Latest / The Learning Corner by Precursor / Episode #53: The Magic of DTC, Power of Iteration Speed, Secondaries in Term Sheets

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Episode #53: The Magic of DTC, Power of Iteration Speed, Secondaries in Term Sheets · The Learning Corner by Precursor

• 0:00
  I think we're coming back to a world where the answer is every successful company is a
• 0:04
  snowflake.
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  The way that they're successful will be unique and special to that company, and trying to
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  force them into rigid playbooks is probably a bad thing, both for investors and for the
• 0:12
  companies themselves.
• 0:13
  It's the week of October 20.
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  Welcome to the Learning Corner of Precursor Ventures podcast.
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  Welcome to the Learning Corner by Precursor.
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  I'm Mia Farnam, and I'm joined by RGP and managing partner, Charles Hudson, where we will
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  be talking through the articles and Goodreads that caught our team's attention over the past
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  week.
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  Our first piece is written by Brian Sugar titled, one brand is luck, two is strategy,
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  highlighting the recent attention in playbooks being created to capture d to c value through
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  larger acquisitions in an industry where many investors have been burned.
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  Sugar discusses the recent acquisition of Coterie, a well known diaper brand by Mammoth
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  Brands as the second major d to c brand acquisition this year with Road Beauty coming
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  in at number one.
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  Coterie was reportedly acquired for north of 650,000,000 while Road was purchased for
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  1,300,000,000, signaling the power of identifying companies that have mastered pure
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  play d two c as a mechanism to spot industry leaders, not the outdated wholesale retail
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  growth metrics that have historically driven these decisions.
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  Yeah.
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  Mammoth also purchased prior to Cautery, the deodorant brand Lumi in 2021 and doubled its
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  business in two years without compromising the brand's integrity.
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  Brian said, quote, you don't need 500,000,000 in sales and a Walmart aisle anymore.
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  You need brand devotion, clean unit economics, and an acquirer who knows the difference
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  between breaking a brand and building it.
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  So what's different here is that historically, strategics waited for d to c brands to fully
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  prove themselves out in retail before investing or purchasing.
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  And Brian points to some failed acquisitions by some legacy giants like Unilever and Dollar
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  Shave Club, Clorox and Burt Bees.
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  And Brian said the lesson wasn't don't buy d to c.
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  It was don't buy d to c if you don't know how to scale without suffocating.
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  So I wanted to pause for your thoughts because we have some great brands within our portfolio
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  from CPGs.
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  You've seen a lot of growth and change in this industry.
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  I've had the pleasure of co investing with Brian, and I think he is very thoughtful in
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  this category.
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  Look.
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  I'm not an expert in this category even though we've made a handful of investments, but my
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  perception was always the big brands, one of their big asset is retail relationships.
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  And so they tend to view the world through retail relationships because they've got the
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  shelf placements at Target and Walmart and whatever the relevant set of retail partners
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  is.
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  And I think when all you have is a hammer, everything looks like a nail.
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  And so it makes sense if you're like, hey, we're really good at pushing things through
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  retail.
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  Let's find companies that have already achieved some level of retail distribution, and we can
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  turbocharge slash unlock that stuff for them.
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  And if that's your playbook, you will be successful with brands and products where
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  that's true.
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  But if you're like, hey.
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  We're gonna buy this company that has a really different go to market motion than we do, that
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  we're not gonna break it.
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  That's harder to do.
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  But I don't think that's unique to CPG.
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  I think that applies to almost every business.
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  If you're an enterprise software company that does a lot of top down selling, and you try to
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  buy something that's PLG, and you try to make it fit in your org, I think that's I think it's
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  really hard.
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  I also find this very fascinating because a handful of our companies where I have the
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  highest outcome expectation are CPG companies.
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  They're physical products companies that sell direct to the consumer as one of their core
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  channels.
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  And, you know, two or three years ago, LPs would tell me, this category is dead.
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  Why are you investing?
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  I was like, well, nobody told the companies that the category is dead because they're still
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  growing.
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  And it's a category where it's really hard to get investor capital.
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  So in some ways you're sort of forced to run a good business.
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  There's no other way.
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  And it's one of those things where we've continued to invest in this category and I feel
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  really good about the companies that we're in.
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  And I think having more exit paths for these companies is a good thing because Yeah.
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  There are some of these brands who are where the founders are like, I put ten years of my
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  life into building this brand.
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  The last thing I want is some big conglomerate to snuff out the magic of what I've built,
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  either intentionally or through, like, negligent management.
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  We've come full circle in some ways.
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  Me, it was like, d to c is the future.
