Tag - breakingvc

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How J.Jill’s IPO Could Help Define E-Commerce Valuations
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Breaking The Mold With David Hornik

How J.Jill’s IPO Could Help Define E-Commerce Valuations

You’d be forgiven for missing a small cap retail IPO last week in the midst of the global Snapchat mania. Last Thursday, without much fanfare, J.Jill, a nearly sixty year old former mail order catalog company selling women’s apparel, quietly went public at a nearly $900M enterprise value. And surprisingly, for the complex world of digital commerce, J.Jill’s public market reception might actually be an indicator of what all these next gen direct-to-consumer commerce businesses are actually worth.

How a Small Cap IPO Could Help Define2

In past pieces for BreakingVC during 2016, I’ve discussed Amazon’s impact on both e-commerce and retail at length, as well as the three areas I’ve observed for opportunity to penetrate Amazon’s digital commerce force-field: (1+2) In Why Amazon Has Consumer Investors Bemused and Confused I wrote at length about both off-price retail (Marshalls and T.J. Maxx, for example) as well as mid to upper tier brand opportunities that Amazon fundamentally can’t capture and (3) in The Middleman Strikes Back, I described how Amazon’s anemic commerce margins prohibit it from a service heavy assisted/concierge-commerce provider.

But for everyone else – from Warby Parker to Harry’s to Bonobos to Everlane – what are these weird, sorta digital, sorta omni-channel, sorta personalization brands actually worth? And why is a sixty year old women’s apparel business that was previously spun out of a legacy retailer, Talbots, a leading indicator of value?

As usual, the Company’s S1 is a store of insight and surprises:

Personalization and Loyal Customers

If I were reading an untitled prospectus, I would’ve bet my money that the following block of text from the Company’s S1 “Overview” described a millennial-first next gen commerce brand, with a small but growing retail footprint:

We believe we have strong customer and transaction data capabilities, but it is our use of the data that distinguishes us from our competitors. We have developed industry-leading data capture capabilities that allow us to match approximately 97% of transactions to an identifiable customer, which we believe is significantly ahead of the industry standard. We maintain an extensive customer database that tracks customer details from personal identifiers and demographic overlay (e.g. name, address, age, household income) and transaction history (e.g. orders, returns, order value.) We continually leverage this database and apply our insights to operate our business as well as to acquire new customers and then create, build and maintain a relationship with each customer to drive optimum value.

Believe it or not, that is a sixty year old company talking.

The truth is that most retail businesses are really merchandising and logistics businesses more than personalization businesses. Most big box retailers – or at least the many that I speak with – admit that closing the loop between online-to-offline transactions is amongst their largest struggles.

This is a flaw that digital first businesses – even those with a retail footprint – claim they can solve. And all the moreso, a business such as Stitchfix, which is truly a data business at its core, led by Eric Colson, Chief Algorithms Officer. Case in point, a recent Stitchfix blog entitled “Ruminations on Data Driven Fashion Design,” which noted:

For example, can statistical modeling identify when a successful blouse has an attribute that is holding it back? If so, can we suggest a mutation that replaces the underperforming attribute? To illustrate, can we identify when a parent blouse is successful despite its leopard print, and then change it to the floral print that everyone loves this season? We are also examining how we can leverage less structured types of data. For example, can we extract features from images of blouses or the text feedback that clients provide in response to a blouse?

[To be blown away, visit the Stitchfix Algorithms Tour, built by Colson. It is a wow.]

Data is powerful. But it’s goal is to yield a more engaged customer; in J.Jill’s case existing active customers [within the past five years] represent 70% of annual revenues – an awfully consistent customer who sounds pretty darn comparable to all those subscription commerce businesses that have proliferated the market. And very similar to the vision today’s D2C brands are claiming: own a customer’s wardrobe/apparel/bathroom/etc with a non-commoditizing product and they will come back to you year after year.

J.Jill also looks a lot more like a direct to consumer business than your traditional retailer, with 42% of 2016 sales (growing to 50% in 2017) coming from direct channels.

