Venture Scenes | Take 3
My blog about Startups, Venture Capital, and Movies.
The Script
The Remoras of Amazon
Heyday, which was founded in August, came out of stealth on Monday to announce that it has raised a massive Series A funding round. Arbor Ventures and executives from Amazon, eBay, PayPal and Magento also participated in the round. It’s the latest company rushing to bet on Amazon’s third-party sellers, which now generate roughly 60% of the e-commerce giant’s product sales, up from 3% in 1999 and 30% in 2008. While these sellers from the backbone of the nation’s largest online marketplace, most of them remain small. Deep-pocketed investors have spotted an opportunity to roll up dozens or hundreds of Amazon-native brands, pool resources and invest behind them to goose sales and profits…
The critics of Amazon deride the company for its harbored quest for world domination. Many fear the company has become too big. Some make the valid argument that it has historically been an unfair actor when it comes to competition by hurdling into new marketplaces with lower prices than its competitors, subsidized by its astronomically successful AWS business. That is an argument that I have always felt was valid. I do think Amazon has pushed the boundaries of modern capitalism in a few instances, as its profits from other business segments allowed it to undercut prices in a new market. I would not go so far as to say it has broken any boundaries yet, though.
In the wake of those criticisms, I love to see that a new startup ecosystem has been borne from the back of the whale that is Amazon. As previously discussed in my previous posts, I think we have recently hit an inflection point of e-commerce penetration. I think Amazon has established itself as the leading e-commerce marketplace in the world. I believe these two developments are likely the reason that VC dollars have poured into this particular vertical of the e-commerce and DTC market. And the enthusiasm with which Venture Capital is eying this particular market is incredible. I mean, $175mn for a company that has been in stealth mode and made its first hire in August...
Heyday is not the only player in this market — in fact, it is not even the largest. That title belongs to Thrasio, which last raised $260mn in July at a post-money valuation of $1.26bn (we have our first unicorn in the space!). In October, Perch raised $124mn. Earlier in November, Berlin-based Sellerx raised a $118mn seed round at a post-money valuation of $270mn. Also in November, British startup Heroes raised a $65mn seed round.
How This Model Works
These startups incorporate a business model that would not be possible if Jeff Bezos had not unilaterally decided to allow third-party sellers to list their goods on Amazon’s e-commerce marketplace. This decision made it easy to sign up for an Amazon account and begin to list goods, and over 1,000,000 third party sellers joined the platform in 2017. Currently, there are 2,000,000 third-party sellers on Amazon. With so many suppliers in the marketplace, startups like Thrasio and Heyday decided that there was untapped value in aggregating these brands and “small businesses” under one roof.
Thrasio, and startups like it, will scout the marketplace for “breakout sellers,” usually placing first or second in their particular category on Amazon. Once they have identified attractive businesses that are generating anywhere from $5–8mn in revenues, they approach the brand owners and offer them a quick exit/payday. Thrasio Co-CEO Josh Silberstein has said that these businesses typically sell for 2–3x multiples on revenue. Once the company acquires these businesses, Thrasio will essentially act as an Amazon Accelerator. The company will provide the entire operation with a “facelift” — compliance checks on the supply chain, vetting the product for safety and virality, utilizing consumer data and preferences to improve the product offering, and usually cutting prices. These third-party sellers on Amazon are typically achieving 30–40% gross margins (pre-advertising costs) before Thrasio even steps in.
Why This Model Could Work
Amazon is the largest online marketplaces on the planet, with a GMV of roughly $339bn, 3.8x larger than the next closest competitor, Ebay. The sheer scale and power of the marketplace alone mean that third-party sellers will continue to flock to the platform, providing an endless stream of small acquisitions that these startups can make. The pipeline will always be full in that regard.
The description of “Amazon Accelerator” (first coined by StrictlyVC) is what excites me most about this business model. I think these companies can add tremendous value to the third-party sellers’ products, and I believe they already have in many cases. The companies that Thrasio and Heyday target are already profitable in most instances, and achieve enticing margins. These companies are not looking to turnaround flailing business models — the execution risk is much lower. While these seed funding rounds have been insanely large, it’s understandable why investors are so excited. The unit economics, the scale of the market, and the relatively small lift necessary for each brand that these startups acquire are the main reasons to be enthusiastic about the growth prospects for Heyday and Thrasio.
The rapid growth of Thrasio is an example of how quickly these startups can scale. In just two years, the company achieved profitability, generated $300mn in revenue, acquired 6,000+ products, and is now one of Amazon’s top 25 sellers. Thrasio is the industry leader in this nascent market, but I expect companies like Heyday will soon achieve this similar kind of growth trajectory.
