Banking on the Future New Financing Models Are Emerging to Accom- Modate Metrics That Don’T Fit the Old Mold

BANKING ON THE FUTURE NEW FINANCING MODELS ARE EMERGING TO ACCOM- MODATE METRICS THAT DON’T FIT THE OLD MOLD.

LISA JOHNSTON

irect-to-consumer selling certainly isn’t for the faint of heart, and no one knows that better than those who are financing the brands going this route. D While retail has taken its share of lumps over the years—and will undoubtedly continue to do so—DTC sellers operate on a formula that combines the uncertainty of consumer behavior with a lack of sales history to predict future performance. What’s more, many DTC financing being cobbled together—convertible hyper growth that especially sets them apart. apparel and footwear brands rely heavily upon notes/friends-and-family money, etc.—in the Wholesalers typically experience a significant social media for their marketing strategies, [small and medium enterprise] space.” expansion by receiving an open order from a which can cause customer acquisition rates Roli Saxena, chief customer officer of B2B new retailer, which carries a longer lead time to fluctuate wildly. As such, many traditional solutions provider Brex, agreed that the and is easier for a bank to digest, said Eric Fisch, financing options fail to translate into secure banking industry has failed to keep up. head of retail and apparel, commercial banking lending experiences. “It’s not just legacy banking, but legacy at HSBC. Brick-and-mortar retailers, meanwhile, “Most lenders are still struggling to financing broadly,” she said. “Banks have similar grow through expanded store presence, which is provide good financing solutions to DTC/ underwriting policies for all businesses, and a more gradual capital constraint. B2C companies, particularly the newer and don’t offer products tailored to the specific However, DTCs don’t bring the benefit smaller—less than $100 million in sales— needs of DTC. Non-bank financing options like of these historical financials, and it can be companies,” said John Stillwaggon, Tradewind some of the digital lenders are charging high difficult for a federally regulated bank to CEO for the Americas. While Tradewind interest rates and putting onerous payback structure a loan for a company that went from doesn’t currently support this type of business, requirements on the brands.” $2 million in sales, to $18 million, to $60 Stillwaggon said it’s something it’s reviewing DTC brands differ from more traditional million, and then forecasts that it will do $100 given the emerging need. “So far I see a lot of selling methods such as wholesale and retail million, said Fisch. unmet needs, and a lot of very non-traditional in many ways, but it’s their propensity toward “Traditional sellers have the stability of DTCS: SCALING NEW HEIGHTS