How a Small Cap IPO Could Help Define E

What about its retail footprint? As discussed in the past, many of the next gen millennial brands are launching brick and mortar stores to prove a new customer acquisition channel against an overly saturated (and unprofitable) digital marketing environment. But with a footprint of only 275 retail stores, its brick and mortar presence is at least relatively comparable to the type of presence today’s next gen retailers are aiming for (as of today Warby has 44 B&M locations, Bonobos has 11, etc.) And these stores, like the millennial brands are conceptually customer acquisition drivers, as the S1 notes: While 64% of new to brand customers first engage with J.Jill through our retail stores, we have a strong track record of migrating customers from a single-channel customer to a more valuable, omni-channel customer.”

At the end of the day, J.Jill, this under the radar retailer looks surprisingly similar to today’s D2C commerce businesses:

  • Data-first approach (97% of transactions properly attributed to customer profile)
  • Heavy direct sales focus, with stores used merely as customer acqusion tool (42%, growing to 50%).
  • Not overbearing retail footprint
  • Brand quality margins (65.9% gross margins), as compared to 42% for Macy’s, 35% for Nordstrom or 40% for Gap – effectively double the margin basis as a traditional retailer.

What’s It Worth

I like J.Jill as a comp for many of today’s e-commerce companies for two reasons. First, as proven in the prior section, I think it looks much more similar than a casual observer might guess to those businesses. But secondly, at ~$500M in annual revenues, J.Jill is surprisingly small for a public retailer. Gap posted nearly $16B in revenue in 2015, Williams Sonoma is on the small side with $4B in revenues – even Lululemon has trailing revenues greater than $2B. This looks similar to emerging commerce brands which are typically much smaller than their relative press coverage would imply: Dollar Shave Club was on a $250M revenue run rate when acquired by Unilever, Warby Parker booked an estimated ~$200M revenue in 2016, and Trunk Club was on a reported $100M revenue run rate when acquired by Nordstrom. Most of today’s emerging brands, even at triple their current size, would look substantially similar to a small cap IPO.

The first piece of very good news for emerging brands is that there was a market appetite for a small cap offering of this nature whatsoever. Although the Company ultimately priced at $13/share, just below its suggested range of $14-16/share, the good news – again – is that market interest was strong enough not to justify pulling the offering entirely.

But that’s mostly where the good news stops. J.Jill’s IPO (even based on an estimated $15/share offering) would have it placed towards the bottom of a peer set on a valuation basis. The following graphs on valuation comps were initially published on Seeking Alpha:

How a Small Cap IPO Could Help Define 4 How a Small Cap IPO Could Help Define 3

Those are sobering multiples (and, the company actually priced 10% below these estimated multiples) for a company that stacks up extremely well on most operational metrics – for example, they boast higher product gross margin that brands such as Tiffany’s, Michael Kors, Ralph Lauren or even Abercrombie. They boast a higher direct to consumer sales percentage than most of their peers. They have an exceedingly loyal customer.

The biggest knock on the company is their growth rate: 10-15%/year – and one of their biggest divergences against today’s emerging brands who are mostly growing at 50-200% annually.

Given these multiples, e-commerce brands need to bank on the following two factors to earn a premium valuation in the market: maintain strong growth rates and maintain high visibility, momentum brands. J.Jill is a fundamentally strong company – and it has stolen much of the playbook from the online brands – but it lacks both velocity of growth nor excitement around its brand proposition.

Breaking The Mold With David Hornik

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There’s an old adage that if you want to get something done, find the busiest person you know to take on the task. David Hornik is the embodiment of that manta.

I first met David a year and a half ago as part of my journey with the Kauffman Fellows. He was so insightful that our group unabashedly asked him to spend an additional two hours answering questions a month later (the only time we did this in our program’s history). He obliged. As a young investor learning and growing in the industry, it’s almost unfathomable to me what David has accomplished – but moreso how much he’s able to give back in spite of the constraints on his time. David’s reputation as a giver – he’s been nicknamed the “Robinhood of VC” – is so prolific that he was profiled for an entire chapter by Adam Grant in his bestseller Give and Take.

