Over the past 2 decades, e-commerce venture capital has gone through several whipsaw cycles — up in the late 90s, down in the early 2000s, up again in the late 2000s, down in early 2010s, and up yet again in recent months.
While there have been several high profile failures — Pets.com, Webvan, Fab.com, etc — there have been several outsized exits as well. Alibaba, Zappos, Zulily, Dollar Shave Club, Jet.com and Chewy.com all sold for sums in excess of a billion dollars.
In addition to those huge success stories, there’s also a huge list of up and coming companies who may eventually join the $1 billion e-commerce exit club — Blue Apron, Warby Parker, Honest Company, Houzz, and Ipsy just to name a few.
Unlike some other industries, early success is not necessarily an indicator of ultimate success. Several later stage companies have flamed out after initial staggering success led to eye-popping amounts of invested e-commerce venture capital. For example, Gilt Groupe was liquidated for less than the $286 million of venture capital they raised, One Kings Lane dropped from a $900 million valuation to less than $30 million virtually overnight.
Unfortunately, my experience on this topic hits too close to home — my own substantially lower-profile company hit hard times after raising $104 million of funding. While I certainly wouldn’t call my company a failure, we didn’t reach the lofty billion-dollar valuation goal we hoped to reach.
Since that “failure” I’ve done quite a bit of angel investing in e-commerce companies. In that role, I rely on the hard-earned lessons I learned as my own company failed to reach unicorn status. Without these characteristics, I simply won’t contemplate an investment:
Compelling Gross Margin — my business had 27% gross margins. In our case, the low gross margins were caused by selling commoditized products produced by outside manufacturers. Additionally, we offered free shipping and free return shipping — table stakes in our industry. While I don’t have a hard and fast floor in my investment thesis, many vertically integrated high-flyers have gross margins well in excess of 50% — some even exceed 80%.
Strong Repeat Purchase Behavior — selling products like cowboy boots is a tough business to engender repeat purchases. Boots last a long time, and most people don’t own dozens of pairs — our average customer purchased 1.28 times. Companies like Dollar Shave Club and Ipsy, on the other hand, have more powerful repeat purchase economics. The purchases auto-repeat every month — subscribers stay with the platform for a year or longer generating a 10-fold higher level of repeats than my business.
The Ability to Create a Brand — other than a few notable exceptions, the ability for a retailer to create a powerful brand around selling other people’s products is minimal. Zappos is perhaps the only notable exception to this rule. The vast majority of billion-dollar companies with powerful brands are vertically integrated — they design, manufacture, and sell their own branded products directly to the consumer. I won’t even contemplate investment in a retailer who sells brands they don’t own.
Low to No Inventory Risk — nearly all of the e-commerce companies I’ve evaluated underestimate the cost of carrying their inventory. (Here’s a refresher on how to calculate inventory carrying cost.) Even in very well run companies, I rarely see this cost dip below 20%. Most are 30% or higher. That said, for me to consider an investment in an inventory-dependent business, the inventory must turn very, very rapidly. Ideally, the business would have zero inventory risk — Zulily famously carried no inventory at all!
Minimal Platform Risk — I’m well known for saying “Don’t be Google’s Bitch.” I’ll add to that by saying “Don’t be Facebook’s Bitch,” “Don’t be Instagram’s Bitch,” etc, etc. While those platforms provide a great way to reach customers, the ultimate goal is to build your own customer base that isn’t reliant on the whims of algorithms outside your control.
My company’s failure to reach its goals should serve as a stark warning — after we built a following of 8 million fans, Facebook made it nearly impossible for us to reach those fans by continually altering their organic reach algorithms. Whereas 5 million fans (around 60%) would see every post we’d make in the beginning of 2012, by the end of 2013 only 20,000 (around 0.25%) would see our posts organically. Ouch!
Fortunately, we made hay while the sun was shining — we acquired 11 million email subscribers from Facebook before they changed the game. We built our brand on a platform (email) over which we had much more control.
Customized Technology — while Shopify, Woo Commerce, BigCommerce and others have made it incredibly easy to get started, I won’t invest in an e-commerce company that doesn’t have a custom or semi-custom e-commerce platform included in their product roadmap. I’ve written many times about the limitations of those platforms, and about the “million dollar ceiling” resulting from their deficiencies.
(Shameless plug — I believe so firmly in the limitations of existing e-commerce platforms, that I’m building a custom e-commerce platform for stores looking to grow — it’s called Engine. If you’re contemplating a re-platforming for your store, I’d love to chat about the “revenue secrets” we build into our stores, email me email@example.com.)
E-commerce is hard. And raising e-commerce venture capital can be especially challenging. In a post-Amazon world, it’s even harder. But the future is bright — the next generation of e-commerce companies are rising quickly. If this cycle is like previous cycles, it will be driven by e-commerce venture capital investment in companies that change the game. Sure, many will flop — but the recent history of billion-dollar successes almost certainly catalyze continued venture capital investment.
If you’re raising e-commerce venture capital on a company that has the characteristics above or simply need help evaluating your e-commerce technology, email me — firstname.lastname@example.org