Over the past 18 months, I’ve been exposed to a number of emerging consumer brands. There are very interesting companies reinventing traditional consumer services, those putting a new twist on an established space and those that are pioneering new niches. For companies that have a product orientation, we are seeing a new paradigm emerge. Gone are the days where a product could lead and demand would follow. Today it takes real marketing and advertising spend to drive sell through and institutional capital wants hard data that the risk they are taking is distribution risk, not product risk.

Beverage comps are a great example of this. Companies like Tazo Tea, Sobe and Oregon Chai raised minimal institutional capital. Odwall was the exception back in the early days raising $8 million from Catterton Partners. Contrast that to Izze, which raise more than $11 million from the likes of Sherbrooke Capital and Greenmont Capital, FRS, which raised $25 million from Oak Investment Partners and Radar Partners, and Honest Tea, which raised $12 million from Inventages, the investment arm of Nestle S.A. The reason this came to be, is that the money necessary to differentiate yourself from the competition has accelerated exponentially. For example, FRS utilizes Lance Armstrong as a spokesperson. I suspect that’s not cheap.

The problem, as previously alluded to, is that institutional investment funds that focus on consumer products, have been loathe to take product risk. If you ask them their ideal company metrics for a private placement and many of the traditional players will tell you $10 million in capital requirement and $10 million in revenue run rate, if not trailing. Notably, this investment class has been buyout in terms of its orientation. However, few companies can achieve the required growth sans institutional capital given the competitive environment. We call this the Consumer Capital Conundrum.

While well heeled investors in this space are morphing to fill the capital void, Catterton, historically a buyout fund, closed a $300 million growth equity fund in March of 2008. Swander Pace has countered with its “brands of tomorrow” (or future?) program. A number of permutations have ensued, VMG Partners, Encore Consumer Capital, etc. Health and wellness funds have filled this void for appropriately situated companies, as their interest tends to be piqued at between $3 million and $5 million in trailing revenues. That all notwithstanding, if you are a consumer brand whose revenue base is beholden to a national Whole Foods contract, you’re facing an uphill battle on the capital front. On a regular basis my partners and I meet interesting consumer brands with $2 million in trailing revenues who are seeking an agent for their $10 million Series B financing. So how do these companies survive until they are ready for institutional capital?

If my partner Tom Newell were here he would tell you that a sound capital development program starts with a focus on profitability. Let’s assume that you don’t have the luxury of the slow growth plan that Tom would advocate. Survival begins with an emancipated view of capital recruitment. Yes, it would be wonderful to find a handful of deep pocketed angels to see you through, and some do, but in the consumer arena this is a rarity, especially in markets dominated by technology investment. My advice to companies is two fold — a) don’t be above using organized angle groups to recruit capital and b) do not let you valuation get ahead of itself.

When I talk about organized angel groups to entrepreneurs, often times they make a face that one might make if they had opened a skunked bottle of Chateau Margueax. In reality, organized angel groups are providing an effective funding avenue to consumer oriented companies. As an example, Adina World Beat Beverages raised $5 million through the Keiretsu Forum. That’s not pocket change. Consider that angel investors placed $26 billion into companies in 2007 vs. institutional investments of $30 billion. Some say that angels account for another $10 – $20 billion in angel investments outside the organized reporting environment. For example, my wife and I have invested in her business outside of any regulatory reporting environment other than the IRS. Net net there is no shame capitalize your company $50,000 at a time. Keiretsu Forum, Alliance of Angels and others are delivering real value for companies by connecting them to angel investors without forcing them into an endless string of one-on-ones.

The second piece of advice to consumer companies I can convey is keep your valuation reasonable. Let me be clear, I am not saying bend to the whim of investors or agents. What I am saying is keep your valuations grounded in tangible business results. A large pre-money valuation on a de minimis revenue base only constrains capital recruitment. It might make your early money feel good about your progress to have an every increasing valuation on their incremental capital contributions, but it is only going to create a headache later when valuation is leveled by an institutional investor. A rule of thumb is don’t let you valuation exceed 3.0x revenue plus intangible value (brand value). I haven’t seen a situation where intangible value had exceed $10 million prior to $5 million in revenues, that’s not to say it can’t happen (see FRS). Net net, I ask that you simply bring realism into the equation.

Long short the consumer capital continuum looks as follows:

> Product Risk > Sub $3 million in revenues > Angels and angel groups

> Early Distribution Risk > Sub $5 million in revenues > Local VCs/small consumer capital/local VCs

> Distribution risk > $10 million revenue run rate > Mainstream consumer capital

/bryan

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