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Q&A: Provenance’s Anthony Choe on Investing in the Next Wave of DTCs

The next generation of direct-to-consumer brands is already here, and with it comes a different investor mindset.

Enter Anthony Choe and Provenance. Choe spent 20 years at private equity firm Brentwood Associates, before founding his own company. During his career, he’s developed statistical tools that help drill-down on how well a consumer brand is doing. While Provenance is category agnostic in the consumer space, roughly half of its investments are in apparel and accessories, with current investments including handbag firm Dagne Dover, custom tailored men’s clothing brand Knot Standard and the men’s and women’s California lifestyle apparel brand Marine Layer. The latter is known for MicroModal, the brand’s signature fabric that’s made from recycled beechwood.

Choe knows a thing or two about DTC brands, and he’s got the chops to prove it. He’s invested more than $400 million in the consumer space, and those investments have generated $1.4 billion in returns for investors. More impressive is that there were no losses on the investments made on the platform in the new millennium. When Choe says the next generation of DTC brands will be smaller in size, with a correspondingly smaller revenue base, it pays to sit up and listen.

Sourcing Journal caught up with Choe to talk about investing in direct-to-consumer brands, why growth for growth’s sake is an outdated model, how the scale of business has completely changed and what it takes to make an attractive exit.

Sourcing Journal: Tell us what you’ve seen in the consumer space, and what has changed for you as an investor?

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Anthony Choe: I’ve been investing in the consumer space since 1996….For us [at Brentwood], e-commerce was the wrapper on all the channels. It was where everybody was starting their journey….Towards [the end of] my tenure in 2013, and increasingly into 2014 and every year after that, I was spending more of my time with brands that were born online. There were lots of interesting stories and nobody knew how to make any of it work. There was ModCloth, Nasty Gal, Bonobos. They were the first generation of this next generation of companies. It became clear to me that [online] would be part of the permanent brand landscape.

SJ: What does this new landscape mean for the next generation of brands?

AC: It’s become more fragmented as barriers to entry have become easier for companies who want to enter the space. We see that for beauty, home, apparel and accessories. There are a lot more brands, and [these brands] will be smaller than they used to be. Nobody is creating the next Victoria’s Secret or that kind of volume in sales. There are too many brands out there, and the market is getting chopped up.

SJ: How did that change your investment strategy?

AC: My view was that nobody was investing in that [middle] stage in the market….When I started Provenance, I began by stitching together a bunch of tools that I knew would be critical, not just for identifying and deciding on which brands to be a part of, but also for mapping out the strategy for the companies that we do invest in.

SJ: What does this fragmented landscape mean for investors?

AC: Gone are the days in the consumer space when you can look for the next brand to get to $1 billion in revenues. That business is gone. I have yet to see any new brand get even close to that number. You may hear a company talk aspirationally about [getting to $1 billion] but it won’t get there–not because the business is bad, but because the brand landscape is too fragmented. To be a successful investor in a growth brand, not only do you have to grow the brand under your ownership, but you also need a growth path for [the next person when] you sell it. If there’s no growth story, there’s no attractive exit and you’re better off leaving the meat on the bone.

SJ: What about a company like Rent the Runway? They just did a Series F raise for $125 million in March, with an aggregate raise of $321.4 million. Those are huge numbers. Does that mean an initial public offering is its only exit?

AC: Maybe. You need big numbers to get a big exit. When Bonobos was sold, it was a good deal for Walmart (which acquired it for $310 million in June 2017). Bonobos had cleared about $100 million in revenues, so [the $310 million] wasn’t a bad valuation, but [investors in] the last round of capital didn’t make much money and the early-stage guys got diluted [by later funding rounds before the sale].

SJ: What has anyone learned from the past investment landscape?

AC: Some companies have been too irresponsible with capital for the last five years. There’s been an appetite for more money, but they’ve also lost more money, too. That’s a flawed game. Now people are going to raise capital only to the extent that they need it. You will see more discipline. Maybe a company isn’t going to grow 300 percent a year and will grow 60 percent instead. That’s now going to be OK.

SJ: What about learnings from brands that received a lot of hype, but then flame out? One example is Nasty Gal, which eventually became bankrupt.

AC: In this second generation of brands, one example is Dolls Kill, which has made money since Day 1. They don’t want a Nasty Gal outcome….One can point to different people to blame for what happened, but the opportunity there was killed by trying to grow the brand too fast. Now we see growth settling back to a more natural state….Many of those guys who raised a lot of money got over-capitalized, and then faced a ton of pressure to grow really fast.

SJ: What is Provenance’s key criteria when you vet brands and what makes you confident that you’re looking at the right information?

AC: For the sweet spot that we’re targeting, there’s a lot of confusion over how to evaluate brands that are growing 30 to 100 percent a year, but still aren’t yet profitable….The data we use creates clarity and tells us what the company will look like when it grows up.

The first thing we look at is customer loyalty. [In] any transaction business, there’s an incredible amount of predictable data on the customer. The secret to every great brand is that there’s a small portion of the customer base, the 20 percent, that’s generating 60 percent of your company’s value. You need to know what they look like and map out who you think is part of that tribe….I call it the law of consumer behavior. If you are generating brand loyalty, it comes down to what that 20 percent looks like vis-à-vis the rest of your customer base.

SJ: Provenance took a stake, estimated at $15 million, in the men’s wear company Knot Standard. What made the company special, and what are you bringing to the table besides funding?

AC: What attracted us to the business is that it’s got the best customer unit economics that’s nothing like we’ve seen in apparel. The average order value is best in class. It operates in a much narrower market than most of the brands we look at. Knot Standard is premium to luxury so that automatically narrows down the customer base. It’s never going to be the next Men’s Wearhouse and it’s not meant to be, but it does have the best customer-unit economics possible. What we’re doing is entirely tactical. We’re sharpening our focus on branding and marketing, and rolling up our sleeves on the accounting side, looking at real estate and hiring more people. It’s mundane, but all are matters that make a business work.

SJ: Is the founder—and management team—still important at your growth stage?

AC: Almost always because when we look at companies, we’re looking to back the founder as opposed to bringing in someone from the outside….If you think of venture capital as elementary school, we get involved in the junior high school stage, shaping what isn’t yet fully formed. The founder is very critical to that. If you take the founder out, you are taking out the DNA of the company.

SJ: Many companies get multiple rounds of funding even though they’re not profitable, and it seemed that the idea of profitability was old school when it came to start-ups. Will that change?

AC: For most truly omnichannel apparel brands, it’s not really going to make much money until it gets to north of $50 million in revenue. My problem is with the large-scale businesses that still don’t make any money…. The good news is that people are starting to understand the value of making money again. Three years ago, it was ‘Grow, grow, grow.’ Now they are saying ‘Just kidding’ and ‘Get as profitable as you can, as quickly as you can’…. The middle ground is to grow at a sensible rate and try to be incrementally more profitable. It’s never all or nothing.

Read more about the ways in which direct-to-consumer brands are changing every facet of the industry—and the pace at which they’re doing so, download Sourcing Journal’s Direct-to-Consumer Takeover report. The report is sponsored by The Studio, Shima Seiki, Texworld, and AIMS360.