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  Then everyone's like, hey, you can't scale a brand.
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  You've gotta be omnichannel, so then you gotta go get you if wanna raise your series a or b,
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  you gotta go get an Ulta deal or a Sephora deal or and I think a lot about for folks, if you
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  haven't read the Ami Kolet story about the impact that going into Sephora had on her
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  brand.
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  I've seen this even within our own portfolio.
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  In some ways, investors started creating this model in their head about how you scale these
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  brands.
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  And there were a lot of brands who follow that playbook to their own peril.
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  And so I think we're coming back to a world where the answer is every successful company is
• 4:42
  a snowflake.
• 4:42
  The way that they're successful will be unique and special to that company, and trying to
• 4:46
  force them into rigid playbooks is probably a bad thing, both for investors and for the
• 4:51
  companies themselves.
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  And I sympathize so much with founders who are building in space because you'll talk to one
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  investor who'll tell you, I need to see you build out wholesale in these channels before I
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  come in.
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  And then you'll talk to other investors at the same stage who'll say, I don't believe that you
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  need wholesale and retail in order to succeed.
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  But I don't blame the founders for kind of being like, what route am I supposed to follow?
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  If venture capital is the money that I wanna take on into this business, but I agree with
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  you that for some businesses, wholesale and retail have been almost like poison pills for
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  them because then you're stuck in this funnel of hurting your margins, trying to get back on
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  shelves, working with buyers on the other side who leave the company every single year, and
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  then trying to chase coming back onto shelf.
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  It is something that can potentially destroy all the magic you place into the d to c side if
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  you don't do it correctly.
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  Going back to kind of like where we sit at precursor, when you're super early stage like
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  us, what signals indicate that a D and C brand is ready for maybe its next infusion of
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  capital, maybe its first partnership if it wants to go that wholesale retail route versus
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  a brand and company that perhaps needs to iron out deeper aspects of the business and its
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  relationship with customers before investing further?
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  And I know that you have other examples in different industries.
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  Yeah.
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  So happy to open it up.
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  I think most of our portfolio companies, the successful ones that have gone d to c, have
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  gone from d to c to some other iteration.
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  It's usually been pull.
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  It's usually been the d to c pieces working, and a category manager at some company saw the
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  product and said, we'd like to carry this.
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  Or somebody at corporate was like, this brand is seems to be taking off.
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  Somebody should go figure out why this is working.
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  Or it's like, hey.
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  We're rolling out a whole new category of naturals or Mhmm.
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  Go find the companies that have already built some audience.
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  And in some ways, to analogize it to other businesses, non CPG, I meet founders who are
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  like, if we could only get this distribution partnership with Microsoft, everything will be
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  golden.
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  And I'm like, well, a, you probably won't get it.
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  And b, the more audience and more success you have on your own, the more interested Microsoft
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  will be in working with you.
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  Yeah.
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  And I think the same is true with a lot of our CPG companies.
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  The notion that you're gonna go into Target or Walmart and be discovered is, like, backwards.
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  It's like you go into those locations and you go into wholesale and retail when you already
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  have built an audience and some level of demand.
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  I'm very sympathetic with startups who like, this could be the silver bullet for me.
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  I'm like, it could be, but you probably won't get it.
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  It reminds me of health care too, when folks Yeah.
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  Feel like, once I land this pilot or contract with this payer, I'm gonna unlock so much
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  growth.
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  And that's just the saddest myth in healthcare entirely if you've ever done b to b business
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  because you have to convert all of those members who basically never interact with their
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  payer ever.
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  And so Yeah.
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  Landing a contract with the payer is a great milestone, and you should celebrate it.
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  But it's zero conversion until you know how to reach those members, which payers themselves
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  don't know how quite to do.
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  Hence, why they're enlisting all these startups to be a better front door.
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  So it's applicable across so many industries.
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  Our second topic is a LinkedIn post by Hadley Harris at Eniak who shared his perspective on
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  what the largest driver will be to determine if you raise a series a or not.
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  He claims it is iteration speed, aka the speed at which you test new hypotheses, shift and
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  pivot, and launch new ones and have more shots on goal.
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  The more experiments you can run during this time, the more you can get closer to product
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  market fit with the right market motions to position you well for a series a conversation.
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  Things like shorter feedback loops, deep prioritization, and the ability to abandon
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  ideas quickly are examples of founder behaviors that can increase your iteration speed.
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  Ultimately, Harris argues the leaders and teams who can harness this will graduate, and those
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  who aren't able to make those adjustments will struggle far more.
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  I think every founder does believe that they are able to make decisions quickly.
