The Fundamentals of Food & Beverage Funding

March 12, 2021
From SPACs to hacks, SWAT Equity Partners’ Sarah Foley talks about all things venture capital in this podcast episode.

Have you ever wondered what venture capital firms look at when considering whether or not to fund a food and beverage start-up?

Sarah Foley, Partner at SWAT Equity Partners is giving us the low-down on food and beverage funding. In this podcast episode, we talk about trends, sustainability, why SPACs are seeing a resurgence, as well as providing actionable advice for anyone considering launching their own food and beverage brand.


Erin: Sarah Foley, welcome to the "Food For Thought" podcast.

Sarah Foley: Thank you, Erin. It's such a pleasure to be here. I really appreciate you having me on the show.

Erin: It is great to have you on. And I'm so excited to talk to you today and also to let our audience learn more about who you are and what you're doing, especially for the food and beverage industry. Let's start off talking about who you are and what you do.

Sarah: Well, I'm a partner at SWAT Equity Partners. We are an early-stage venture capital firm focused on investing in consumer brands, which wonderfully includes the large category of food and beverage. But I've spent, you know, more than a decade or so really focused on the food and beverage space amongst these roughly 20 to 25 years I have a pure investing experience. And to boot, I was also the CFO of a food company that was based here in the New York City area that I truly enjoyed. It was a lot of fun.

Erin: We've had a couple of guests on the podcast recently who have been in the CPG startup space, they've discussed product, innovation, but we haven't really touched on funding. Being on the funding side of things, can you offer our listeners some ideas of what venture capital investors are looking for when they're considering investing in early-stage consumer startups?

Sarah: I'd be excited to, and a lot of that perspective really is formed from the way we've established SWAT Equity as a firm. We tend to leverage three different lenses to evaluate opportunity before we make an investment in a company. Those three lenses include venture capital, obviously, which is my background, more private equity-oriented assessment, which helps us think about how to build scale and grow a company, particularly into profitability, and then the third is branding, marketing, advertising, really understanding how a brand can articulate their DNA as well as our ability to assess do they have real DNA that could evolve into brand equity over time, which for me, is, kind of, the most exciting part.

Five things that we tend to look for, that are a bit more macro level, and then we dive down into detail as we go into the diligence process on any particular opportunity. The first one we think about is how we evaluate what really makes that brand authentic, and how they have brought appeal and true differentiation. So here is an example of where we, kind of, work closely with people on my team that are affiliated with a branding agency called SWAT by Kirshenbaum, founded by Richard Kirshenbaum, but we look at packaging, we look at all digital assets, we look at the market space, we look at the brand on the shelf, if you will, and we really try to think about how that differentiation is pouring itself out because that's important.

The second thing we really look for is a passionate founder, and obviously a real dedicated team of go-getters that are executing on an everyday basis. It's really important. It's not something that's formulaic, only driven by, kind of, data, if you will, it's a lot of time spent with those founders, really understanding their vision, understanding their passion, and their dedication to really providing the best product they can to growing a tribe of consumers.

The third indeed is that tribe of consumers where we really think about how we measure strong customer engagement and sentiment. And that manifests itself in a loyal group of customers that continue to engage with, come back and buy more of a particular product. And we try to think about creative ways to measure that but it's everything from social media to turns on the shelf as we talk about velocity in this category.

The fourth thing we think about is more of an obvious one, but it is very real clear and proven market fit for this product is it's speaking to a need, a problem, an issue, a pain point that a customer is experiencing that they find enjoyable to consume. That's important. And we really look at traction in terms of how we measure success there.

And then the last thing is proven financial performance or momentum going back to our more mature investing experience days where we think about unit economics, gross margin, contribution margin, channel diversity, are they only selling into retail doors or are they also selling via an e-commerce channel or an e-commerce partner? Do they have account diversity? Are they too concentrated in one particular grocery retailer or not? And I would throw velocity in there as well as something that we pay attention to, how quickly is the product moving off the shelf?

Erin: What sort of things give you pause about investing in a startup? Are there any deal breakers you can share?

