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The direct-to-consumer sector — perhaps more accurately referred to as digitally native businesses — is facing a reckoning this year as venture capital flees the category.

Why it matters: It's a fact that leaves startups with fewer options for survival, Richard writes.

Driving the news: Last year, investment in the space plunged to over $130 million as of November from its peak of more than $5 billion in 2021, per Crunchbase.

The big picture: "It's been an accident waiting to happen," Howard Meitner, a managing director at advisory firm Carl Marks, tells Richard.

Funding hysteria was partly driven by the pandemic and the presumption that store closures of nonessential retailers would bring the end of brick-and-mortar.

Yes, but: While the pandemic underscored the necessity of digital sophistication, it also highlighted the limits of e-commerce.

By the numbers: A 2023 report from VTEX says that 37% of retailers report that e-commerce is not meeting profit goals. Plus...

38% have seen a reduction in digital ad effectiveness.

22.5% are experiencing falling demand and increasing average inventory volume.

The most stunning of all, 69.8% of e-commerce shopping carts are being abandoned by shoppers.

"It shows you how difficult it is for DTC business to be profitable," Meitner says.

The business model struggles without large cash infusions because of high customer acquisition costs, low customer retention, costly returns, and inventory issues, he says.

Meanwhile, many DTC companies were errantly valued like software companies. 

Startups were feeling market pressure to raise loads of cash at astronomical valuations, and founders were incentivized by the prospect of cashing out of a percentage of their positions.

Catch up fast: Some of the fallout began last year. Underwear brand Parade sold to Ariela & Associates International, a licensee of Fruit of the Loom, the lawyer says, likening it to a liquidation.

There was also the sale of Dollar Shave Club to Nexus Capital Management for what was likely a fraction of Unilever paid to acquire it, Meitner says.

Other examples include Morphe Beauty's parent Forma Brands' bankruptcy filing, SmileDirectClub's collapse, perhaps most famously Glossier, and more recently, Farfetch.

1 big thing: A sector in distress 

Illustration of a cardboard box and a ballpoint pen surrounded by abstract shapes and money elements.

Amid a new DTC environment, investors have become wiser on what works and what doesn't, Kimberly writes.

Why it's the BFD: This is crucial to separating the wheat from the chaff, a dynamic that will play out this year as more startups shake out.

What they're saying: There's this whole shift in the "permissible playbook," says IRL Ventures founder Taryn Jones Laeben. 

IRL's portfolio included Parade and virtual fitness provider Mirror, which sold to Lululemon for $500 million in 2020.

"When there was a lot of capital to be had, it was very easy to build vanity strategies, as opposed to really building a durable consumer business," says Laeben.

That means ensuring efficient headcount, employing low-cost approaches to customer acquisition, leveraging new tech, and building a multi-channel strategy, she says. 

For VMG Partners general partner Robin Tsai, a multi-channel strategy isn't a must-have — but companies have to meet consumers where they are.

"You want to build your business with maximum flexibility so that you can be pure play DTC if that's what your consumers want, or you can be more omnichannel," he says.

They also should have products that are highly repeatable purchases and that draw a loyal following. 

What we're watching: Several DTC companies have gone public in the past couple of years trading at a fraction of their IPO valuations.

The exceptions are players that straddle tech like beauty company Oddity Tech, which saw a successful public debut last summer, Laeben says.

Zoom out: But there's another side to this equation, and that's M&A, she adds.

It could "present some opportunities for earlier stage businesses who have quickly gone to profitability during this time to seek transaction opportunities."

The big picture: Consumers want a curated buying experience, says Tsai, whose firm's portfolio includes popular brands Kosas (on the auction block) and The Honey Pot (acquired by Compass Diversified) and troubled baby brand Hello Bello (acquired by Hildred Capital Management out of bankruptcy). 

"They want to be able to walk into an environment and actually be very confident that what they're going to be selecting from is somewhat pre-vetted," he says.

Meanwhile, channels like TikTok and Instagram Live have proved to be effective ways of building DTC offerings, says Michael Jones, CEO of Science Inc., whose companies include Liquid Death, Dollar Shave Club, and Rover (acquired by Blackstone).

Be smart: Many DTC companies face a steep learning curve in manufacturing, distribution and marketing, says Jones.

"Some of those companies just literally can't figure out those components to become a margin-positive growing company before they run out of money," Jones warns. 

The bottom line: All investors agreed that profitability is king (or queen) — and, as Tsai notes, serves as a good indicator that consumers value a brand at a premium. 

2. The BFD: Investors change their tune

Illustration of women's clothes on hangers and a bag of groceries surrounded by abstract shapes and money elements.

Distress presents opportunities for investors with the stomach for risk, Richard writes.

