Member Exclusive   //   May 24, 2022

DTC Briefing: ‘Some canaries in the coal mine’: Startups brace for VC slowdown

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 →

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. To receive it in your inbox every week, sign up here

In some ways, it feels like the beginning of 2020 all over again.

At least when it comes to the economy: Stocks experienced their worst monthly fall since March 2020, while Silicon Valley VC giant Y Combinator issued a warning advising its portfolio companies to “plan for the worst” and extend their runway in a memo that was eerily reminiscent of the ‘Black Swan’ memo Sequoia issued just over two years ago. Startups ranging from Klarna to Cameo are laying people off and bracing for belt-tightening ahead of a likely recession. 

This puts venture-backed direct-to-consumer startups in a precarious situation. While a record amount of money was invested into startups last year, suddenly, investors are warning that venture capital is going to be harder to come by over the next year. Some investors argue that consumer startups are less likely to be impacted by the venture capital slowdown than tech startups, but all agree that now is the time for startups to start conserving cash and doing more with less.

“We are due for a reset,” Lunya founder Ashley Merrill — who is also an investor through her firm NaHCO3 — told me in an email. 

Selva Ventures founder Kiva Dickinson told me that compared to a year ago, the fundraising environment is “definitely tougher,” for consumer startups. He said that investors who deploy capital across both consumer and technology startups have been hit hard by the tech sell-off, and as a result “are being much more cautious in deploying capital everywhere, including consumer.” 

But the retail sector hasn’t totally been in the clear. Last week’s Walmart and Target’s earnings are a harbinger of what’s to come; both big-box retailers reported profits that came in below expectations, as they struggled to ward off rising supply chain costs and keep the right product in stock as consumers shift their spend away from things to experiences. 

“We do have some canaries in the coal mine of what the rest of this year might look like,” Dickinson said.

All of this, Dickinson said, makes many investors cautious about deploying capital right now, which impacts startups at both the seed stage and later stages.

“The more later stage you are, the scarier it’s gonna get,” Mike Duda, managing partner at Bullish said. He said part of it is narrative-driven; as more billion-dollar startups like Klarna and Cameo cut costs, the pressure will only ramp up for other highly-valued startups to do the same.

“There’s much greater pressure on [later-stage startups] reaching profitability sooner,” Dickinson said. “There’s not the same expectation that if you grow, another investor will invest at a significantly higher valuation in a year or two. Generally, these companies need to prove that not only that they can grow but that they will have access to capital in one or two years, if and when the fundraising environment is even harder.” 

And while seed-stage startups might be shielded from the pressure of having to drastically cut costs quickly, they are also likely to face challenges in fundraising over the next year. 

“In addition to a softening economy we’re seeing rising costs of user acquisition and [cost of goods sold],” Merrill said. Startups can’t double down on retention the same way more established companies can and it’s hard to pencil a profitable plan from day one.” Dickinson said that for seed and early stage startups, there’s only “a few really specific consumer-focused investors,” as some firms like Forerunner shift their focus toward software

But, it’s not all doom and gloom for consumer startups right now. Duda pointed that consumer spending remains strong in certain categories like travel and restaurants, as people want still want to spend their money in ways they weren’t able to during the pandemic. “Consumer spending has been chugging along at all costs.” 

As such, the advice from many investors is that while a recession is expected in the next year — nothing is a given, and consumer spending will continue to ebb and flow. In fact, warnings about fundraising imminently drying up for consumer startups have been issued previously, in 2019 when customer acquisition costs rose, and in 2020 when the pandemic first hit.

“Everything is cyclical so 12 months from now we could be looking at an entirely different situation,” Merrill said. 

When asked what her advice was for startups that are fundraising right now, Merrill said, “I think they need to be able to demonstrate that they are lean and can build a long runway with the capital, that they are poised to survive a soft economy and that they are where investors want to be as the recession lifts.” 

Turning to other sources of financing

Duda said that as venture capital gets harder to come by, he expects to see more down rounds or bridge rounds. Alternative fintech firms like Clearco are also expecting an uptick in business — as they did during the pandemic. CEO Michelle Romanow told me that the number of mid-market companies Clearco has provided funding to — defined as companies that do more than five million in revenue – has doubled in the past year. 

Clearco positions its solution as “revenue-based financing”; Clearco looks at certain data from startups’ ad spend, bank accounts and payment processors to determine which companies to give a cash advance to, and under what terms. Clearco then takes a portion of the company’s revenue until the advance is paid back.

“This market, for so many of our founders, has become very, very difficult on the VC side,” Romanow said.

What I’m reading

  • The founders of Bearaby and Boxed commiserated on the challenges of scaling in a founder-on-founder interview in Inc. magazine 
  • CNBC profiled Asian grocery startup Weee, which recently tapped Crazy Rich Asians director Jon M. Chu as its chief creative officer.
  • Fortune interviewed Shopify president Harley Finkelstein about why the company isn’t making employees return to the office, and how it’s embraced a digital-first work model

What we’ve covered 

  • DTC formula brands Bobbie and ByHeart have temporarily stopped accepting new customers after seeing a huge spike in demand due to the formula shortage
  • Diffuser brand Vitruvi hired a new brand president with brick-and-mortar experience as the predominantly direct-to-consumer startup looks to expand its wholesale presence. 
  • Startups like Simulate and Thousand Fell are using rapid delivery services to drump up hype for new products and services.