His personality shines in our interview. In fact, behind the scenes, I actually tried to end the interview several times – to which David objected, requesting that I push deeper. My sincerest appreciation to David for his time, and I hope all readers (entrepreneurs and VCs) are able to benefit from his poignant insights.

Ezra: Thanks David for doing this. You are a man of the people. Let’s start – you built a reputation as an ultra-nice, transparent, likable guy in an era where Venture Capital was rather opaque. But as VCs now fight for the moniker of most “founder friendly” and are no longer chair tossing curmudgeons, do you still find niceness an effective strategy for winning the hearts and minds of entrepreneurs? Or are you become surly just to differentiate? 

David: I can tell you with great certainty, that I have never thrown a chair. I don’t think I will start any time soon.

First, thanks for the kind words about my reputation. I am hopeful that it is well-earned. I firmly believe that startups are the byproduct of incredibly hard working and thoughtful entrepreneurs, really great markets, and some luck. My role is to support those entrepreneurs in any way that I can — certainly with money, but also with all sorts of support (recruiting, fundraising, publicity, strategy, etc.). So it isn’t really about being a nice guy. It is about being a supportive guy. It is about understanding that we are all in this together and doing everything I can to be on your side and help you build something big and great. Are there others who view the venture business this way? Sure. There are some folks out there. There are a lot more pretending they do than the ones who actually do. But there are others who are truly entrepreneur first. I’m glad that there are more of them these days. Those are the VCs I want to work with.

Ezra: Those are the VCs I want to work with too! But here’s the thing…I once heard Bill Gurley say “Whenever you hear a VC speak, know that she is speaking to the entrepreneur she hasn’t met yet” – namely, recognize that investors are always marketing themselves. Do you agree with that? How do you – either as a fellow investor or as an entrepreneur – discern who is genuine and who is transactional? I’ve made a lot of mistakes in my first four years, so are your instincts better than mine or it simply a matter of experience/existing relationships?

David: I do think that good VCs understand that they need to market themselves. Some VCs have taller tales to tell than others. But it is awfully hard to be what you aren’t over an extended period of time. So one of the best ways to tell if a VC is full of shit is to spend a bunch of time with him or her. The more time you spend with them, the clearer the picture you will get of how they view the world. It is exactly the same way with entrepreneurs. When an entrepreneur is pitching a VC, she is putting her best foot forward. If you are excited about the deal, spend some more time with the entrepreneur — you will either grow to like that entrepreneur more or less. If it is less, move on quickly. If it is more, then it is worth doing some more work.

So if you’ve spent time with a VC and find yourself liking them more, what work do you do next? Reference checks. And lots of them. There is no better way to know what it is like to work with someone than to actually speak with someone who has worked with that person. VCs are really easy to reference. We list our portfolios on our websites. Look at the companies in which we’ve invested and call those entrepreneurs. See what they are like to work with. I make it even easier for entrepreneurs I’m interested in working with. I give them a list of all the founders and CEOs I’ve worked with over the last 15 years. All of them. And I encourage them to call the folks I’ve worked with. Because you can fake it when you meet someone for an hour. But you can’t fake it for 11 years (which is how long I’ve been working with Splunk so far — I’m still on the board) or 14 years (which is how long I worked with Ebates before it was sold for a billion dollars to Rakuten) or 15 years (which is how long I’ve been working with Rene Lacerte across two companies so far).

There are lots of great venture capitalists out there. You just need to do your homework to find out who they really are.

Ezra: Great thoughts, thanks. You know, when I first discovered you David, you were something of a prolific blogger. Now you’re something of a non-existent blogger, with a stellar 3 posts in the past 24 months. What on earth happened? And is it indicative of something larger, more fundamental in either your own personality or the venture ecosystem?