Sarah: So I'll think about the things that do give us pause. Deal breakers are a little bit harder for me to speak to because I feel like they're specific. But let's start with traction as one fairly large filter that we use to go through the funnel of pipeline activity that we see at SWAT Equity Partners. And that means traction in terms of sales. We like to invest at the seed, the Series A stage; the first round of institutional capital. After you've talked to your friends and your family and other acquaintances about providing you a little bit of capital to get started so you can at least have a product to sell, we like to look at businesses that have been selling for a little while and have about a million dollars of annual revenue. That means they've broken into a chain or a couple of retailers, or they've had great success scaling on their own e-commerce site. But it gives us some data to study in terms of how much the consumer is enjoying the product, coming back to repurchase.

The other thing we think about that can give us pause is growing too quickly. So almost the opposite side of my former statement. And that implies are you taking the call and filling the order if a large nationally known retailer comes knocking on your door and says we love that particular product, and we wanna put it in all of our doors? Taking something on like that is a massive challenge and can bring and potentially wreak havoc on a, kind of, fragile business in the very early stages of its involvement. We don't like to see a business grow too quickly and we don't like to see a business take on a national account that has never had national exposure before.

The product itself here in the food and beverage space, it has to have a, kind of, clean ingredient panel, in our opinion. The more processed, the more challenging we just believe it is to filter through the clutter of all sorts of information on different products that a consumer is being bombarded with on a day-to-day basis. So clean, the cleaner, the better, the fewer the ingredients, the better. If it's not in that category, it's something that we will generally stay away from.

We look at whether or not the product is too expensive, and just not sustainable and really going to keep its intended customer, you know, CAD size, or number of customers interested. And then the other thing we think about is if there's no finance support within the company even if it's not a full-time person, it may be some outside service that the business can work with on a temporary basis, that gives us pause because we do believe financial discipline, even at the beginning, is really critical to building that foundation to, you know, successfully scale from going forward.

Erin: Can you talk for a bit about how both the pandemic and the new presidential administration have impacted the VC space?

Sarah: First, the pandemic. I think it's had an impact on my business and venture capital and startups in two ways. First is, from a business operation standpoint, the pandemic, the quickness with which it's captured, I think, at least us in the U.S. really put companies to a stress testing period. And that means everything from operations to financial discipline was tested and sometimes all at once. And that's challenging for any kind of business of any size. But it really did put our founders and many companies that we have been looking at and studying through a process of evaluating everything from their supply chain, are they getting access to the ingredients they need quickly enough? Are they getting access to the packaging that they put their products into quickly enough? And if they're not, how they put those different puzzle pieces with respect to timing together.

Distribution chains were disrupted in terms of how quickly product could move around. Retailers were disrupted in terms of the ways in which we were purchasing products towards the beginning of a shelter in place in a period of time to where we are now. A lot of product resets weren't happening. A lot of disruption on the operational side that required management teams to really coalesce around prioritizing what's most important, what do we have some control over and how do we wanna handle it? I would say there was that side of COVID impact on business ops.

The other side, was, in my world, kind of, deal impact. At the beginning, I would say the vast majority of VCs in my ecosystem were very focused on their portfolio and making sure that the companies in their portfolio were situated well to weather the storm, whether that meant spending a lot more time with them, going through budgets, making sure that they were doing everything that they could to extend their runway, meaning preserve cash for a period of time, that period of time, kind of, continue to grow, until we had more visibility in the beginning of the summer or over the summer as states started to reopen.

So that had an impact on new deals getting done. And in the beginning of the second quarter, we saw a bit of a dip in terms of deal activity across the whole in terms of angel to seed-stage transactions, but they really did recover and by the end of the year, kind of, finished out 2020 slightly above 2019 overall. I would say deal activity was lagged for a period of time. We were very busy in the fourth quarter, kind of, catching up, which is good. I think founders just realized that investors were preoccupied for a period of time, rightly so, and if they could delay going back to market to raise more capital, they did, and have been successful, kind of, closing on that capital now.

I think the last thing that I would add here is the change in consumption behavior that we all started to see, witness, as well as participate in was more e-commerce channel purchasing behavior. And that, as far as our assessment of business models today, probably has more importance on it than it did before. Knowing that you have access to a channel that can safely conveniently deliver a product to a consumer is important whether you own your e-commerce site, or you're working with an e-tailer, an Amazon, a Thrive, just to name a couple, that you can have access to, again, make sure that your consumer has access to your products if they are not comfortable finding them on a shelf in a store, you can deliver them and continue to sell product to them and continue to grow your customer engagement.

