This is the latest installment of the DTC Briefing, a weekly Modern Retail+ column about the biggest challenges and trends facing the volatile direct-to-consumer startup world. More from the series →
The holidays have come and gone, and brands now have a complete picture of how their 2023 sales ended up. Now, founders face a critical decision: whether this is the year that they should go out on the market, and try to sell their business.
It’s been a challenging few years for DTC brands, as they have had to deal with decreasing rates of VC financing, higher interest rates, inflation, and an increased pressure to become profitable more quickly. As a result, the M&A market wasn’t that great for DTC startups in 2023, and even during parts of 2022. In interviews with Modern Retail, CEOs of aggregators and other companies that are in the business of acquiring DTC brands say they don’t expect that sentiment to change much in 2024.
There’s still interest in fast-growing, profitable brands, especially in hot categories like beauty. But one of the big hurdles standing in the way of more M&A right now is high interest rates. The business environment has gotten more amenable to DTC brands over the past 12 months in a few notable ways. Inflation has cooled, while e-commerce sales have continued to grow.
But until interest rates fall – a rate cut is expected to come sometime later this year – acquirers don’t expect M&A to come roaring back this year.
“I think there is going to be a lot of transactions, and I think a good amount of them are going to be driven by need versus want,” Nick Ling, co-founder and CEO of home goods aggregator Pattern Brands said.
“The couple of bankers that we talked to in the consumer space, they kind of advised their clients last year, probably wait it out another year before going out,” Fan Bi, CEO of the Hedgehog Company said. “And I think they are giving that same advice this year.”
A year marked by fire sales and soft landings
While there were some bright spots, overall 2023 was a gloomy year for retail exits. According to a report from GlobalData, published earlier this month, the number of retail M&A deals globally totalled 1,435, up 12% compared to the prior year. However, the value of all of these transactions added up to $73 billion, down 29% compared to the worth of M&A deals in 2022.
What this indicates is that while plenty of M&A was still happening in 2023, brands weren’t getting the valuations they used to. Indeed, it was the year of the fire sale, marked by once-promising brands like Parade getting sold for “peanuts” (as one former employee put it to Business Insider) to intimates company Ariela & Associates in September.
Business Insider reported that in an email to employees around the time of the acquisition, Parade founder Cami Tellez said the acquisition was driven by a “massive macro-economic shift” that made it difficult for brands like Parade to get funding. According to Crunchbase data, the amount of venture capital funding that went to e-commerce and consumer product startups declined 97% compared to 2021.
It’s difficult to ascertain just how much the financial health of some brands has improved over the past year. There have been some positive industry signs. Ling pointed out that the volume of dollars that flowed through e-commerce juggernaut Shopify was up 22% over last year. “Brands are doing well, and e-commerce is growing broadly.”
But, in general it remains hard to run a business amid high interest rates, and while debt is harder to access. Bi noted he saw more instances last year of brands that he was tracking who fell behind on paying their vendors on time.
However the M&A market isn’t just dependent upon the financial health of brands, it’s also dependent upon the financial health of acquirers.
“We’re still seeing really great businesses out there,” Ben Cogan, co-founder of aggregator Agora Brands said. “Probably fewer that are growing as quickly as they were in 2020 or 2021, or even early 2022 – but we’re still seeing a good number of businesses out there that are growing and profitable.”
But, he added, the challenge for many aggregators is “the difficulty in the fundraising environment for the aggregations space, and the difficulty with higher interest rates.” That particularly impacts aggregators that use debt to fund their acquisitions.
“We’re fortunate, but a lot of other aggregators – especially on the Amazon side – don’t have the capital or the desire to really buy anything right now,” Cogan said.
In the face of venture capital funding drying up last year, many founders were advised to spend the year heads down, working on their business, and improving some of the key business metrics that acquirers were increasingly prioritizing. Namely, profitability.
But, Ling said that in speaking to founders, the sentiment he is hearing from many of them is that “I did all that work, but there’s still not many options available to me.” That is – even though they spent 2023 heads down and focused on profitability – debt is still hard to access, VC fundraising is still difficult, and the M&A market remains muted.
“I think people are feeling hemmed in by the options they really have, even though businesses are doing super well,” Ling added.
What acquirers are looking for in 2024
Of course, there are still deals to be done. Last year, Pattern Brands acquired one brand – towel startup Miracle – for an undisclosed amount in July. Ling said that ideally, Pattern Brands would like to acquire one to two brands per year, and brands that range from $20 million to $100 million in revenue.
“That allows our team to really focus,” Ling said, adding that Pattern Brand’s portfolio collectively grew revenue about 40% last year.
Cogan of Agora Brands said that his company typically tends to look at brands that are $1 million to $15 million in revenue – brands that, he said, typically have fewer exit options in today’s market. “Agora was founded in order to give these companies great opportunities to pass on their business to experienced operators,” Cogan said.
While Agora is still out making offers and acquiring businesses, he acknowledged that the company is being much more “conservative” about the types of businesses it is acquiring now compared to a few years ago. He declined to say how many brands Agora has acquired in total.
The Hedgehog Company operates in a slightly different space in the acquisition market. The company acquires VC-backed brands that have shown “early signs of brand equity” according to Bi, but are in need of a turnaround for some reason. One of the startups The Hedgehog Company acquired last year was Baboon to the Moon.
Bi said that The Hedgehog Company expects to acquire more brands this year, but doesn’t expect the “floodgates” to open.
“Markets have gotten much more conservative the last two years – this isn’t just an e-commerce thing,” Bi said. “And that’s just a really, really tough thing to navigate.”
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