Editor's Note: This story is part of a package on DTC exit strategies. Find the rest of the stories here.
Eleven years after its founding, Warby Parker last month made its public debut.
The DTC brand, which disrupted the way consumers buy eyewear, helped pave the path for other DTC companies, spurring the phrase "The Warby Parker of X" whenever a new, hot brand entered the scene. Warby Parker, which got its start selling glasses directly to consumers online, has grown its business over the years, from opening its first location in April 2013 to expanding its physical footprint to over 145 stores.
And it appears Warby Parker is betting on those stores as it works toward becoming a profitable retailer. DTC brands have used stores as a tool to help offset the high marketing costs associated with acquiring customers online, which often hinder a company's ability to reach profitability.
Nonetheless, Warby Parker's direct listing came amid a flood of e-commerce brands looking to go public over the past two years: Other DTC darlings, like Casper and soon Allbirds, have placed their bets on the public market as well.
Warby Parker's public listing has been one to watch. When Warby Parker went public via direct listing last month, it began trading at $54.05 a share — more than double what it was being sold for in the private markets in August. In the month or so since its public debut, the brand's stock has remained around the $50 per share mark.
In contrast, when Casper filed for an initial public offering in early 2020, it initially set its share price between $17 and $19. Just over a week later, the mattress brand slashed that price, and when it officially began trading on the New York Stock Exchange, it opened at $14.50 a share. About a month and a half after its public debut, Casper's stock hit an all-time low of $3.18 a share. Though its stock has ticked up in recent months, it has yet to exceed — or even reach — its opening share price.
For companies that have operated in the private markets for their entire existence, why take the risk of not only listing shares publicly, but also making financials publicly available?
Theoretically, if a company is growing quickly and is cash flow positive, it could delay going to the public markets forever and remain a privately held company, according to David Wessels, an adjunct professor of finance at the University of Pennsylvania's Wharton School. But at some point, a company needs more.
"If you need cash — historically speaking, at some point the private markets could no longer fill your needs," he said. "That's when you would have the public markets."
Aside from gaining access to more capital, entering the public markets also gives companies a tremendous amount of credibility and gravitas, Wessels added, because brands not only have a strong consumer base at that point, but also an investor base supporting the business.
"A strategic sale usually doesn't have quite the splash that an IPO would have," Wessels said.
And sometimes, when the conditions are right, the market can help sway a brand in the direction of an IPO.
While acquisitions have remained the most popular option among DTC exits, public listings have been gaining steam: Retail Dive has tracked 17 major IPO or other public listing filings this year alone. And according to Pitchbook, IPOs in the DTC space this year have already hit a 12-year high, reaching 19 IPOs, up from nine and seven in 2020 and 2019, respectively.
So far in 2021, IPOs are up over 100% year over year
The number of DTC IPOs, per year, from 2010 to 2021.
Even outside of the e-commerce space, the public markets are so attractive right now that some unlikely companies have started eyeing IPOs. Guitar Center, Mattress Firm and Claire's — three retailers that have made the rounds in bankruptcy court recently — last month filed confidential registration papers for initial public offerings with the Securities and Exchange Commission.
"The market's on fire," Alex Song, CEO of DojoMojo, said. "If people are willing to value these things with very generous valuations, it's natural for founders to want to look in that direction."
Why some founders favor IPOs
A brand is often a founder's life's work and they envision leading it from concept to when it matures. In that case, a founder may lean toward an exit via the public markets so they can retain greater control over their company.
"You see the Warby Parker founders and the Allbirds founders — I mean these are founders that are really passionate about their companies and this is really what they want to do for the rest of their lives," Andrea Hippeau, a partner at venture capital firm Lerer Hippeau, said. "They've chosen the IPO route to be able to continue to build, while bringing on more cash, as well as giving liquidity to their investors."
If a company can't reach the scale of a Warby Parker, it needs to consider a non-IPO exit in order to provide liquidity to investors, Hippeau added.
With a traditional IPO or direct listing, the founders or existing leadership oftentimes stay on board longer than with an acquisition. That is partly because the company dynamic may change if the founder has to report to the management of the acquirer. The acquired brand oftentimes will become a smaller entity housed within a larger company. Take Unilever's acquisition of Dollar Shave Club: When the DTC brand was snapped up for $1 billion, it became one of the more than 400 brands within Unilever's portfolio.
"You're going to be a very small cog often in a very large firm," Wharton's Wessels said. "Maybe you report to the chief executive officer or the strategic buyer, but most likely you'll be a few levels down and you'll be reporting into a new corporate culture — that's going to put constraints on you because it's going to have to be consistent with the broader firm's vision."
Additionally, management might change hands after an acquisition simply because the founder has a strong entrepreneurial mindset and wants to move on to their next project when their company is sold.
