Consumer businesses and venture capitalists are uneasy bedfellows. There are times when the match makes sense, but often the fit just isn’t there.
Here are the basic reasons:
- The majority of venture capitalists have made their mark outside of the consumer realm. Their “go-to guy” networks are of little use to them in screening consumer ventures.
- Consumer businesses usually have little IP that can give the investor comfort on the defensibility or sheer resale value of the enterprise.
- The enterprise value of a consumer business is greatly increased if it is built around a powerful brand. Assessing the viability of a brand takes deep brand-building experience and a very current read on critical consumer behavior and social trends. Again, not the stock-in-trade of most VCs.
For these reasons, venture capitalists shy away from these early stage consumer investments. Even Fred Wilson, one of the most notable consumer internet investors once told me, “For us, it’s all about usage and traction. We didn’t “get” etsy until we saw the numbers take off. When a service goes from 100k users per month to 1mm users per month with a lot of direct visits and not relying too much on Google, that gets our attention. I don’t know how to predict what will strike a chord and what will not, so we don’t try”
Fred pretty much gives away the critical secret to getting venture capital investment in a consumer venture. As an entrepreneur you have to wait until the investor no longer has to apply exceptional judgment, skill, or experience to assess your consumer venture. You have to wait until that guy can go into his Monday morning partner meeting and show numbers that no one around the table can refute.
(Nota bene. Fred is, above, using metrics to assess low ARPU consumer internet ventures like etsy and Twitter. He would likely set a much lower “user traction” bar for e-commerce businesses that have much higher annual revenues per user than the typical marketplace like etsy, or a deferred-monetization service like Twitter.)
There are exceptions. There’s the legendary story of how Maveron’s Dan Levitan recognized a spark of brand genius in Howard Schultz when he funded Starbucks in its very early days. However instances of such a mind meld between VC’s and consumer biz founders are exceedingly rare. Dan Levitan also told me about how the founder of Blue Nile, Mark Vadon, had to work that business extremely hard, with very little capital, before Dan could see its promise and offered to invest. It took numbers. Undeniable numbers.
A huge reason for this is the decision-by-committee nature of venture capital investments. It isn’t enough to convince a guy like Dan alone. He has to have all the firepower and conviction to convince his partners. And 99 out of 100 times it just isn’t going to happen without the numbers.
My advice? Stick with angels until you have those undeniable metrics that work for a VC. There are FAR more consumer-savvy, professional angel investors who don’t have to get permission from inexperienced partners to make an investment. Those one-on-one conversations can be magical, in which those investors really take the time to see your vision. You have to knock on a lot of doors to find the right angels, but the investment decisions tend to be swifter, and there are far less strings attached to the investment. These investors, often successful entrepreneurs and corporate titans, can also have networks matching and exceeding that of VCs. Make sure your venture shows steady progress, and a path to making great returns, and the angel investor is going to stay “on side” and help you grow.
Here is my checklist for when a consumer venture should approach VCs:
- Be able to PROVE fantastic economics. It’s very simple. Show that you know how to acquire customers and that the lifetime value of those customers is very attractive against the cost of their acquisition. This is a chicken and egg problem. If you have never had funding to acquire customers, then it is hard to demonstrate the cost of acquisition. Purely organically acquired customers “don’t count.” VCs want to invest when your company is at the “pour on money and it will grow stage.” So do whatever it takes to get some cash together and invest it in various acquisition methods to prove out the ones that are scalable and cost-effective. May 2012 edit: I see the landscape shifting here now. VC’s are both ignoring high marketing costs (daily deal sites like Fab.com) if the top line or user growth is high, and they are ignoring revenue models altogether in some cases like Pinterest. They are favoring exponential “free” growth over solid but slower CAC/LTV based models.
- Make sure you are building a large business, and not just a product. I am talking a minimum of a $50M topline business, and in consumer considerably more revenue should be possible.
- Execute execute execute. Technology ventures can sometimes get away with being crappy operators. Consumer ones cannot. Ever.
- Assemble a deeply experienced team as the VCs will not have much of a Rolodex to help you, and that will worry them.
At Daily Grommet, even post $3.4M in angel investment, I still sleep on friend’s couches and eat cheap lunches while traveling, to preserve our marketing budget. Our whole team makes similar sacrifices. Why? We are not gluttons for punishment. But in our case, a $21 investment in marketing creates a 350% return in gross profit contributions, and a 2,000% return in enterprise value. (So I look at that expensive NY menu and keep on walking to the next bagel joint.)
But until we had a decent marketing budget, I could not prove that basic economic power. Now we have. It was not easy to get to this point. We first had to invest all of our limited resources in building a consumer experience that would be satisfying to the people we would eventually bring into our community. There is no sense in acquiring customers to simply disappoint them. In allocating our resources, we have not been able to build up our dev team as rapidly as I would like, because ROI on fixed costs (salaries) does not immediately translate to a good investment opportunity. But investing in proving our economics is what it takes to eventually get the dev budget and all the other budgets that the company needs and deserves and have high–albeit longer term–ROI.
- Finally, it’s a lot of pressure for your marketing team to carry the central role in demonstrating the economics of your venture, so make sure you have a great CMO. They are worth their weight in gold in making your startup venture capital-ready.
One final note. You will see plenty of VC money going to pure copycat ventures that do not meet the criteria above. The 250 funded Groupon clones are the current best example of this. But some irrationality enters the VC mindset when they see something hot and want to “have one of those.” Copycats are not defensible, and are very rarely future giants. The truly revolutionary consumer companies like eBay, Facebook, Zappos, Net-a-Porter, Vente Privee, and WholeFoods took a different level of investor vision, patience, and experience than any copycat. If you have one of those breakthrough companies, the VC road is a very tough, but not impossible, one.