Raising capital: What investors look for before writing a check

Casper's IPO misfortunes may have made headlines recently, but those stumbles don't obscure the fact that the mattress brand made a significant impact on its market.

The brand grew in popularity and attracted interest from mass merchants like Target, and celebrities like Leonardo DiCaprio and Ashton Kutcher.

But before Casper grew to make more than $350 million in annual sales, before it forged partnerships with some of the biggest names in the industry and before it had more than 1.4 million customers, the company started out like many other companies: pitching early investors to believe in its company as much as the founders did.

'Investing in people'

Before most founders approach investment firms, they've likely already raised a bit of capital, whether that be through angel investors or friends and family.

And while investors usually have a company's financials, or even sometimes their QuickBooks, on hand, they're taken with a grain of salt. During the early days, startups sometimes don't even have a product launched to present, so profitability at this stage isn't likely.

"Before you get to what's considered a Series A or Series B, the earlier stage investor rarely makes an investment based on financials because they know, at that phase of life, it is a complete pipe dream," Patrick FitzGerald, a professor of entrepreneurship at Wharton and CEO of entrepreneurship consulting firm TFC Ventures Group, told Retail Dive in an interview.

Patrick FitzGerald

Professor, Wharton and CEO, TFC Ventures Group

These companies are looking to get somewhere between $1 million and $3 million from seed investors, the first big round of funding. This is the part Lerer Hippeau specializes in.

Lerer Hippeau is an early stage venture capital fund that has invested in some of the biggest names in the DTC realm — Casper, Allbirds, Warby Parker and Everlane, to name a few.

A key factor in deciding to invest, according to Andrea Hippeau, principal at Lerer Hippeau, comes down to whether the investors truly believe in the team presenting the product. It's great if the founder or co-founders have expertise in the space or experience starting successful businesses, but "at the end of the day, all investors are investing in people," Hippeau told Retail Dive in an interview. The startup's founder not only has to be passionate about the brand and its product, but also have the flexibility to adapt to changing consumer needs.

Room for growth

The specific category and market a company is trying to enter impacts future growth and is therefore critical to investors when deciding where to put their money.

"This is becoming increasingly difficult in the DTC space because there just isn't much white space left for new companies," Hippeau said. "There aren't many untouched sectors anymore."

There are very few categories that haven't been "disrupted," at least to an extent, from eyeglasses and mattresses to orthodontics and homewares. While this doesn't mean an investor will automatically turn away any company looking to enter a popular market, it means startups have to prove how they will differentiate themselves, and if there is room for their business to enter ancillary markets.

For example, Casper helped lead the disruption of the mattress category, but the space quickly became saturated with countless other bed-in-a-box companies. This pushed the brand to launch into adjacent categories with products like dog beds, CBD sleep gummies and a smart nightlight.

Marketing strategy

When a company files for an IPO, its future plans aren't the only things made public. Publicly released documents allow onlookers to see where a company spends its money. For online retailers Wayfair and Casper, a lot of funds have been funneled into their marketing efforts. In Casper's S-1, it was revealed that between 2016 and September 2019, the brand spent more than $400 million on marketing alone. And online home brand Wayfair has spent nearly $785 million on advertising in the first nine months of its current fiscal year.

For many brands operating exclusively online, the cost of customer acquisition can get prohibitively high, which is why, "investors are looking very early on for you to have a diversified marketing mix," Hippeau said, adding "if we meet with someone and they say, 'Oh, you know, I'm just going to do Facebook advertising,' that is definitely a red flag."

"If we meet with someone and they say, 'Oh, you know, I'm just going to do Facebook advertising,' that is definitely a red flag."

Andrea Hippeau

Principal, Lerer Hippeau

This is why, for even direct-to-consumer brands, omnichannel is becoming a necessary part of business strategy. Casper in 2018 announced plans to open 200 locations across North America, Warby Parker already operates some 120 stores and Bonobos has more than 60 locations.

Public companies are also required to provide financial figures, making it easy to tell how financially successful they are by whether they make or lose money. Since filing for an IPO, Casper revealed that although it has grown since inception, it failed to make a profit. The same can be said for Wayfair, which hasn't been profitable since its 2014 public debut.

Investors are looking at these companies as examples, in addition to those with success stories, when looking at a brand's finances prior to investing, FitzGerald said. "They're taking the bet that those financials are going to get better over time because they've seen other companies do similar things and deploy similar tricks or tools of the trade to reduce that customer acquisition cost or that, you know, cash burn rate," he added.

Uber, for example, was merely an "investment idea," according to FitzGerald. It took the problems associated with hailing a taxi and aimed to fix them. In the beginning, the company was still trying to convince consumers to change their behavior, but "the customer acquisition costs got lower and lower and lower as they ramped up and they went over to regular drivers. But they couldn't have predicted that, the early stage investors, they were just betting on the transformative concept," he said.

As a company grows and looks to that next round of funding, Series A, B and beyond, investors are looking deeper at its finances and how the company spends. In post-launch early days, it's understood that a brand's acquisition cost may be high, but ideally that will go down over time.

Though initially getting a customer to make a purchase with the brand may be difficult, it pays off if it can retain those customers for life, FitzGerald said. Diapers.com, for example, offered $50 to each new mom a customer referred to the site. "They're losing 50 bucks every mom they get. However, once they get them once they don't have to get them again."

Sustainable growth

There was a time when the consensus approach for direct-to-consumer brands was to grow at all costs. Now, investors are really pulling back on this. They want DTCs to grow, but be aware of how much they're spending.

"There is definitely a tension, I would say, with venture capital between growth and profitability," Hippeau said. "I think kind of the beginning of DTC, the consensus was like, 'Grow at all costs.' Just grow, grow, grow as fast as you can and worry about profitability later. I think the new DTC investor is saying, 'Yes, you need to grow and we know you need to spend to grow. But let's do that consciously.'"

"[T]he new DTC investor is saying, 'Yes, you need to grow and we know you need to spend to grow. But let's do that consciously.'"

Andrea Hippeau

Principal, Lerer Hippeau

Investors now want sustainable growth, Hippeau added, which comes back to a company's marketing efforts, and "whether that means you have a really great online community that follows you, or you are opening stores and your stores are profitable, and you're getting a lot of foot traffic."

While Casper isn't profitable at the moment, there are other key metrics Hippeau pointed out that investors look at, such as customer retention, repeat purchase rate and whether a company has expanded into other product categories. "I think there's value in companies beyond just kind of a top-line revenue and the profitability," she added.

And even though the mattress brand's public debut has been hailed as one of the major IPO flops of this year, FitzGerald doesn't think it signifies the end for the mattress brand. "I think Casper can recover because it has a legitimate customer base and legitimate market share. People always need mattresses. They may not need coworking spaces but a mattress is a mattress. It's a physical thing."