David: I suppose my lack of blogging is mostly about being too busy. When I started VentureBlog, I was new to the world of venture capital and had a lot of time on my hands. There were no other VC bloggers at that time, so everything I thought about made a good blog post. These days there are lots of VC bloggers and not a lot of new stuff being discussed. That said, I really should write more. I have been contemplating a series of posts about the things I’ve learned in my first 15 years in the venture business. So don’t give up hope. Keep your eyes on VentureBlog.

Ezra: Quite the cliffhanger – I’m sure many fans will now be refreshing religiously. Given the saturation of blogging, if you were a young person entering the venture scene today, what would be your strategy for making a mark and standing out – besides the requisites of being transparent, make winning investments, good follow through, etc: Apprentice a lot and say little? Be funny and silly? Do something scandalous for the free Gawker PR? Pick up skateboarding and become a Vine star? 

David: Wow. This is the million dollar question. Or, if things go well, it is the billion dollar question. How does anyone differentiate his or herself in the venture business? In some ways I got a little lucky and hopped into blogging early. And then I started podcasting early as well. I’ve been a little more consistent in recording VentureCast these days than I have been in writing VentureBlog. And then I decided that the world needed another conference, so 9 years ago I created a conference called The Lobby. It has been going strong ever since. In fact, I now have a digital media Lobby conference and an enterprise version of the conference as well. So should a new VC jump into blogging or podcasting or creating a conference? Probably not. If you want to really differentiate yourself, you’ll need to come up with something new. Maybe you’ll write a novel making fun of the venture business. Maybe you’ll create a series of online classes that reach millions of people. Maybe you’ll get a television show. Maybe you’ll just be an amazing networker. Who knows? The key is to use some medium to share your passion for startups and make clear to entrepreneurs what makes you different. You may be able to do that in a rap album. You may be able to do that in a picture book. Whatever it takes to connect with entrepreneurs and get them excited about telling you what they’re working on next.

Ezra: A few weeks ago you announced a large investment in MassDrop, a community platform for enthusiasts of a wide variety of interests. It’s actually quite apropos, and reflective of your entire track record: in addition to MassDrop you’re also on the boards of vastly different companies ranging from Splunk to Stumbleupon to Bill.com, just to name a few. At the same time, over the past few years the VC world has become far more specialized – with firms such as Emergence Capital, IA Ventures, ForeRunner – many firms now also boast partners with deep domain specific knowledge. Simply put: you are a generalist living in a specialist’s world. So how do you do it? How do you compete? Do entrepreneurs value your generalist lens? Or, is the question fundamentally wrong – that you are an absolute expert at building growth companies, or asking the right questions, irrespective of your expertise in any specific field.

David: There are all sorts of ways to be a VC. I’m not sure which one is best. I am sure which one is best for me. I like lots of different businesses. On the one hand, I think consumer businesses are amazing. They naturally appeal to VCs because we are consumers. So we think to ourselves, “that is awesome. I’d use that.” And that can create excitement around a business. On the other hand, I have also had the good fortune to work with spectacular enterprise teams and seen what it looks like when that works. I funded Splunk when three founders and a great idea. Eleven years later I still sit on the board and it is a multi-billion dollar company and there are 1,500 or so employees. It is hard to not get excited about that. I am sure that there are VCs out there who can share valuable insights because of their focus on a particular space. But I think that most of what I do as a VC is broadly generalizable across companies. My job is to help make entrepreneurs successful and that is something that requires experience and perspective and patience and faith, but doesn’t necessary require a particular industry specialization. I suppose it is possible that after 20 years working with startups across the spectrum, I have become an expert in both enterprise and consumer businesses. But I think it is more likely that I have become an expert at being helpful — I am happy to help the entrepreneurs with whom I work recruit great people, raise capital, develop growth strategies, connect with partners, get good press, not fight with each other, design great t-shirts, motivate their troupes, judge Halloween competitions, and a million other things. There is no one qualification for the venture business and there is no one approach that guarantees success. So I’m just making it up as I go along.