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  But where have you seen that process break down and then impact the company and its trajectory
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  as a result?
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  I read this and I was like, this has always been true.
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  You know, we have our own internal review process after we make an investment, and at six
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  months, the most important thing I evaluate companies on is product velocity.
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  It's like, what have you done since you got the money?
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  And I think in a pre AI world, there was a sense of, like, this is what good looks like.
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  And it took into account that development cycles were longer and that you couldn't build
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  as much and you probably had to hire people.
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  So I would say the grading was more forgiving before.
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  Even so, the companies that had velocity always stood out.
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  Now, I would say we have the world's harshest graders in series a funds.
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  I just saw it was like a podcast or some interview where someone's like, if you don't
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  get to 10,000,000 in ARR in three days, I'm I'm paraphrasing.
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  That it's not good enough.
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  And I'm like, wow.
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  Like, that is both a very harsh bar, and there are companies I know that can clear it.
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  Whether they clear it cleanly or not, that's a subject for another podcast.
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  It's true, and I think people's expectation for what best in class velocity looks like are
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  probably 10 x what they were before.
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  And I don't know that every founder I talk to has absorbed that.
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  Some of them are like, yeah, we're going really fast.
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  We're getting a lot done.
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  And I'm like, on an absolute basis, that is true.
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  Relative to market expectations, it is untrue.
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  And this is one area where I think being in a dense builder area, whether that's San
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  Francisco or New York, you just get a better sense of what best in class speed and execution
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  look like.
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  And I've met a bunch of teams where I've talked to the founders, and they're like, we are
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  working so hard.
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  We are doing we're nine nines, and we're doing everything we can.
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  And I'm like, yeah.
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  But other people are doing the same thing you're doing, and I'm looking at the output,
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  and they're getting three times as much stuff done.
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  And those companies are like, how?
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  I'm like, I don't know.
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  I don't work at those companies.
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  All I can observe is the amount of time that you've both been given and the output on their
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  end.
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  You should go visit that company or you should come to Sam and people come.
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  You know, we've been doing these field trips to our office where we bring companies in who are
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  not building in the Bay Area.
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  And they always are like, this the rate at which information propagates here is
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  unprecedented.
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  The rate at which we can fix problems when you get stuck is unprecedented because everybody
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  here is working on the same thing.
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  And they're like, those are the edges that I didn't realize I didn't have access to in my
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  hometown, which doesn't mean you need to move, but it means you need to periodically get an
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  injection of that special magic.
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  And just come in temporarily to see what's the baseline, and then go back home, and then
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  really take a good look at what you guys are doing and say Yep.
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  Am I making decisions as quickly as I possibly can, or is it just in my own bubble?
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  I mean, we've talked a lot about how speed is not a moat.
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  So how does this logic differ from your perspective?
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  Or is this a completely different
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  No.
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  I think they're related.
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  Every time someone tells me speed is a moat, I'm like, I don't actually know what that
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  means.
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  I mean that in the most honest way.
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  It's like I thought it was a funny
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  sarcastic joke that people are saying Yeah.
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  In Vengeance.
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  It's like
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  I took it as like the the shrug emoji of the moment.
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  It's kind of like, we've run out of good answers.
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  It's not technology.
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  It's not network effects.
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  So I guess it's speed, for lack of a better answer.
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  But I think people are so desperate to find a narrative.
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  And so I think what ends up happening is if you're a series a investor, you're like, I need
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  to have some narrative that I can use to try to sort through all of these companies.
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  If you're just like, alright, I'm gonna find the ones that are compounding revenue the
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  fastest in the shortest period of time as a proxy for two things, the ability of the
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  company to execute and customer interest in the product or service that the company's building,
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  that's not a bad that's not a bad proxy.
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  I wouldn't say that's a bad way to invest.
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  You run the risk of sometimes finding ephemeral things.
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  I'd say the equivalent is if you invest in consumer companies, and you're like, oh, wow.
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  This company just got to a 100,000 downloads really quickly.
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  You're like, but what's day 90 retention gonna look like?
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  Well, I don't get to wait till day 90.
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  I have to make a decision in the moment.
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  And you either believe that the product has legs or you don't.
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  Going on that line, I've met with so many different consumer AI companies right now that
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  will say the same thing of I've gotten x thousands of downloads on our app in the first
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  two months.
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  I have this amount of engagement that's happening there.
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  And it maybe used to mean something when that felt like an outlier, but now that everyone is
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  saying it, because I think everyone has kind of maybe unlocked the masterful way of to go quote
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  unquote viral in different social channels.
