DTC Briefing: What’s driving recent private equity challenges in consumer

According to investors and investment bankers, recent challenges in private equity have been driven by the poor returns generated by many of the direct-to-consumer startups that went public in 2020 and 2021, as well as continued inflation and high-interest rates. The hope is that an eventual rate cut will open up the M&A markets, and lead to more IPOs that can once again remind skeptical LPs that consumer can be a good investment. Still, sources say, private equity firms are more closely scrutinizing consumer brands, and are most interested in those that have hit scale — say, around $100 million in revenue — and are profitable.

“I think it’s certainly indicative of recent challenges in the space,” said Patrick O’Quinn, partner at investment banking platform Axcel, when asked about the recent moves from Carlyle and Skky Partners. “I think there are a number of reasons that have led to, say, less enthusiasm and more tempered hopes and expectations [in consumer],” he added. 

“I think consumer has been a more challenging part of private equity,” Andrew Dunst, a managing director at The Sage Group said. He added, however, that “there has been a challenge across all of private equity in general, not just consumer, just around liquidity and exit opportunities.” 

In 2021, there was a record amount of private-equity deal-making. But, the following year, as market conditions worsened, U.S. IPOs hit a 32-year low. Now, there are a huge amount of companies that raised funding in 2021 — at huge valuations — still waiting on the sidelines to go public. And their private equity investors have yet to see any returns. 

Consumer startups haven’t been helped by the fact that many of the DTC startups that went public in 2021 have not performed well on the public markets. A recent analysis from Ben Cogan, co-founder of holding company Agora Brands, found that many of the DTC companies that went public in 2021 are now reporting stock prices that are 90%-95% down from their peak. 

But, the hope was that the Federal Reserve would have cut interest rates at the beginning of the year. This, in turn, would have spurred more high-quality consumer startups to go public, rather than staying private for another year. But, that hasn’t happened yet. A recent survey of economists found the majority of them still believe the Fed will cut rates at a June meeting. But, given how long it has taken for a rate cut to come, some are starting to operate under the assumption that it might take even longer than mid-summer.

Thus, what’s changed is that more LPs and firms are making plans based on the assumption that this high-interest rate environment is here to stay for a while. For some, that means that they are investing more in sectors that they feel like can more reliably generate big returns in a high-interest rate environment — like technology and AI — rather than consumer.

Of course, there are still pockets of activity. On a macro level, U.S. private equity activity is up 54% year-over-year, according to the London Stock Exchange Group. Stories also continue to pop up of new private equity firms looking to raise consumer-focused funds. Meanwhile, the most well-known consumer-focused private equity firm, L Catterton, continues to make new investments. Just on Monday, L Catterton announced that it was taking a majority stake in Italian beauty brand Kiko Milano. 

“I know several funds that are raising new rounds,” Dunst said. Another point in favor of consumer startups right now is that – despite fears that inflation would crater spending – that hasn’t proven to be the case so far. 

Still, the feeling is that private equity firms are being more cautious. It’s a sentiment that’s continuously reinforced by anecdotes from fundraising conversations. O’Quinn said that a few years ago, he felt like private equity firms were more willing to explore acquiring a smaller company as a bolt-on acquisition to one of their existing companies. But he hasn’t heard anyone bring such a strategy up recently. 

“We might market an undersized but really well-performing business and a lot of times it’s just not enough to get people interested,” O’Quinn said. He also added that, “we know of a number of — I would call them pretty high-profile brands — that have gone out to raise minority rounds in the last six months, with pretty ambitious expectations, and those have not transacted.”

Profitability also continues to be an area of focus, as it has been for the past two years. “The thing that private equity funds are very, very focused on right now is the quality of the brand,” Dunst said. He added that private equity firms also want to see the potential for multiple growth levers right now – that is, that a company has a significant opportunity to grow in the near future by expanding internationally. Or, has been able to build a significant business through mass retail but hasn’t tapped into say, club retail yet. 

“Finding a brand that ticks all those boxes is not easy,” Dunst said. 

The sentiment among investment bankers is that it will take more big IPOs from consumer brands to “just give a little bit more excitement and enthusiasm around the near-term future of consumer,” O’Quinn said. There have been a few standouts on the public market, most notably Cava, as its stock price has more than tripled since going public last summer. But the feeling is there needs to be more.

“LPs want exits, they want liquidity. And I think when that happens, that will help with fundraising,” Dunst said.

What I’m reading

• Earnest Analytics details how brands like Alo Yoga and Vuori are taking up a bigger proportion of spending in the activewear market. As one example: Earnest Analytics found that Vuori shoppers spent 17% less through Nike’s DTC channels this April, compared to a year ago.
• In an internal memo obtained by CNBC, Thrasio CEO Greg Greely told staff he intends to step down. The Amazon aggregator filed for Chapter 11 bankruptcy in February, and Thrasio has also lost other top executives recently. 
• Founders of three brands: True Botanicals, Adwoa Beauty and Subtl spoke with Beauty Independent recently about what it took for their brands to get funding from investors. 

What we’ve covered 

• The closure of Foxtrot, a modern convenience store, was the big story in the CPG world last week. We examined what went wrong, based on interviews with former employees. 
• Brands that sell through TikTok Shop face increased fees and an uncertain future.
• Goodr, which built its following by developing sunglasses that were ideal for runners, plans to double its product portfolio this year. Its focus is on developing styles designed for athletes who play different types of sports, ranging from baseball to pickleball.