"Most founders really want to get on to building the next thing — I think it's kind of in their DNA," Hippeau said. "Most [founders] kind of do their earnout or their contracted time at the bigger company and then tend to either get back to building a new company, get into VC, become advisers to other companies. I think that entrepreneurial spirit stays strong in those founders."
But with an IPO, the founders of a company more likely want to be there to see their brand grow from the private markets to the public ones.
"Imagine that you have a senior team, or chief executive officer, or founder, who has a really clear vision on who they are and what they want the company's vision to be," Wessels said. "Then it's the public markets that they want to access because they can retain control."
While a founder or CEO will still have oversight from a board of directors, as well as media attention, they will generally maintain voting rights, leaving control over the company in their hands.
Taking advantage of the IPO window
Not all brands that file for an IPO have reached profitability — in fact, in the DTC space, it's rare that one has. Why, then, have so many brands filed IPOs without evidence of profitability? Part of the reason is to take advantage of trends in the market and jump on the opportunity to raise more capital, with the hope that it leads to profitability in the long-term.
They need to consider when the market is rising and when the space they operate in is "hot" with interest from investors, Wessels said. "And then you have that window, and you have to move on that window."
That window — while it won't be open forever — is still enticing brands to move forward with this particular exit avenue. A lot of the companies entering the market today are showing high revenues, high operating margins and scalability, Wessels said. The challenge with DTC brands is that they tend to be more capital intensive and it takes a little longer to reach that level of scale needed to exit, especially through a public listing.
"You obviously have to grow and most growth in the DTC or brand world is by spending marketing dollars and that can come at an expense," said Hippeau. "I think it's about really understanding your model and how it will mature. At what point do you need to be thinking about profitability?"
Many digitally native brands have moved offline since launching their businesses as a way to reach more customers and break through the noise of e-commerce. Having a physical presence has, to some extent, offset the high cost of acquiring customers online by creating an additional marketing vehicle.
But brick and mortar isn't cheap, and the capital required to invest in it may mean lower profitability in the short term.
Many DTC brands are moving into spaces in cities and other well-established retail areas. The actual store, while in a great neighborhood that lends the potential to expand the brand's customer base, may not be move-in ready. The space might have worked well for the previous tenant, but in order for it to align with the brand's messaging and aesthetic, it often requires a lot of work — and a lot of money.
"It requires a lot of capital in, and if the profitability is not there to compensate for the capital in, then investors, of course, start to get nervous," Wessels said.
But those costs — related to acquiring customers and building a distribution network — aren't necessarily a long-term concern. If the losses stem from investments the brand is making for its future, Wessels believes those will dissipate once the company scales and pulls back on its selling expenses as a percentage of revenues.
"That's what we're always trying to tease out as investors," he added, noting that it's important to determine whether a brand is "incurring the losses because they're building the brand and the distribution, or are they really losing money on their basic product? If they're losing money on the actual product, well that's not exciting at all, because in a competitive market if you're losing money on a product, it's not clear how you're going to make that up."
A brand that is EBITDA positive and profitable are good indicators it's ready to start thinking about an exit, especially in the IPO market, according to Hippeau.
This has become apparent now more than ever: Since filing for an IPO, Casper has shown just how hard it is to make money selling goods online. While the brand was able to shrink its losses slightly in 2020 — operating loss was down almost 7%, while net loss was down 3.7% — it still has yet to reach profitability in any year or quarter. And in February, S&P Global Market Intelligence included Casper on its monthly list of the most vulnerable retailers, citing a 12.7% chance of default over the next year. The brand has regularly made an appearance on S&P's most vulnerable retailers, most recently in September when the firm cited a 19.3% chance of default over the next year and a 24.4% chance over the next two years.
Brands need to be "building a business model that doesn't have just a future promise of profit, but actually has a line of sight to generating profits as a business," said Hemant Kalbag, managing director of Alvarez & Marsal.
The rise of direct listings
Warby Parker didn't follow the traditional route of going public through an initial public offering. Instead — following other big names that have done so recently like Spotify and Slack — it filed a direct listing.
While IPOs have been the most popular way for a company to go public, direct listings have been on the rise recently. In choosing what option is right for a company, founders need to consider what needs their brand has. An IPO offers brands access to capital at a magnitude not often possible within the private markets, allowing it to expand its business. Both a direct listing and an IPO provide some liquidity to the founding team and employees.
However, if you don't need the cash, it's generally a better option to go the route of a direct listing because it eliminates the "guessing game" associated with floating millions of shares and determining the price of those shares, Wessels said. A brand can list its shares and the market will be able to determine, relatively quickly, what those shares should be priced at, without so many shares changing hands. What this means for a brand is: It can go public without giving up a lot of equity in the company. A brand also won't list any new shares through a direct listing. Instead, existing shareholders can sell their shares to the public directly.
With a traditional IPO, a brand will hire an intermediary to underwrite the new shares that are created. The underwriters will help determine the initial offering price, assist with the regulatory requirements and buy shares from the company to sell to other investors. Because brands going through an IPO hire outside firms, it can result in a costly process. With a direct listing, however, there are no underwriters involved because existing shareholders are the ones selling shares to the public.
