustainability train for the good PR it affords, so Scanlan and his peers seek out those who’ve been validated by an external source, like those vetted by the Organic Consumers Association or that have been Fair Trade certified.

“I could tell you how sustainable I am until I’m blue in the face, but without some sort of auditing service to validate those assertions, it doesn’t hold a lot of weight, especially with consumers who can Google results and get information so easily,” he said.

Innovation meets personalization
Beauty brands that are truly doing something different, and at warp speed, are the golden ticket for investors today.

Dong points to Winky Lux, which she calls “the Zara for beauty,” as an example.

“They have a very differentiated backend production and logistics network,” she said, which allows them to take products from ideation to release within 45 days on average. “They’re giving consumers beauty that is always fresh and always evolving according to what they want.”

One investor, speaking under condition of anonymity due to current fundraising, said that Winky Lux (and its speed-to-market capabilities) has exactly the brand blueprint he and his colleagues are looking for today. Alongside its constant customer-listening that leads to speedy product innovation, it’s selling lower-priced and trend-driven products, like eyeshadow palettes and highlighter, largely online (the company only has one storefront in NYC).

Customization is also on investors’ minds these days, with many pointing to the aforementioned hair-care brands Function of Beauty and Prose, which offer products curated to customer needs, as particularly exciting.

“That level of personalization is crucial across categories today,” said Keidan.

Knowing your customer (and where to find them)
Of course, none of this matters if a brand can’t effectively reach its target consumers.

“Product market fit is vital,” said Scanlan. “You need to know who your customer is, and your branding needs to service that audience.” Glossier, for example, has succeeded thanks to its knowledge of its target “cool girl,” the aesthetic she likes and the channels she hangs out on, he said.

Kylie Cosmetics and LimeCrime have seen similar success targeting their makeup-heavy and edgier consumer, respectively, on social media.

“These brands only go after who their girl is,” said Scanlan.

Many of these less mainstream or minority demographics have historically been shunned by legacy brands, said Dong, and tapping into that whitespace is key. Fenty Beauty, which has shot to success thanks to offering a more diverse product range — including 40 foundation shades — is a prime example.

“We look for companies that can leverage the reach of social networks to really speak to and capture these consumer groups that have long been on the periphery,” she said.