Ezra: A year or two ago I heard you say that August was “notorious” for losing an extra $500k-$1M on deals for routinely going one bridge too far. You added that overall, it was worth it, because it built genuine long-term authenticity and trust with founders. But I have to wonder if that’s a bit too easy… a fitting strategy for such a “nice” guy. Further, a multi-decade, very successful GP recently advised me that funds “live and die by the quality of their follow on investment.” Do you agree with that? How do you balance and juxtapose those two interests? Or, is it simply that you’ve done the math and $20M worth of failed extensions is a palatable “marketing” (or testimonial) expense for a $450M fund?

David: I suppose the good news is that we have a pretty small number of companies that fail outright. So most of the time we aren’t really losing another million dollars. Most of the time, we are supporting great entrepreneurs and helping them to find a good home for their businesses when they aren’t working. But it is certainly the case that we do, on occasion, invest an additional million dollars when we could have cut off the investment earlier. I don’t think it is really marketing dollars. I think it is more about supporting your entrepreneurs while they are still fighting the good fight. And some of the time that money makes all the difference in the world. Some of the time, companies are able to get to profitability on that last million dollars or find the right acquirer, or get to some better outcome. And in those instances, we’ve made a great economic decision, not just a great relationship decision.

As for follow on investments, whoever told you that funds live and die based upon the quality of their follow on investments has an odd view of the stuff that’s important from where I sit. That isn’t to say that follow on isn’t important. It certainly can be. But it is so much more important to find great companies and invest in them in the first place then to figure out how much to invest in a follow on round. That said, we own a big percentage of three of our most promising companies right now because we invested in those companies early and then led subsequent financings as well. If those companies are successful, we will reap the benefits of having been early investors and then having doubled down on those businesses. But the more important financings will certainly have been the initial financings, even if the subsequent ones ultimately drive real value as well.

Ezra: I also heard you say maybe a year ago that you should only invest in an entrepreneur or team that you’d want to be friends with and that you’d in fact de-prioritize an otherwise healthy, growing, business if you weren’t extremely passionate about the team. I’ve taken that advice to heart and it’s helped me a lot in my filter. Where I’ve personally struggled is falling in love with “people” that I think are extraordinary – deep domain experts, thoughtful, self-aware, intellectually curious – but where its unclear if they have the founding skills or acumen to build a great company…perhaps they weren’t able to communicate a clear go-to-market vision or have really unreasonable growth or hiring expectations, whatever it might be. I always find myself stuck in that spot. What’s your approach? Do you err on the side of backing people that you “click” with and that have a really unique approach to a market? Do you try and convince them to find external help? Do you wait and see while building the relationship? Or it case specific and you’ve taken many approaches?

David: It is an old trope but I stand by it — it is all about the people. Great entrepreneurs build great companies. There are some surprising exceptions to the rule. But, for the most part, amazing businesses are built by people with whom you would love to work. That is a rule I do not break. People, People, People.

But here’s the thing. I back a very small fraction of the entrepreneurs with whom I meet. And I definitely do not back all of the entrepreneurs I like. I don’t even back all of the entrepreneurs I love. I back great entrepreneurs with whom I’m excited to work, but only if think they will build a great business. And great businesses are hard to build. They require you to be smart and thoughtful and a good sales person and have a great idea, etc. etc. But more than anything else, a great business requires a great market. And great markets are hard to find. Most businesses are too small for a traditional venture fund. Some have too much competition. Some are not likely defensible in the long run. Some have sales cycles that are too long. All of these issues add up to either a great market or a less than great market and it is very hard to build a big business on a less than great market.

So what do I look at when investing — people, people, markets, people. Great people and a great market will build an amazing business. It is the killer combination. And it is stunningly rare.

Ezra: Do you think you would you re-write any of your prior answer if you were a pre-seed/seed investor as opposed to primarily a Series A/B investor?

