Recently I had the pleasure of a lively conversation with consumer focused investor Mehtab Bhogal of Karta Ventures. Mehtab is an experienced entrepreneur in the consumer goods space and active investor with a unique strategy. You can read more about his story here.
Consumer investing is notoriously hard - what do you look for that stands out?
I actually think consumer is easier than technology investing as valuations in tech are ridiculous right now, plus the tech best deals go straight to a small handful of VCs anyways. Conversely, consumer brands are very straightforward to value, as you can usually go off an EBITDA multiplier.
Moreover, outcomes are less binary than tech because it's relatively easy to get your money out of consumer companies via dividends. Companies are also less likely to need subsequent financing rounds as consumer brands tend to generate substantial cash flow quickly. That cash flow allows consumer brands to do things that most tech companies can't do without going to a specialized lender, like utilizing debt. Suppliers are also an easy way for consumer brands selling physical products to quickly improve cash flow if needed as well.
I don't look for anything in particular with consumer other than my ability to add value myself and via my network of contractors/people that can help train the companies I invest in to improve core operations. A reputable, strong brand (or the ability to build a good brand!) is vital though as that's what keeps other companies from knocking off your product.
What are your thoughts on venture capitalist getting into more traditional consumer companies such as Allbirds?
They will likely keep moving in as margins have become so much more attractive thanks to direct to consumer channels. Direct to consumer has opened up a lot of doors that simply didn't exist 15 - 18 years ago.
Especially early stage for consumer - how do you test whether the product has any real legs or is just a fad?
The company needs organic growth. It might be tempting to look at a successful crowdfunded company via a platform like Kickstarter and assume the same sales will carry on post-crowdfunding but these products are often too niche because backers of crowdfunding campaigns are their own niche.
I also test companies I’m looking at by running a bunch of PPC tests on their product (with their permission of course) to see how receptive people are to a product and how much growth might be possible. Google, Facebook, and Bing are great for this. Facebook in particular is great for this because you're throwing a product out in front of an audience instead of those searching for a specific solution like with Google/Bing search ads. If a product just well via Facebook ads, it's very likely to scale up nicely.
What consumer trends are you interested in investing in 2018?
Smart drugs/nootropics. Companies in the space are largely made up of those who jumped into the industry because they are passionate about nootropics, but don't necessarily have any meaningful level of sophistication when it comes to handling the business end of things. Many of the companies I've looked at in the space don't even have retargeting pixels on their websites which is...odd. I nearly launched a smart drug company a few years back but ended up working on something else instead.
What are some resources you use to stay up to date on consumer trends?
Mostly a network of people I know or reach out to in the space.
How do you source your deals?
Sourcing deals in the consumer space is much more difficult than tech because there isn't a go-to platform or place for it. Platforms like AngelList are largely focused on tech, and the consumer brands doing deals on those platforms are often blatantly bad deals.
The other major issue is that well managed consumer brands will generate cash flow quickly, which gives them access to affordable debt facilities. This negates any real need for cash, which means as an investor you have to be able to do more than just write a check and be hands off. You need to be able to show them exactly how you can help take them from doing $700,000 - $2M a year to $5M - $10M in 2 years.
As a result of the aforementioned issues, I've expanded my focus to doing my own deal assembly, buying IP, and building companies around that. This means hiring a CEO, providing them with funding and any other resources they need, etc...
How important is the brand when you are looking to invest?
A strong brand provides the company with a good moat to protect them from competitors and knock offs. When seeding a deal, companies typically have little to no brand value but that's something that's relatively easy to building a clear identity, a reputation for only making excellent products, and by focusing on delivering amazing customer service.
What do you think of all these Fulfilled by Amazon consumer businesses becoming more mainstream over the last few years?
I don’t like companies that rely on Amazon. Amazon can and does shut down or disrupt those selling on Amazon and it's an issue that is notoriously hard to deal with. Worse yet, being overly reliant on one platform heavily impacts the multiple you're likely to receive for your business when you sell. If I company I invest in is relying heavily on a particular platform, whether it's an influencer, a marketplace, or a social platform, the first thing I try to do is build out other sales channels to hedge risk.
Any investors you personally look up to?
Warren Buffett in one of my all-time favorites because his philosophy really resonates with me and it's managed to work for him for decades. Ray Dalio is another one of my favorite because he is amazing at building systems...and he's built some of the best in the world that have scaled up beautifully.
Any predictions for 2018?
Blockchain technology will keep going and hopefully crypto cools off.
Anything else you think potential consumer investors or consumer entrepreneurs should know?
- People need to get better at testing to identify niches. They need products that target a niche but are very shareable outside that niche. Testing only costs $300 - $500 if you have the patience to learn how to write copy, run ads, and create landing pages. Facebook is a good platform for testing this type of thing for consumer products. If you do well on Facebook then your product has a ton of potential for organic growth. I think a lot of entrepreneurs skip this step because they want to express themselves creatively instead of building a profitable business.
- If you're not handling manufacturing yourself, take the time to find a great manufacturer. Very few people realize this, and it sounds obvious, but manufacturers can make or break a company. A great manufacturer will provide you with financing, introduce you to key retailers, help with R&D, etc... A lot of entrepreneurs seem to go with the first guy they find on sites like Alibaba. Don't do that, because you really do get what you pay for. Our manufacturing partner - Dunlop/MXR - for our guitar pedal company Horizon Devices has helped us immensely in more ways than we could ever ask for. Even if someone offered to build the same products for us at half the price we wouldn't switch over because nobody can match what they've done for us.
- Never compete on price, the bigger players will win that game and put you out of business. They can afford to bleed money if they have to because their warchest is massive. You'll also end up attracting a very...difficult kind of customer.
- Stage capital carefully, especially before you establish demand. Test any idea you have for the company and then double down when a test does well.
- Always utilize pre-orders when possible. If you can’t get demand before launch, your product probably doesn't have that much potential.
- Everything is negotiable. Unless you hear something coming out of the mouth of the person that actually owns the company you're negotiating with, then don't take their answer too seriously. We've bypassed $100,000+ MoQs by cutting around intermediaries and speaking with major CEOs.
- If everything is executed beautifully, it only takes $15,000 to $25,000 to build out a company doing a few million in revenue in the consumer space. $50,000 to $75,000 provides you with a lot more room for error, but you don't really need much money to get started.