Driving the news: Firms such as BlackRock and Oaktree are raising structured equity funds that may be better described as distressed venture funds, says David Spreng, CEO of Runway Growth Capital. 

The funds would invest in digitally native companies to fix their cap tables, though the minimum check would have to be $100 million for the deal to make sense, he says.

Such funds are not unlike the distressed debt funds firms like PIMCO raised to take control of retailers like Neiman Marcus during the early days of the pandemic.

Another example is the lifeline Silver Lake and Sixth Street threw home-sharing company Airbnb at the onset of the pandemic, Spreng says.

Zoom in: Among potential investment opportunities include Warby Parker, Allbirds, Rent the Runway, Wayfair and Care/of, which is owned by Bayer, a turnaround specialist says.

These companies could be acquired at a relative value, and new management teams and strategies could be deployed to turn them around, the source says.

Yes, but: DTC's troubles don't mean that all venture investors will want to abandon existing investments, Spreng says.

Some firms will want to move forward with some of the more promising, even if struggling, parts of their portfolios.

Those financings, however, will include a pay-to-play provision. The fellow VC firms who don't want to participate in new financing will be wiped out, he explains.

Threat level: Struggling DTC companies have a few tricks to stay relevant, Meitner says.

That includes partnering with retailers and expanding into wholesale.

In some instances, like Madison Reed, they could deploy a strategy for opening stores, such as utilizing small footprints and flexible leases, Spreng says.

"When you blend it in with other channels, DTC's challenges can be mitigated," Meitner says.

State of play: According to Meitner, some bright spots exist in the DTC landscape.

These include scrubs maker Figs, sneaker brand On Running, earbuds brand Studs, and T-shirt maker True Classic.

Additionally, Meitner cited hair coloring brand Madison Reed, skin care provider Droplette, cookware seller Maidenware, clean luxury brand Merit and skin care startup Rhode Skin.

BlackRock declined to comment, while Oaktree did not respond to a request for comment.

the lifeline Silver Lake and Sixth Street threw home-sharing company Airbnb

3. The buyers and sellers

Illustration of a stack of money and a handshake surrounded by abstract shapes and money elements.

Want more retail deals? Go deeper into our full database in the Axios Pro Deals Tracker.

• Kost Capital, a Danish VC firm focused on food tech, is raising €25m for its debut fund. https://axios.link/3UfYZ9L

• Chef Robotics, an SF-based provider of commercial kitchen robotics, raised $14.75m in equity and debt funding from MaC Venture Capital, MFV Partners, Interwoven Ventures, Alumni Ventures, Construct Capital, Kleiner Perkins, Promus Ventures, and Red and Blue Ventures. https://axios.link/4993PtN

• Cargado, a U.S.-Mexico cross-border logistics startup, raised $3m in pre-seed funding. Ironspring Ventures led, and was joined by Zenda Capital, Wischoff Ventures, Proeza Ventures, and Sahil Bloom. www.cargado.com

• Blue Sage Capital, an Austin, Texas-based midmarket PE firm, is raising its fourth fund, per an SEC filing.

• Brynwood Partners hired Houlihan Lokey to find a buyer for Hometown Food Co., the Chicago-based maker of Pillsbury's shelf-stable baking products, per Reuters. https://axios.link/3SenDVL

• Bloomreach, a Mountain View, Calif.-based e-commerce personalization provider valued by VCs at $2.2b, acquired Radiance Commerce, a San Mateo, Calif.-based conversational commerce platform that had been seeded by Foundation Capital, Flight Ventures, and NEA. https://axios.link/42i19Ia

• Fresh Vine Wine, a low-carb wine producer, and Notes Live, the Colorado-based live entertainment and hospitality company, have agreed to merge in an all-stock transaction valued at $350m. https://axios.link/3udvafr

• Fantuan, a Vancouver, Canada-based Asian food delivery platform, has acquired Chicago-based Chowbus' food delivery business. https://axios.link/3U9F6kD

• Oak Hill Advisors, the credit arm of T. Rowe Price, is raising $3b for a new senior private lending fund, per the WSJ. https://axios.link/3SAeMin

4. Retail transactions

❌ Situational awareness: Amazon canceled its $1.4 billion acquisition of Roomba maker iRobot, marking the first time the e-commerce giant has been stopped from buying another company. 

✍️ Programming note: Today we're giving you in-depth insights into the state of distressed e-commerce retail. Let's dive in.

🏈 What we're watching: Richard celebrated the win by the Kansas City Chiefs over the Baltimore Ravens to advance to a fourth Super Bowl in five years.

✏️ Many thanks to newsletter editor Claire Rychlewski and copy editor Mickey Meece for today's edits.

🙏 Thank you for reading Retail Deals! 

January 29, 2024

1 big thing: A sector in distress