In Warby's case, the company went public in September at $54.05 a share. Because it pursued a direct listing, it was able to offer financial guidance into its future performance ahead of its public debut — something companies can't do ahead of IPOs because it's a violation of Securities and Exchange Commission rules. Issuing guidance into its future sales can potentially attract investors because it shows a brand expects to grow down the line.
Warby Parker projected third quarter net revenues to be between $131 million and $133 million, an increase up to 28% from the year-ago period. For the full year, the brand said it expected net revenue of $532 million to $537 million, an increase of 35% to 36% from 2020 and up 44% to 45% from 2019.
"At the end of the day, it comes down to: Do you need the cash? And if you need the cash, you're going to go down the IPO route. If you don't need the cash, then you're more likely to do a direct listing," Wessels said.
‘It really didn't go as expected': The risks of becoming a publicly traded company
A public listing comes with many benefits, like capital and a sense of greater legitimacy. But it also comes with risks, namely market downturns or an IPO that doesn't perform as expected. While more DTC brands have gone public in recent years, it doesn't mean they were all deemed successful. In fact, several notable names in the space had pretty underwhelming public debuts after investors got a deeper look into the brands' financials.
"We haven't really had any successful DTC IPOs in a while. I mean, I'm sorry to say this about our friends at Casper, but it really didn't go as expected," Song said. "Unfortunately, the investor community didn't give it much serious consideration. They felt like there were a lot of holes in their calculations and, today, it has not stood up to what the expectations were."
When Casper filed its S-1 in early 2020, the public quickly saw the brand wasn't making money and it wasn't immediately clear when it would turn a profit. While brands that have gone public have generally been able to show increasing sales and revenue, what the IPO documents have revealed is that losses have been increasing steadily as well.
Casper itself said, "we have a history of losses and expect to have operating losses and negative cash flow as we continue to expand our business." When it filed, it showed that in the first nine months of 2019, the company reported net revenues of $312.3 million, up 20% from the same period in 2018. At the same time, the retailer's net loss widened to $67.4 million from $64.2 million a year prior. Casper's advertising and marketing expenses also grew to $114 million — or more than 36% of total net revenue in the period — from $92.7 million in 2019.
"This isn't like technology ... This is consumer where your taste changes week to week."
Alex Song
CEO of DojoMojo
Song cautioned Allbirds, which in August filed documents with the Securities and Exchange Commission to go public, could potentially face a similar fate.
"Their metrics aren't good, they're losing just way too much money," he said.
The sneaker brand said net revenue in 2020 reached $219 million, up from $194 million in 2019. But its losses in the period also grew: In 2020, Allbirds' net loss was $25.9 million from $14.5 million a year prior.
"This isn't like technology, where you can easily have a very strong recurring subscription revenue and a very strong foothold in a market where you can continue to scale up over time with really great barriers to entry and competitive advantages. This is consumer where your taste changes week to week," Song said.
Before even considering going public, a brand needs to make sure its financials are in order. Companies in the public markets face harsher scrutiny because they are watched daily. Public companies, Song said, also don't have as much leeway to prove to investors that their financial metrics will improve in time as a private company would.
"Naturally, public market investors are just going to be more rigorous, they're going to be more disciplined, they're going to be more challenging and difficult," he added. "The lesson I would take away from the Casper experience is to really get your metrics in a row. Don't try to do ‘funny, asterisk-type math' to get a cash flow that looks better than it actually is."
Entering the public markets also introduces factors outside of a company's control, like changes in the market, which could negatively impact the company.
"Imagine there's a major macroeconomic announcement, which spooks the markets," Wessels said. "The markets are down for a few weeks. You can find that the public markets dry up pretty quickly."
And though the market is favorable right now for many DTC brands, it won't be that way forever, potentially complicating that avenue as an exit in the future. "If your sector starts to dry up, or there's a set of failures in the sector where the price of the IPOs is well off its initial offering or even off its highs, people will start to sour. And you've missed that window," Wessels said.
Listing publicly also means there are additional things added to a brand's plate, such as having to manage a public company, filing quarterly earnings reports and navigating the SEC governance that comes with that, Song said.
Given the nature of many DTCs, a brand may find more value in forgoing a public listing altogether.
"The traditional path for a DTC shouldn't be an IPO and that's probably a little bit controversial," Song said. "Because we're talking about physical products based on a brand where there is an existing supply chain, manufacturing fulfillment distribution, marketing — all of the things that you need are strategically quite similar to what the bigger Fortune 100 versions of these businesses are already doing. That's the perfect environment for M&A to occur."
Editor's Note: This story is part of our ongoing coverage of the direct-to-consumer space. Sign up for our weekly newsletter, Retail Dive: DTC, here.
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Caroline Jansen, Khareem Sudlow