Why This Could Specatuclarily Fail
When has Amazon ever played nice? They are the most competitive company in the history of commerce. It is hard for me to imagine that they will allow, without recourse, billion-dollar companies to flourish off the back of their marketplace.
When looking at a new entrant to a long-standing market, the apparent execution risk is that the incumbents will try to squash that new entrant. This is true for countless startups, especially those who have gone up against the major tech goliaths. If I was a potential investor in these companies, the idea that these startups could potentially run-afoul of Amazon in some way would give me extreme pause.
That said, I am not sure what Amazon can do to squash companies like Thrasio. And thus far, Thrasio has stated that Amazon is “favorably inclined” towards them. Amazon may ultimately see themselves as beneficiaries of the work that Thrasio and other actors perform. After all, these companies are refurbishing and improving the safety and quality of the goods listed on Amazon’s marketplace.
So perhaps the risk of Amazon is merely existential in this case? Only time will tell how these startups will navigate the cohabiting relationship with Jeff Bezos’ marketplace. One thing is sure, though — future funding rounds for these companies will continue to make headlines, and investors should be on the lookout for new kinds of business models borne off the back of Amazon and other online marketplaces.
Venture Debt Takes Center Stage
Just this month, edtech company Udacity announced it had raised $75 million in a debt facility from underwriter Hercules Capital, while on-demand electric car company Envoy raised $70 million in debt through the Macquarie Group. In September, another edtech company, Skillsoft, raised a $75 million credit facility from CIT Group.
I have seen a lot of headlines and think pieces recently about Venture Debt, or “Venture Debt vs. Venture Capital.” In the depths of the pandemic, the general story is that startups looked to Venture Debt to extend their runways and provide emergency influxes of cash to stay alive. An important distinction about Venture Debt that I do not believe some of these articles or blog posts make is that it is not a form of financing used by most early-stage companies. Specifically, very few pre-series B companies chose traditional Venture Debt over equity (or convertible debt). Roughly 2% of startups chose debt when it comes to capital. This is not some new vehicle that is sweeping the VC and startup ecosystem.
Another important distinction is that Venture Debt is rarely issued without the company taking on a new round of Venture Capital financing. To quote Brad Feld and Jason Mendelson:
The first rule of venture debt is that it follows equity; it doesn’t replace it. Venture lenders use venture capital support as a source of validation and the primary yardstick for underwriting a loan.
This is how Venture Debt has traditionally been viewed. It is not a substitute for Venture Capital. Again, some of the articles and think pieces that I have read are not making this distinction. Instead, they are insinuating that we may potentially see Venture Debt as a preferred method of financing for startups in the future.
To be sure, we have seen a few companies pursue Venture Debt instead of Venture Capital. That decision typically happens at the later stages (post-Series A) — but I cannot, for the life of me, understand why a startup would pursue debt as a substitute for equity so early in its company life cycle. I understand the arguments behind ownership dilution and “Cost of Capital.” But we are dealing with early-stage investments. There is still a tremendous risk that they will fail, even if they have achieved their Series B or C. Burdening yourself with debt at such an early stage is unwise and, I believe, could increase the chances of failure. That is capital that must be repaid (with interest!), which may ultimately hamper future growth opportunities. Debt has a not-so-sneaky way of complicating the cap table, even for mature and public companies. (Note: This merely my opinion — I would love to chat with someone from SVB on the topic someday)
For those startup CEOs that do choose Venture Debt, I would bet that many will find themselves dedicating large amounts of time to financial engineering. They will be forced to figure out how to raise their next round of funding even though they still owe millions of dollars of debt from their last round. If I were on the board of a startup company, I would probably argue against Venture Debt in most instances.
Obviously, COVID was an extraordinary circumstance. I can understand why companies sought quick cash in the form of debt. But I fear we may see some of those decisions ultimately come back around in the next 6–12 months — and not in a good way.
Startup Close-Up
Have we hit peak subscriptions? As I alluded to in my previous post, the rise of companies like Truebill, Trim, and SubscriptMe would suggest that there is a market for subscription-monitoring services. These services have mostly branched out to include other kinds of financial health offerings, but they all started out offering consumers a way to monitor and cancel their subscriptions. But does the existence of services that allow you to monitor your subscription spending mean that consumers are tired of signing up for subscriptions? I am not convinced for a variety of reasons. And, I actually think focusing on the consumer is a red herring in this particular argument.