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  I'm starting to struggle with just taking everyone for their word or wanting to ask
• 13:01
  further questions about how long people are spending the app, how often are they coming
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  back, and also will they pay for it.
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  It makes a difference if it's a freemium.
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  I love trying out different tools.
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  I'll sign up for anything once, but the moment that you start wanting to charge me $20 a
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  month, I wonder how long your community will stick.
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  Also, think as an investor, I always have to remind myself that what works propagates
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  through founder communities really quickly too.
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  I mean, I felt like as soon as the the Cloolie thing happened, all these people were like,
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  quick.
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  We gotta, like, Cloolie ify our marketing message.
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  That worked for them.
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  That was a moment.
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  We've seen this before.
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  Everyone, the Dollar Shave Club video came out, everyone's like, we gotta get our founder to
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  make a funny I was like, that worked because no one had really done that.
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  Yes.
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  And the derivatives are almost never as interesting as the original.
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  One last question for you, because I know how important it is for founders to be able to make
• 13:51
  decisions quickly and draw that analysis early on.
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  Where have you seen founders struggle the most in this, and and kind of what have been their
• 14:01
  Achilles' heel there?
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  I think the hardest, there are many things about that are hard about being a fund right
• 14:05
  now.
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  I think one of the harder things is depending on when you go fundraise, the bar for
• 14:10
  excellence might have changed dramatically in a month or a quarter, and you might have been
• 14:16
  racing toward a goal that was the right goal when you started the company, but now it just
• 14:23
  isn't enough.
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  And it's much easier to have a sense of that as an investor because you're in market and you're
• 14:28
  constantly getting feedback than it is when you're a founder and you're like, hey, I'm
• 14:33
  heads down building, and I saw a tweet that said that triple triple double double was good
• 14:37
  enough.
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  And now I see another tweet that tells me that it isn't.
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  What am I supposed to do?
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  I'm like, I don't know.
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  It's really hard.
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  Grow as fast as you can.
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  Answer as many questions as you can, and hope that it's enough.
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  That's like the double edged sword of popping your head up and looking around at other
• 14:50
  people.
• 14:50
  You want enough of it so that it motivates you, but then you don't want too much of it, then
• 14:53
  it, like, drives all your decisions to try and imitate.
• 14:56
  Totally.
• 14:56
  Totally.
• 14:57
  Our final topic of the day was a brief mention of a recent Axios pro rata issue that shared
• 15:02
  news of Menlo adding details about secondaries to their term sheet.
• 15:07
  Secondaries have indeed become less stigmatized across venture.
• 15:11
  If reports are true, Menlo is taking it a step further by outlining their liquidity intentions
• 15:15
  upfront.
• 15:15
  Concepts like telling founders that the fund will participate in secondaries when its
• 15:19
  position reaches a 10 x cost basis, and the founder is selling are examples of a more
• 15:25
  direct approach to the type of founder friendly secondary we've discussed on the podcast.
• 15:29
  Mhmm.
• 15:29
  I did like a historical look through basically all 53 episodes we've done, and we've been
• 15:35
  talking about secondaries on this podcast since maybe the first month.
• 15:38
  And that conversation has evolved so much since then, but in the beginning, it felt like we
• 15:43
  were shouting into a void.
• 15:44
  So clearly, there's been this consistent flow of support for the concept, and this reported
• 15:48
  piece is another data point.
• 15:49
  So, of course, this isn't also a direct report from Menlo.
• 15:53
  But wanted to ask you if you were surprised that we've arrived at this point in venture
• 15:57
  capital, that these are the the tools and levers that we're pulling now.
• 16:00
  I think if you had told me this five years ago, I would have said, you can't put that in the
• 16:06
  term sheet because every other venture firm will use that against you.
• 16:10
  And they'll say, why would you wanna take money from someone who's gonna sell their shares in
• 16:15
  your company?
• 16:15
  We're long term holders.
• 16:17
  We're not going anywhere.
• 16:18
  And people would have used it against you, and it would have probably have been successful.
• 16:22
  And I think it says a lot about where we are in the venture ecosystem.
• 16:27
  Whether or not this is true, I know there are firms who've adopted very similar policies.
• 16:32
  And so to me, it says a couple of things.
• 16:34
  One, secondary liquidity is not only an emerging manager small fund issue.
• 16:38
  It is an industry level issue.
• 16:40
  And as I told an LP last week ago, it can't be only an emerging manager issue because emerging
• 16:45
  managers don't have enough money for it to be a problem.
• 16:47
  The problem is the money that's locked up or tied up in the funds that have the most assets.
• 16:53
  And so to me, this is a signal that even large venture funds are thinking more critically
• 16:58
  about managing liquidity cycles.