factors and retailer purchasing commitments. That goes away with the new online DTC entrants,” noted Saxena. “Moreover, e-commerce is growing a lot faster than traditional retail, which means the funding needs are more pronounced. It’s more of a risk, but often has a TOP 5 higher reward as well, which is why this space INVESTORS SHARE THE KEY METRICS THEY USE TO VET is quite exciting and growing so fast in recent POTENTIAL INVESTMENTS. years.” When it comes to investors, there seem to be no shortage of dry powder. Every day another Inventory plays a significant role in all of startup announces another funding round, securing astronomical sums series after series. this. Whereas the balance sheet of a traditional But while the cash appears to be flowing wildly, the reality is investors really are quite wholesaler would typically display a large picky about which companies they’ll back. And each has a slightly different formula for number of receivables and lesser inventory, determining which up-and-comer could be the next unicorn in the making. Here, four said Stillwaggon, the balance sheet for a DTC experts share their top criteria for evaluating a potential investment. company would indicate the reverse. And so —Reporting by Vicki M. Young while traditional brick-and-mortar retailers in fairly good standing could borrow against their inventory and physical real estate, today’s SAPNA SHAH Sole Focus: smaller and mid-sized DTCs often have very little Red Giraffe Advisors in terms of assets other than their inventories Sapna Shah, principal at Red Giraffe Is it a big idea where and IP, he said. Advisors, specializes in the retail we can build a really tech, fashion tech, e-commerce and “This can put a tremendous financing burden consumer sectors. She’s made pre-seed big company? If not, on the [DTC] company, and also presents a puzzle and seed investments in companies none of the other and challenge for the traditional [asset-based like men’s custom dress shirt resource things matter. lenders] and factoring firms that typically support Stantt, online fine jewelry store the wholesale/retail supply chains,” he said. Swoonery, and children’s wear brand Another challenge arises when DTCs forgo Monica and Andy as well as Find Mine, EBITA or net income positive in the hopes of which automates product suggestions, LAWRENCE LENIHAN continuing to grow the top line through more and Modalyst, a service that curates Resonance Resonance can wear many hats from marketing or customer acquisition. “This makes products available for dropshipping. angel to early stage, representing a it difficult for a bank to grow the risk rate,” said She’s only interested in startups new way of investing in the fashion Fisch. “From an equity perspective, it may be the positioned for the future of retail— luddites need not apply. industry. The venture operating firm has correct move, but from a financing perspective, it a particular interest in the fashion sector makes it very difficult.” Top 5 Criteria where it looks to combine industry know- He added: “There’s unsustainable growth in how with manufacturing capability, while a lot of cases. We’re told, ‘I could dial back the 1. Entrepreneur/Founders layering on its vision for technological marketing and be profitable,’ and I’m sure that’s 2. Market size opportunity insight. Co-founder and co-chairman true, but I’ve seen cases where you dial back 3. Scalability Lawrence Lenihan is an investor with an that marketing and the sales drop. And they 4. Revenue model engineering background, financial acumen still can’t be profitable because they’re built an 5. A clear exit strategy and a deep interest in design that can combine right and left brain to fine- infrastructure for this bigger business.” tune the guts of how a company should “It’s hard to scale DTC,” agreed Saxena. “You operate. Early-stage fashion investments have to hit on products people want, then you have included women’s wear brand Tucker, have to finance your advertising to optimize Critical men’s underwear company Tommy John for margins. How much can you return on every Characteristic: and Lolly Wolly Doodle children’s wear. dollar in ad spend? That’s really the name of the game these days.” Founders need Top 5 Criteria Building for today with an eye toward to be coachable, 1. Opportunity size profitability down the road makes it difficult for passionate and 2. Team these companies to demonstrate they’re building capable of building 3. Traction a profitable, sustainable business capable of the business. 4. Business model longevity. 5. Would I be proud to tell my kids I “They plan on being billion-dollar invested? companies and so they often build their system, infrastructure, warehouse capacity [and] C-Suite around the future, which is generally a prudent thing to do,” said Fisch. “But if you’re hiring a staff and putting in systems for a $100 million company—and you’re a $50 million Loyalty First: CONT. company—that’s going to have an impact on TOP 5 your net income and your ability to show a It’s the universal profitable sustainable business.” RYAN DARNELL Some financers are introducing new products defining factor Max Ventures to address these new needs. Brex offers a credit that makes a brand Max Ventures invests in product and card designed for online sellers that’s intended interesting because brand-focused founders across a wide to relieve some of their fluctuating inventory of the emotional spectrum, with the understanding woes: It comes with interest-free 60-day terms connection with its that what’s important for one sector and limits up to 100 percent of a company’s core customer. is likely different for another industry. projected monthly sales. Early-stage investments have included “DTC brands fund inventory cycles that can online bulk wholesaler Boxed, plus- be fairly variable over long periods of time, so size apparel retailer Eloquii and they need financing up front for investment subscription clothing service Le Tote. that may not pay back for many months,” said For Ryan Darnell, the ideal investments Saxena. “This means traditional financing are early-stage startups with just an options can charge high interest, as the brands ANTHONY CHOE idea for a product that could win its Provenance need the money and don’t have other options. category, coupled with entrepreneurs … These companies need money on a frequent Anthony Choe, a middle-stage private that have unique consumer insights. basis and, until Brex, haven’t had an option in equity investor in the consumer He said it’s all about understanding the market that wasn’t extremely expensive.” space, loves data analytics. Through the skillset of the founding team. The company also recently partnered with Provenance, the firm he founded to the BigCommerce and Magento e-commerce nurture promising direct-to-consumer Top 5 Criteria platforms, and it’s offering a 100,000-point and omnichannel brands, he focuses 1. Team signup bonus ($1,000 in cash value) to on brands that are past early stage, 2. Market e-commerce businesses that sign up for Brex but not yet ready for the traditional 3. Product and approach via the BigCommerce and Magento app stores. private equity investment. The investor 4. The likelihood that later-stage HSBC, meanwhile, has historically financed a uses his expertise in analytics to investors will be interested lot of seasonal businesses with non-traditional provide operational insights that can 5. Our ability to help this company inventory needs—such as outerwear wholesalers help consumer brands grow to the and brick-and-mortar retailers tied to holidays— next stage of its lifecycle. Current and it has taken the formula it uses for these investments include handbag firm types of businesses and applied them in a way Dagne Dover, custom tailored men’s that makes more sense for a DTC brand. clothing brand Knot Standard and the “What happens with those companies is that men’s and women’s California lifestyle #1 Question: we have an ability to be flexible around the apparel brand Marine Layer. formula we use,” explained Fisch. “We monitor What are the a company for their projected usage—not Top 5 Criteria professional and necessarily a strict percentage advance on the 1. Customer loyalty personal skill sets of inventory, but cater to the company’s needs. We 2. Brand differentiation applied this to DTC companies, which sort of 3. Margins/unit economics the founders? Do they works in their favor as they have a big buildup 4. Extensibility into channels beyond have clarity of thought of inventory ahead of Black Friday. As they build digital and the ability to that inventory, they can’t fit into a traditional 5. Alignment of interests on strategy articulate what they’re advance rate on the inventory, but if they have trying to do? a history and track record of sell-through and cycling down, that’s something we can buy into and use as a basis of approval for the coming year. We’ve been able to support business like that, even ones that are growing fairly rapidly.”