How to Buy an Ecommerce Business that Makes Money from Day 1
Disclaimer: The article is for informational purposes only and you should not consider any information here as legal, tax, investment, financial, or other advice.
In the world of Venture Capital, investors lose money on most deals. That’s how the model works; for most, nine times out of ten there is no real return on your investment. The hope is that the one investment that does provide a return is a giant win, bringing in enough money to not only cover all the other losses, but provide a high return on the portfolio overall. It’s a numbers game. This model is full of risk and it takes many years to see any return. Now, the best firms like our friends at Benchmark Capital and Tiny do it remarkably well. They are masters at picking the right horse at the right time, but not everyone is that good.
In the Private Equity world, traditionally you go in and acquire an entire business, make it profitable, and ride out that profitability.
But what if you’re somewhere in the middle? What if you’re neither of the above? Maybe you’re a family office, an investment firm, or an individual just looking for a great, high-opportunity, low-risk investment?
Typically low-risk investments come at the sacrifice of the high-opportunity upside. Until now.
In this article, we’re going to take a look at an exciting new model for investors. Since our position at Metacake involves assessing the health and upside of high-growth DTC businesses every day, we’re going to give you the formula we use anytime we look at the potential in a DTC business (whether it’s early-stage or long-standing).
A New Model
What if you could make money from day 1? What if a return on your investment was all but guaranteed, and you could still expect a 10X+ return in the long run?
If that sounds interesting to you (and it should), consider investing in hyper-growth ecommerce businesses. These have been dubbed by the investment community in DTC startups, but startup implies there’s no revenue. The ones we’re talking about have revenue and are
cashflowing, and they’re more common than you think.
Investing in DTC startups is a massive opportunity. The companies we are talking about are companies that have already proven their product market fit, effectively de-risking the market. What they need is investment to scale rapidly and experienced advisors to help them navigate to a successful, strategic exit.
What are the DTC startup exit opportunities?
Strategic sales of DTC startup companies are becoming increasingly common. Large, traditional retail brands are being forced to innovate. They can no longer survive on retail sales and are facing a number of challenges navigating into the direct-to-consumer space including the challenge of launching DTC while not torpedoing their wholesale business.
For many, the best way for them to enter the DTC market is via strategic acquisitions. Unilever buying Dollar Shave Club, P&G (one of our clients) purchasing Native, Movato buying MVMT, SC Johnson Stasher Bags (another of our clients), and Vera Bradley acquiring Pure Vida are just a few examples of this growing trend.
Here’s what you should look for as a buyer
So let’s say you’re interested in this concept. Maybe you’re a new investor or maybe you’re a VC or PE company already focused on this space. Our position as a hands-on DTC growth partner is to assess the health and potential of DTC business from early to late stage. We have a simple checklist we run through to determine this.
Proven product market fit
These startups should already be above or close to the $1M in revenue per year mark. This means they’ve de-risked the market to the extent that they’ve proven product-market fit.
Positive cash flow
These companies should have positive cashflow. One of the great benefits of a purely ecommerce company is its cashflow. Flat or negative cashflow at this stage would indicate another metric is out of wack.
There must be a great product that exceeds its promise. If the company does not already have raving fans promoting their product, it is not a good candidate for investment. Raving fans and a great product are foundational to long-term success.
Equally, the company must have a great story. People take action based on emotion. This isn’t just a fluffy concept, it’s a concept that returns real dollars. Customers buy from brands they feel emotionally connected to, so a brand with a meaningful story (and the ability to tell it) is key.
Make sure the product margin is well over 5X. The ideal product margin is 30X or more. In order to have a truly successful ecommerce business, you must provide excellent customer service and continuously exceed your customers expectations all while winning new customers via a paid-ad model and innovating on your product line. You simply cannot do this profitably without amazing product margin.
Similar to margin, AOV needs to be at a certain place. Even a 100X margin on a product that costs 10 cents to make is not a viable ecommerce business model. Look for a minimum AOV of $50 as a starting point. For us, we shoot for $75 which tends to be the magic number to support paid new customer acquisition.
Ad spend as a percent of revenue
You can go crazy trying to figure out ad spend attribution per channel. That only matters in the nitty-gritty. What you really care about is Ad Spend to Revenue, which should be anywhere from 35% – 55% (in high growth mode). Remember the importance of margin and AOV?
Percentage growth year over year
Finally, look for companies with a high percentage of growth year over year. If an ecommerce business has been around 10 years and has just reached the $1M revenue per year mark, the potential for viral growth is low. Instead, look for businesses that are able to reach this volume of revenue in just a couple years. This high growth at the beginning is a good indicator of future growth potential.
Some other factors to consider as secondaries and possible areas of opportunity are:
- The X factor: Does this brand have the potential to be really, really special?
- The product line: What can it be expanded to? Is there a current product development cycle?
- Shipping costs: You don’t want to get caught by surprise with this one. Bonus for fully digital products.
- Current technology infrastructure: We prefer Shopify Plus as the ecommerce platform simply because of the ability to be agile when marketing off of it.
- Customer lifetime value: This is THE key to scaling a successful DTC business. This already being in a healthy place is a bonus. Points for a product line that lends itself to a subscription model
A business might look good on the outside. It might have a great product, a great story, high revenue, and good site traffic. But don’t stop your investigation there. This list serves as an excellent benchmarking system to quickly identify good opportunities, but make sure the rest of the fundamentals we’ve outlined are there under the hood as well. These are all key to guaranteeing success in your DTC startup investment.
Need help in finding or assessing an investment or acquisition of a DTC business? We can act as an advisory role here, just reach out.
At what stage should you look to buy an ecommerce business?
There are two different stages that we recommend looking at for DTC startup investment.
The Survival Stage
The first is around the $1M yearly revenue mark with a goal of existing for over $10M. This requires a lower investment. The product market fit has been proven, but the companies in this stage are still young. These require not only capital to grow, but also more structural changes. Learn more about the ecommerce survival stage.
The Health Stage
The second is around the $10M yearly revenue mark. With these investments, the goal is to exist for over $50M. Obviously, these acquisitions require a higher level of investment. However, they also can typically scale much faster as the structure is already in place. These companies should already be in a healthy cash position, have an R&D department successfully growing the product line, and a good supply chain in place. Learn more about the ecommerce health stage.
What else should you look for when considering a DTC startup investment?
- Make sure you not only have the capital to make the purchase, but the right network of advisors on board with experience growing this type of company.
- Make sure there is an experienced growth team in place (or you have one on hand) to execute your strategic growth plan. This could be an internal team, or an external growth team like Metacake.
- Identify a potential exit from the beginning. DTC investment exit opportunities are primarily strategic acquisitions. Keep this in mind from day one as you work to grow the business. This will heavily influence your product and marketing decisions.
- Maintain the “soul of the brand” on the team. This may be the original founder or another early employee. It is important that the main driver of the brand stays on board as it is their original product and story that resonates with their audience.