• 17:00
  Second, I think one of the less well reported things that happened in 2020 and 2021 were just
• 17:08
  gigantic founder secondaries in businesses that didn't end up working out for investors.
• 17:13
  And where founders took a ton of money off the table, investors didn't have the same option.
• 17:17
  And founders were like, hey.
• 17:19
  I'm good.
• 17:19
  And then investors were like, well, I'm still long with this company.
• 17:22
  You're so motivated.
• 17:23
  Right?
• 17:23
  Oh, yeah.
• 17:23
  Yeah.
• 17:23
  I'm so motivated.
• 17:24
  I'm just motivated with $10,000,000,000 in the bank.
• 17:27
  And and I I think a lot of investors now are saying like, hey.
• 17:30
  This doesn't feel right that we can have these situations where we're sitting on a position
• 17:35
  that has increased dramatically in value.
• 17:37
  I think it's really the and condition in that Mendlow statement.
• 17:40
  If it's up to n x and you're selling Yeah.
• 17:42
  How can you tell me I can't sell?
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  Or we wanna make it clear that our intention is if the position has grown a lot and you're
• 17:48
  selling, that we want the right to participate too.
• 17:51
  And also, you know, I've seen situations where firms have come in, offered secondary liquidity
• 17:57
  only to founders as a way to buy positions in companies where it's a way to skirt provide
• 18:03
  there's there's a lot of reasons people have structured them this way.
• 18:06
  And I think a lot of investors are like, I don't wanna be forced to stay long if the
• 18:10
  founders taking a bit off the top.
• 18:13
  And I think when things like this come into the term sheet, it's kinda like pro rata.
• 18:16
  Everyone's like, oh, don't worry about pro rata.
• 18:18
  We'll give it to you if you're a good if you're a good actor and you're supportive.
• 18:21
  You gotta earn your pro rata.
• 18:23
  Cool.
• 18:23
  But also, I'd like it in writing because Mhmm.
• 18:26
  I wanna be assured of it.
• 18:28
  And if I decide to be constructive and waive it or reduce it, I want that to be my choice.
• 18:34
  We're well past the stigma of secondary, and now I think we're into the structurally how do
• 18:39
  we start building this in to the relationship upfront?
• 18:41
  And I think probably by this time next year, almost every term sheet will have some
• 18:47
  secondary language in it at the a and beyond about that firm's intention.
• 18:51
  So you think at this point, secondaries are going to be more of a feature within venture
• 18:56
  and it's here to stay rather than like a blip?
• 18:58
  That's a feature.
• 18:59
  It's a feature.
• 19:00
  And look, I think also if you zoom out again, so much of the capital in our business is
• 19:07
  concentrated in the small number of firms, and so much of the capital in that small number of
• 19:11
  firms is concentrated in a small number of companies.
• 19:15
  So if you're Menlo and you're an anthropic, you're like suddenly a significant part of our,
• 19:20
  not just our fund, but maybe our firm AUM is tied up in a single security.
• 19:25
  I mean, this is gonna be a completely different podcast, but I do wonder what's gonna happen
• 19:28
  when all of the giant foundational LLM companies start buying up all the smaller
• 19:32
  companies, and you roll up in a stock to stock purchase, so then everyone is now an owner in
• 19:36
  some sort of amount of share of Anthropic or OpenAI.
• 19:41
  How deep will this secondary market be at that point when everyone owns a little piece of it?
• 19:45
  I don't know.
• 19:46
  There will certainly be more shares on offer.
• 19:48
  It's a lot easier to control price.
• 19:50
  But I also would say, like, for OpenEye and Anthropic, from everything I can tell, the the
• 19:54
  demand to purchase shares in those companies are well in excess of what's available.
• 19:59
  And so it would take a lot of dilutive share issuance to change that.
• 20:03
  But I think what'll be interesting is there will be some venture funds who get those shares
• 20:07
  in Anthropic or OpenAI through acquisition and immediately sell them.
• 20:10
  And there'll be some people who are like, hey.
• 20:12
  We're gonna have a strategy here, and we're gonna hold some of these.
• 20:15
  And it'll be interesting to see the differences in performance across funds based on those buy
• 20:20
  sell decisions when those shares end up in their lap.
• 20:22
  Well, we are all out of time for today.
• 20:24
  Thank you, Charles, for stopping in.
• 20:25
  Thank you to our listeners for stopping through as well.
• 20:28
  Please like and subscribe, and we'll talk with you all next week.
• 20:30
  Thank you.
• 20:31
  Bye.
• 20:32
  Bye.