Online D2C brands grapple with moment of truth in the valuation game

Valuation demands of around 10x of revenue had become way too common despite the fact that consumer brands are fundamentally different from tech businesses.

For more than a year, online D2C start-ups have been seeking, and sometimes commanding, valuations like software start-ups. According to industry insiders, valuation demands of around 10x of revenue had become far too common despite the fact that consumer brands are fundamentally different from technology businesses.

But a course correction is happening now. “In the last two months, sanity has returned and the investor community is driving home the point that the best consumer brands can’t grow as fast as the best tech firms. It is that simple a reasoning,” says an investment banker who works with start-ups.

The founder of a D2C brand that is valued upwards of $100 million says a similar thing. “I am hearing that the conversations between brands and investors on a round is stretching too long. If a funding has to happen, it is generally finalised within three months,” he says.

“The 8-10x revenue multiple bit was true even during late last year. That is not the case anymore,” he adds.

The online D2C rush started in India as e-commerce transactions rose massively amid the pandemic in 2020. As a result, funding in the sector jumped three-fold to $462 million in calendar year 2021 on a year-on-year basis, according to data from Tracxn.

Last year also saw the emergence of the online house of brands model which is also popularly referred to as the Thrasio model. What happens in this case is that a holding company acquires multiple consumer brands – which are a mix of omnichannel and D2C – in the hope that centralising marketing and technology spends will drive fast growth. 

Investors found this model so irresistible that several Thrasio start-ups like Mensa, The Good Glamm Group and Globalbees entered the unicorn club within months of coming to life.

“The spike in D2C valuations seen last year was also in part due to the house of brands start-ups. Market values of the brands heated up as there was a bidding war between the roll-up businesses,” says Chaitanya Ramalingegowda, co-founder of Wakefit, a D2C brand in the homecare category. In November last year, the start-up raised Rs 200 crore at a valuation of around Rs 2,800 crore in its Series C round – which was based on a 4X multiple of its forward looking revenue estimate of Rs 700 crore in FY21.

According to Ramalingegowda, the dynamics of arriving at a valuation figure changes with each round. “In Series B, it has a 80-90 per cent dependence on financial metrics – and the revenue figure is not the only factor. Investors also check how dependent on discounts those revenues are, what is the state of the bottomline, whether customers are making enough repeat purchases and strong are the gross margins,” he explains.

The valuation multiples also differ from category to category for consumer brands. A veteran growth stage VC investor in consumer brands says: “A cosmetics brand can command a 7x multiple of revenue as gross margin could be around 70 per cent, a milk products company can get 2x revenue with gross margin of 5-10 per cent.” 

Further, the VC says that founders of D2C start-ups need to appreciate the difference between the movement of bits (software products) and atoms (consumer products). “This is what ultimately decides how large gross margins can be and how fast a company can grow.”

Kaushik Mukherjee, co-founder and COO of SUGAR Cosmetics which is reportedly seeking a valuation of $500 million in its next round of funding, has a similar view. “ Suppose a D2C brand has 10 per cent gross margin and Rs 1,000 crore of revenues. It will need a lot of investment to fund future growth. But, if you have 60-65 per cent of gross margin, that gives you enough ammunition in terms of free cash flows to fund your growth.”

“Last year, valuations on the basis of revenue multiples of 7x-10x were quite common. But things have become much more muted now and things will settle at the historical multiples of 4x-6x,” he adds.

Experts are also of the view that a lot of brands are calling themselves D2C although their sales mostly happen through e-commerce marketplaces like Flipkart and Amazon or offline channels. 

“This is why it is important to use a weighted average of sales depending on the blend of channels – I am ready to go up to 10X for pureplay D2C sales, 5x for third party online marketplace sales and a 2x multiple for offline sales,” says the founder of a Thrasio style company that has made more than 10 acquisitions in the past one year.

However, not everyone in the ecosystem subscribes to the view that D2C valuations will come under fire. According to Siddarth Pai, managing partner of VC firm 3One4 Capital which was an early investor in D2C unicorn Licious, traditional Indian consumer brands have failed to consistently innovate which has created a vast opportunity for D2C brands to tap into.

“With the per capita income rising above $2,000 in purchasing power parity terms, it signals a shift from sustenance spending to discretionary spending, leading to a shot in the arm for D2C brands. But the legacy consumer behemoths do not have a gameplan to capitalise on this as they’re relying on older playbooks and the need to be profitable from day 1,” he says.

“For this reason, D2C brands that can capture the imagination of the market will continue to attract a lot of funding and also command rich valuations,” he adds.