Nikhil Trivedi wrote an excellent piece on Consumer Subscription Fatigue or lack thereof. Here is my favorite part of that post:
Of course, a natural question given the number of subscription businesses that are out there is “have we hit peak subscription?”
According to an analysis earlier this year by Mint.com for the New York Times, each of us in the U.S. spent on average $640 on digital subscriptions in 2019, up from $598 in 2017.
With an average household spend of $63,036 in 2019, and an average of 2.52 people per household, the $640 spend on digital subscriptions represents 2.55% of an individual’s annual expenditures.
Nikhil’s main argument, and one that I agree with, is that consumers are adopting subscriptions at a greater rate each year — but spend on subscriptions still only compromises a very small portion of total annual expenditures. Therefore, consumers are certainly not “fatigued” by their subscription spending. In fact, there is plenty of room for growth!
Matthew Ball took that argument one step further in his post from earlier this year. In his eyes, subscriptions have provided consumers with more freedom and an easier method of purchasing goods that they need on a frequent basis:
It’s important to highlight subscriptions are often a preferred buying path for consumers. Most would rather spend (or can only afford) $10 a month for Microsoft Office than buy a multi-year license for $300. Subscriptions also meaningfully reduce the cognitive burden of repeat decision making. No longer do you need to “track” your toothbrush for wear, risk “running out” of toilet paper and then be forced to overpay for a small-volume purchase, or need to scan and hoard coupons to ensure a great deal.
The rise of fully flexible monthly commitments also means that consumers no longer have to worry about having made a bad decision and being stuck with it. In this sense, every subscription is still á la carte, but unlike in the analog era, the default outcome of “doing nothing” is to keep getting value you enjoy rather than running out of a thing you need.
Now, some argue that consumers have exceeded their appetite for subscriptions and that the market for subscription services is simply too crowded. Others say that the main issue is that consumers have lost track of their total spend on subscriptions because subscriptions are increasingly easy to sign up for but less intuitive to track over time. To that point, West Monroe conducted a study (pre-pandemic) that showed that Americans are typically unaware of how much they spend per month on subscriptions. The study results showed that, on average, people in the US guessed that they pay $79.74/month on subscriptions, but their actual spend equaled closer to $237.33/month.
But, the study also provides evidence and support for Nikhil’s argument. In general, consumers are happy with their subscriptions, and in many instances, they are happy and “hooked.”
So yes, consumers are surprised by the amount of money they spend every month on subscriptions. And services like Truebill and SubscriptMe have thus far found product-market fit by helping consumers understand their spend, and act upon it if they so chose. But the data tells us that most consumers are happy with their subscription stack. Ultimately, I do not believe these services will be primarily utilized to cancel subscriptions, but instead for monitoring and general personal finance purposes. On the whole, I do not think the rise of Truebill signals “Subscription Fatigue” writ large.
With that said, Blissfully and Trends conducted a fascinating analysis of the B2B subscription space. I agree with Trends’ analysis that there is a massive opportunity in that space for startups who can provide the kind of monitoring and cancellation services to businesses that Truebill delivers to consumers.
As Blissfully showcased, the average company spent $343k in SaaS subscription services, up 78% from 2017. Companies now spend more on SaaS than they do on laptops. And the critical problem arises from the fact that SaaS decisions are typically decentralized across the entire enterprise. Each department will make their own purchasing decisions for SaaS products and apps, as opposed to one centralized IT management professional. This situation leads to two massive problems — Orphaned Subscriptions and Duplicate Subscriptions.
(I am committing a writing faux pax here by having two graphs right on top of each other with no interceding paragraph or explanation, so here is a link to the song that I immediately think of when I look at the chart above… I am sorry, and you are welcome)
To me, this is where the true subscription fatigue lies, and this represents the most exciting area for potential VC investment. As the amount of B2B SaaS offerings continues to climb, enterprises will need to invest in resources that help them maintain financial prudence.
Mic Check
Stebbings: Thinking about Seed and Series A where we both play, I'm quite worried. I've never seen the velocity of deals being done. I've never seen the pricing being done. How do you assess the state?
Levine: Pricing has gone up, time to do a deal has gone down… But there are more companies being founded…
The current state of VC funding is tricky. Depending on what metrics you hone in on, you will be able to paint a different picture. Pitchbook and NVCA released their 3Q20 funding report about a month ago, and the data was met with cheers (for the most part). The funding market at-large appears to have rebounded from the beginning of the year.
