Valuations are rising across emerging CPG which forces us to reconsider our frameworks

By Kiva Dickinson, Founder Selva Ventures

Source: Unplash Free Photos

Investors are naturally complaining (as we do) but what is happening here?

First off, consumer products seed and series A investors typically use two methods of valuation: A. Multiple of revenue B. “What do you need to believe?” analysis

Multiple of revenue typically means applying acquisition multiples in the category to your current revenue E.g. Hershey is your most likely acquirer and they typically pay 3-5x LTM sales at acquisition so you should raise at 3-5x sales today

Typically the debate then becomes “which revenue #?” LTM? Likely not representative at seed/A - if you’re growing fast enough to attract investment, your sales 11 months ago should be pretty irrelevant to today’s value

Run-rate is likely more relevant (1-3 months) 1 more fair for DTC 3 more fair for wholesale (need to account for lumpiness of sell-in) Beware seasonality... (NOT "ARR" - there is no “recurring revenue” in CPG sales, especially when it’s non-subscription revenue)

If seed/series A multiples are increasing in parallel to acquisition multiples that makes sense If the former is rising faster than the latter we might have a problem (more on this later)

Most investors consider revenue multiples but focus on a “What do you need to believe?” analysis Basically a less lazy version of solving for ownership: Assume exit revenue, exit multiple, dilution and target return and you get the price you can afford to pay

So what are the bad things that could happen if we pay too high a valuation at seed/A? Bad thing 1: post-money trap / down round This happens if there is a disconnect between your stage and the next stage of investor (or the company doesn't perform)

Need to work backward from the next round How many months of runway do you have? What will your sales be then? Who invests in that stage? What method will they use to value you? If you don’t have cushion for a markup of 1.5-2.5x next round then valuation is too high

Bad thing 2: ultimate returns of seed/A investors could be subpar and capital will leave the market That means working backwards from exit. If you’re paying higher multiples going in, you need higher multiples coming out

This dynamic in tech has driven seed/A valuations upward (average exits have gotten bigger) but it’s not the same in CPG Exits haven’t jumped from 3x to 20x sales So does this mean the music is going to stop (with a bunch of down rounds & bankruptcies)?

Fizzle out (with a bunch of subpar returns for investors in what should be successful exits)?

Source: Goldman Sachs September 2021 M & A Report

Is there a third option? Might these higher valuations make some sense?

Could be that the probability of success has increased even though the magnitude of success (size/multiple) may be the same Expected value = probability of success x magnitude of success Why is probability increasing?

Consumer wellness is exploding More consumers are adopting healthier lifestyles and buying healthier products to do so — these products are all coming from emerging brands (big CPG can't innovate) More consumers mean more winners

Funding sources are expanding More financial investors embrace the dynamics of the wellness economy > More capital will enter the growth stage > More brands will reach escape velocity This likely won’t mean more winners but will mean fewer zeros

Exit routes are diversifying No longer need to rely on only big CPG to acquire you Can sell to private equity (SmartSweets/TPG) IPO (Oatly/Celsius) Consumer wellness SPACs (@humankarp / @RohanAOza)

Source: Goldman Sachs September 2021 M & A Report

This thread might be cynically interpreted as reckless, bubble-fueling rationalization of overpaying in CPG…maybe FWIW I think raising at too high a valuation at seed/A is a common and silly way to break your company I'm NOT saying "pay whatever price! 💁‍♂️"

I just think that as investors, the cost of being right about the attractive macro thesis of your sector is that assets won’t be as cheap as they were in the "good ol days" That's happened in CPG so let's get used to it

Kiva Dickinson

Founder & Managing Partner of Selva Ventures | Investing in emerging consumer brands | Formerly: @tpg @circleup | Toronto sports fan @mapleleafs @raptors | 🚩:🇨🇦🇺🇸 📍SF, CA