Healthy Living Venture Capital Thoughts: Industry, Investors, Valuation, Terms

Today I am following up on a recent blog where I mentioned that I would write more on what I see as happening in the natural products / healthy living venture capital space after the Natural Products Expo West earlier this month.  

Later this week, I hope to make an announcement about a new affilition that I have which will allow me to raise capital for companies outside of the CEI Community Ventures portfolio (I will still retain my full  role at CEI Community Ventures though).  Stay tuned for more....

Today's discussion has some of my thoughts on...

• What's happening with the industry?
• Are deals getting done?
  
• What should companies be thinking about?
• What's new with deal terms?

The short answer is that the industry is still growing, but at a lesser rate (12.5% in 2008) and it is a strong place to be, but micro-trends are important to look at.  Some important micro-trends:

• Retailers are responding to the economy by offering more value, that translates into retailers like Whole Foods Market selling multi-pack products typically reserved for club stores (three Kashi cereal boxes bundled together, Rustic Crust pizza kit boxes [three crusts and sauce packs together]) and moving more and more products to private label.
  
  
• Customers are asking themselves if the extra cost for organic is worth it for all products and in some cases are trading down from organic to natural or natural to conventional.  A mother may say that organic milk is a necessity, but maybe not organic oats.
    
• Probiotics are hot-- another reflection of the continued movement towards functional foods.  There are now 20 probiotic strains used in dietary supplements and functional foods or in mainstream food products.  Click here for a very good, recent 12-page report on probiotics.  As stated above, probiotics are really a part of the move towards functional foods.  If a food has antioxidants, can improve cholesterol, reduce blood pressure, improve cardio health, it's on trend.  One great example are nutraceutical drinks -- up anther 9% in 2008.
  
  
• Allergen-free / gluten free living is growing fast and here to stay.  This is not a fad, but here for the long term.  More and more children, and especially adults, are learning about food allergies and realizing that they have one or several.  Gluten Free sales hit $1.4 billion in 2008 in the US and are predicted to grow another 30% or so in 2009.  Sales could hit $2.6 billion by 2012.
  

On the investment side, the industry is getting more professional and there are more and more entrants (dedicated venture capital funds to healthy living, traditional funds looking to do deals in the space, family offices, angel investors, larger private equity funds with capital to deploy and interest in the industry and fundless sponsors looking to do deals).  One might think that more capital in the space might mean that valuations will remain high.  That's not the case.  Although there may be more entrants in the space competing for deals, many funds are still gun shy at the moment due to the economy or what they might be seeing in the rest of their portfolio.  And there is still a large dearth in early-stage financing available (for companies doing less than $3MM in sales).  This is difficult capital to access.  Many funds are bargain hunting at the moment -- looking for companies at/near profitability with current investors who are tired or out of capital.   

What does this mean for terms:  Valuations are down and downside protection is in.  In some cases, valuations are down as much as 40-50% of where they were a year ago, but in many cases down 20-30% might be the norm.  Companies should be aware of this and prepared for it.  I have seen too many entrepreneurs hold out for that elusive valuation and kill the company in the proces -- literally walking away with nothing.   Entrepreneurs may all think that they deserve the 2-3X+ sales valuation, but very few will get it today.  Too many entrepreneurs compare themselves to the metrics of deals lie Izze, Vitamin Water, Fuze and Stacy's Pita Chips, not realizing that pretty much only beverages and salty snacks get the highest valuations (Pepsi/Coke or Frito Lay can blow out distribution overnight to the near 150,000 convenience stores in the US and turn a $20MM business into a $200MM business).  Another outlier can be personal care, primarily due to Burt's Bees.  But personal care has 60-80% margins and that deal was a relative outlier in a different economy and should be recognized as such.  The following summarizes comments I made publicly at an investor forum  at Expo West:

• Understand that raising capital in today's market is difficult, but it can be done.  How you act during the process and your expectations will impact your chances of success or failure;
  
  
• Think about raising less capital now than they may have originally thought -- prove the model and prove yourself;
  
  
• Proof elements might include:
  
  - Profitability: Many companies should think about getting to profitability as soon as possible (less topline focused); don't abandon the topline as investors use that as a marker for future valuation, but understand that you should make your current capital take you as far and long as possible in today's environment; 
  
  - Show success: Create a "healthy" business that an investor can extrapolate from (go "deep" not "wide").  Get a key retailer like Publix, Kroger, Wegman's, Whole Food Market signed up and blow it out of the water.  Show that you are a "must have" for others and that you can scale and be big and profitable.  Don't dilute your precious capital on getting to 5000 doors overnight, neglecting the fact that your product needs to be more than a shelf warmer for you to stay alive;
  
  
• Get realistic on valuation.  Overall, valuations are down.  That said, there are companies out there still getting great valuations for true home runs that have some solid proof points accomplished;
  
  
• Be prepared to provide downside protection to investors; set it to measurable metrics and milestones (if you say that you are going to achieve something -- whether it be revenue, ebitda, number of retailers, product velocity), then do it.  If you fail, then acknowledge the investor should be compensated; and
  
  
• Realize that you have one chance to prove and retain credibility: so be realistic in what you say you will achieve.

In essence, prove that your business model can scale, customers will love the product and you can be a profitable company that acquirers must have. Deals are getting done in the market today, the more realistic you can be an demonstrate that you are in it for the equity (not current pay) and that you are looking for a partner and mutual success, the better off you'll be.