The valuations for angel, seed, early-stage, and later-stage startups have continued to creep up through the pandemic. As of 3Q20, the median valuation for a seed round was $7.7mn, which is up from $7.5mn in 2019. Angel rounds (pre-seed) have fallen somewhat, from $6.0mn to $5.1mn.
One area for extreme optimism is the mega-deal market and exit market. The demand for IPOs and large VC financings has rarely been more robust, you could argue. VC deals over $25mn now comprise more than 10% of the overall VC financings. The number of IPOs in 3Q20 was higher than at any point since 2Q19. This is important for the overall health of the ecosystem — if investors still view the exit opportunities and IPO market as healthy, they will be more willing to take necessary risks at the early stages.
Now, with all of that said, there are data points that reveal a somewhat shaky rebound. For one, angel and seed combined deal activity has fallen consistently since 4Q19. To me, this says that the appetite for risk in that particular stage of investment has not recovered to full strength. In a similar vein, first-time financings have similarly dropped sharply since the onset of the pandemic. First time financing deal value has also fallen to a historic low of 5.5%. And, according to an analysis by the law firm Cooley, 20% of startups in 3Q20 either kept the same valuation (Flat Round) or lowered their valuation (Down Round) even though they raised new financing. That figure, according to Cooley, has been rising since March. There has also been a resurgence of pay-to-play provisions, which, as Cooley explains, is not exactly a promising development for the state Venture Capital financing:
Cooley also noticed an uptick in pay-to-play provision — which requires investors to participate fully in the financing of future rounds or risk losing some of their rights. While the pay-to-play provision itself is not something founders avoid, its implications — that the company may have struggled to find ideal outside investors — are often undesirable.
Nevertheless, a brief conversation with any Venture Capitalist will typically involve a discussion about the speed of financing rounds. I spoke to an early-stage Chicago VC a month ago who told me that he has never seen financings occurring at the clip that they are now happening. He believes the speed-to-deal time has accelerated even from pre-covid levels.
On the one hand, I share Stebbings’ concern about the velocity of funding. I think most VC’s would say that time matters when performing due diligence on a company, especially if it is a pre-seed or seed-stage investment. At that stage, there may not even be a product or any revenue, and instead, you are evaluating the founder. You are also assessing what your relationship with the founder will look like. I feel like this would be hard for anyone to do over only a few days. But as Joe Pesci would say, “it’s what it is.” These are challenges, but they are overcome constantly — and VC’s will just have to adapt to this ever-changing reality moving forward.
Levine is an optimist, so I am going to side with him on this. The funding environment is still ripe for entrepreneurs — that is a good thing. In most industries, there has never been an easier time in history to start a company. The fact that the environment has proven largely resilient throughout a global pandemic should be cause for extreme optimism. Entrepreneurs drive not only Venture Capital but also the global economy. Each one plays a part, and I think the more encouragement that would-be entrepreneurs have to leave their day jobs and take the plunge, the better. Hopefully, the current state of VC funding provides them with some of that encouragement.
Movie Anti-Rec
Following the loss of their son, a retired sheriff and his wife leave their Montana ranch to rescue their young grandson from the clutches of a dangerous family living off the grid in the Dakotas.
This portion of the blog will typically be reserved for movie recommendations, but I sadly cannot recommend this recent release. I am sure people will be at home in the coming weeks looking to find any kind of fresh film content, as most of the major releases for 2020 have been pushed back due to the Big C. But, steer clear of this one. I truly was disappointed.
I love Kostner, I love Diane Lane. I had high hopes for the two of them, and they are without a doubt the best part of this movie. Their relationship feels so lived-in, so warm, that you instantly gravitate towards them and their plight. Kostner, in particular, has never been better — although in many ways the character feels like a much nicer and compassionate version of his Yellowstone part. I think the screenplay gives Lane more to work with, and she is great, but Kostner feels so comfortable in the role that you are once again reminded of his movie-star prowess. Not many actors will hold onto that talent in their later years.
That said, the rest of this movie is, frankly, lifeless. There is one moment that subverts expectations, and that I was genuinely surprised by. But the rest of the movie is so completely predictable that I actually rolled my eyes midway through the movie at a scene that might as well have had a title card for “Checkhov’s Gun!”
Now, there’s nothing wrong with familiarity in movies like this — I am perfectly fine if a thriller hits the same well-trodden notes. But I want the notes to be hit in a way that is entertaining and exciting. This movie had none of that kind of skill on display.
Ultimately, you may still find this movie entertaining enough. But I could not get myself to a point where it felt like a good use of my two hours. And because of my reverence for the talent on screen, that should tell you something.
