A lot of the time in the CPG space, the earliest investors you line up will themselves be successful entrepreneurs who recognize the potential for your product. But do you ever wonder how those experienced food and beverage entrepreneurs think about what companies to invest in themselves? Seth Goldman, the Co-founder & TeaEO of Honest Tea, has invested in several startup food and beverage companies over the years — and shared this piece with our Food & Beverage University site, just in time for Natural Products Expo West 2014.
Three things angel investors look for in a natural foods company — PLUS Seth Goldman’s bonus criteria
By Seth Goldman – Co-founder & TeaEO of Honest Tea
Although it’s been 16 years since I worked at the Calvert funds, I remember enough from the mutual fund lawyers to know it’s important to say the ideas I’m about to present do not constitute investment advice nor are they a solicitation to buy or sell shares.
Now that I’ve gotten that out of the way, and with the nation’s largest Natural Product Show, Expo West, starting this week, I’ve decided to share the three things I look for when I invest in a natural foods enterprise. One more disclaimer — my full-time job is as an entrepreneur, not an investment professional. So these thoughts are based on observations from 16 years of toiling in the natural foods fields, and a series of eight successful (and one failed, more on that later) investments, including Happy Baby, Sweetgreen and several others.
Rule One: Make sure the product is dramatically different and better than the mainstream offerings.
By definition, any company starting up in the natural food space will be disadvantaged in terms of cost of goods, distribution, and, of course, resources. In order to gain the fierce loyalty of natural foods retailers and consumers, the product has to be significantly different from what is currently on the shelf. In 2007, when we first brought out our Honest Kids drinks, the mainstream options were 100 calories per pouch. A certified organic drink pouch with 90 calories would not have gained much space. But when we launched Honest Kids with 40 calories and organic ingredients, we disrupted the category, and have sustained a 57% compound annual growth rate, to the point where Honest Kids has become more than a third of the Honest brand’s overall business.
Rule Two: Make sure the enterprise uses its capital efficiently.
Over the years we encountered numerous “smart investors” who would trot out the usual Wall Street statistics such as P/E (price to earnings) ratios or gross profit to point out that our enterprise wasn’t worth nearly as much as we thought it was. And while those metrics might be appropriate for comparison among multibillion beverage corporations, they are largely irrelevant for early-stage companies.
Over the past ten years most major natural food acquisitions have been based on a multiple of sales – anywhere from 2X to 6X annual net revenue. The difference between 2x and 6x is usually driven by 1) the company’s annual growth rate (sustained 40+% growth is exciting, low double-digit growth not so much) and 2) whether the brand is the category leader in the natural channel (usually defined by SPINSscan market data). So rather than worry about spinning off profits, an early stage natural food company should focus on growing as quickly as possible without losing too much money.
That changes the key indicator from P/E ratios to how much revenue the company generates compared to its annual sales. My quick rule of thumb is that for every dollar raised, a company should generate a dollar of recurring sales (an example of non-recurring sales would be heavily discounted sales). So if a company raises $10 million in equity and ends up with $10 million in sales, and then sells to an acquirer for three times sales, investors will see a 300% return on their investment. My one failed natural investment was a personal care company that raised close to $1 million in equity but generated less than $100,000 in sales. Not surprisingly, the company was unable to raise additional growth capital, and folded. There are a few exceptions to this formula, such as an R&D focused enterprise (like Beyond Meat), where upfront investments in capital and R&D contribute to a long-term competitive advantage.
This approach helps explain two of Honest Tea’s core mindsets in our financing strategy – 1) raise just enough capital to keep growing and 2) spend your money as efficiently as possible. We saw several natural food peers who lost control of their enterprise either because they raised more money than they really needed and lost governing control of the enterprise, or they made more expensive mistakes, and consequently needed more money, which led to loss of control. Our colleagues on the floor of Expo West used to tease us when we would share hotels at the Best Western ten miles from the convention center while they were strolling to the show from their rooms at the nearby Hilton. But our team kept reappearing at the show year after year.
Rule Three: Fire in the entrepreneur’s belly.
Of course, I’m an entrepreneur myself, so I can be blamed for having a bias here. But when the odds are as stacked against the challengers as they are in the natural foods sector, it takes a lot more than a disruptive idea and a lean organization to break through. The difference often comes down to whether the CEO can achieve his or her three core tasks – 1) create a compelling vision, 2) raise growth capital and 3) bring on great people to make that vision a reality. Though of course all of the usual business skills have to be expected, I look for the extra juice – why is this person uniquely suited to be the messenger and leader for this idea. How does the entrepreneur bounce back after being knocked down? Some investors might prefer someone who hasn’t been knocked down, but I believe if you haven’t been knocked down, you’re not pushing hard enough.
At the end of the day, private equity investments in natural foods companies are extremely risky – very few enterprises survive, let alone deliver a return. That brings me to a bonus criteria which isn’t essential for a successful investment but is something I focus on in my portfolio — the product or service needs to carry an intrinsic health or environmental component. Not only do these mission elements help fuel the passion of the entrepreneur and the team as a whole, but they carry a consolation value for me as an investor – even if the money is lost, I’ll know I’ve helped support an effort to take our diets and our environmental impact in a more sustainable direction.
When we think about the health, environmental and economic challenges our society faces, the growth and emergence of these companies is one of the most powerful tools we have to help make our society healthier. But it also presents a compelling business opportunity — despite the fact that the United States is the richest nation in the history of the world, and has more advanced knowledge of science and medicine than any other civilization, we rank 40th in average life expectancy. Helping the citizens of the world’s wealthiest nation live longer, healthier lives? – now that sounds like a great investment.