David: Absolutely. I would probably answer all of them differently. The angel business is very different from being a Series A investor. You have different information at the time of investing. You likely have a smaller fund. You will have different resources when it comes time to doing follow on investments. And when it comes time to supporting your investments in good times and in bad times you will have different resources as well. The one thing that I suspect would be pretty consistent is that it is all about the people. People, People, Markets, People!

Ezra: Looking at your investment history, the vast vast majority of your investments have been in the Bay Area. It probably doesn’t come as a surprise that as an investor with Chicago Ventures I have to believe that I can drive meaningful returns from my perch in the Midwest or else I’d find a different job. But I might well wrong be wrong, so best to find out know I suppose! SO: What’s your take on the future of outperforming startup companies from a geographic perspective? Do you expect to focus the large majority of your attention on the Bay Area for the foreseeable future? If so, do you buy that the potential for greatness is not incumbent to one geographic region? Or, do you view the Bay Area as an exponentially compounding flywheel – with the compounding knowledge of its accomplished founders & advisors cultivating an increasing delta between the Valley and everywhere else in the world?

David: Good news — no need to move or find a new profession. I think there will be amazing business all around the world. In fact, we’ve invested in some great businesses in the Chicago area. The founders of Avant Credit are some of the best entrepreneurs with whom we’ve ever worked. They are building an incredible business. As a firm, we’ve backed a number of companies throughout the county (New York, DC, Texas, Washington, etc.) and throughout the world (Germany, Israel, Canada, etc.). We back amazing entrepreneurs wherever they are. In fact, there are real advantages to company building outside of the Bay Area — easier recruiting, lower costs, etc.

So why are nearly all of the companies in which I’ve invested in the Bay Area. In part because of proximity. I am necessarily going to hear about a lot more local businesses than those outside of the Bay Area. In part because of resources. The Bay Area has an astonishing entrepreneurial ecosystem. There are a huge number of founders, funders and friends within a 50 mile radius. It is hard to understate the value of a near limitless pool of advisors, investors and support inn close proximity. It doesn’t make it impossible to create and scale a business elsewhere in the country, but it certainly makes it easier in the Bay Area.

Ezra: As we come to close, I want to ask about your support network. The startup world is not an easy industry – I daresay it’s at its most cutthroat in history and seemingly playing for the biggest stakes (and biggest payoffs) in history. The stresses on family, emotions and psyche for all players in the ecosystem should not be understated. And as investors, though we might be spared from the pressure of having to directly lay off employees, we’re affected as de facto therapists – juggling dozens of high intensity issues across the portfolio. So while you’ve been profiled as a prolific giver, we don’t know much about your support and mentorship networks. And I’m fascinated because you’re always expressing positivity, confidence and humility. So how do you do it & who helps you? Is your family a big part of that? Do you still lean on early mentors in your career? Your partners? Friends completely outside the ecosystem?

David: Ezra, this is such a good question. No one really thinks about the psychological challenges of the world of entrepreneurship. It is MUCH harder on entrepreneurs themselves. I know many entrepreneurs who find themselves depressed, isolated, feeling deeply inadequate. It is very clear that being a CEO is a lonely job. I recommend to all of my portfolio CEOs that they should either join a CEO group (there are lots of great ones out there) or hire a CEO coach. At least that way you will be able to discuss the challenges you are facing with someone who understands what you are going through. As far as VCs go, I wouldn’t say that there are similar groups. I don’t know of any CEO group equivalent for VCs, but it would probably be a good idea. I do spend a reasonable amount of time chatting with other VCs. And my conference — The Lobby — is an opportunity for VCs to get together and chat about the challenges of the markets, etc. But I think we VCs would be well served by a better support structure. I suppose other than looking to my friends who are VCs, I mostly turn to my wife Pamela. She is sometimes a sympathetic ear, sometimes a kick in the pants, and always a very good advisor. But, truthfully, I’m so grateful to be a VC and work with such an amazing group of talented entrepreneurs. I guess I’m just not a worrier. That’s not really my nature.

 

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