Now, on the side of the Biden administration, just a couple of comments there. I think, generally, we expect a little bit more stability and predictability from the new administration, which is always a positive for the overall business and investing community. We think that this administration will probably hasten testing and more vaccine distribution as we've been witnessing the last few weeks and that will also help impact positively. We believe the path forward for more economic recovery. But we expect that this administration could start taking a look at the capital gain SPAC treatment that our investment community has on carried interest, which could affect, ultimately, the amount of private equity funding, and potentially will exit businesses. But that's, kind of, far off in our thoughts and we'll just have to monitor and see if anything does end up changing there.

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Erin: It feels as though I can't open up an email without hearing or reading about a SPAC so I wanna talk about that for a bit. Can you go into SPACs in a little more detail, explain what they are and why there has been such a resurgence in them?

Sarah: As you've mentioned, a very popular investment vehicle getting a lot of attention and a lot of capital last year and this year. So SPAC, which is the acronym for special purpose acquisition company, are what investors like to call blank tech companies. It's a shell that raises capital from the public in the form of its own initial public offering, if you will, with the sole purpose of raising that capital to go acquire another company that is private. That's what they do. They generally raise their capital issuing a number of shares at $10 a share. The investors in SPACs are both the institutional market, so different types of mutual funds, other large institutional investors, but also the retail market, which is the investor on Main Street, and they are attracted to these SPACs for a couple of reasons.

I think first and foremost, they're attracted to a SPAC that's being led by an individual or group of people that has a real track record of success. So you're, kind of, making a bet and you have an option on their ability to find a great business that they will "bring public," but not have to go through a more protracted initial public offering process, which takes some months, takes review of the SEC, a roadshow by the management team, etc. and then, kind of, price-setting by the bank that helps take that company public. Here, the company, the targeted company, and the managers of the SPAC negotiate valuation. It, kind of, takes place between those two groups. They agree on a valuation, and then the investor in the SPAC vehicle, whether it's an institution or that Main Street investor, gets to decide if they like the price and vote for the SPAC to happen. And then they call it, kind of, de-SPACing.

I think, has been a resurgence of SPAC activity because there are a lot of folks out there that have great experience. And there's a lot of capital on the sidelines looking for ways in which they can participate, owning a company that they may not otherwise have had the ability to for a longer period of time. I think in the market volatility, in general, from the pandemic, has had an impact on IPO activity, the more traditional path to taking a company public, and it's come down, whereas the SPAC route is just faster, maybe a little bit more certain. And so they are seeing, it feels almost like, dollars that would have gone toward IPO processes funnel more towards this SPAC environment, which is interesting.

We think, with respect to the venture capital world, a SPAC vehicle is really an interesting way to accelerate an otherwise VC-backed business toward a public exit. And by that I mean a company who is in space, in biotech, in heavier technology sectors that might need a few hundred million or more to finish a development of their product, their software, their rocket, their satellites can access to a much larger quantum or dollar amount of capital at one time than it might take to raise that capital over a longer period of months to years with incremental traction on their progress. That's a very attractive option for that VC-backed business, kind of, grab all of that capital at one time and then you have a war test to go execute again. And in that situation and that opportunity is also one of these ways in which a Main Street investor might be able to own a VC-backed company much earlier than otherwise expected if they were to go the more traditional IPO path.

While there has been so much activity, I would say when I last did my math, and overnight I think there were 10 more SPACs that were announced literally between yesterday and today. Roughly 80% of all VC capital, which was like 150-something billion dollars last year, has already been raised in the form of these SPAC vehicles. So, just another way to underscore how much capital is sitting, kind of, on the sidelines, looking for an opportunity to acquire for which they had two years, once they've raised this money to go do. But there are so many of them in that $250 million size range that they're gonna be looking for companies that are gonna have to be valued at, like, a billion dollars or more.

We think there's a really interesting opportunity for additional SPACs to come to market that are raising more like $75 million to $100 million. So instead of hunting for that billion-dollar size unicorn type of deal, that a $200 million, on average, sized SPAC has been raised around right now, these smaller SPACs in that $75 million, maybe $100 million range can look for something in the $500 million to $750 million transaction value space. And we've decided, and I think actually another founder was talking to me about it, we like calling those types of acquisitions or transactions more of a purple squirrel instead of a unicorn because they're smaller and they might be more achievable in the long run.

Erin: From your perspective, which types of food and beverage startups are most likely to be successful going forward?

Sarah: It’s relatively easy to start a food or beverage company. You can get products made, there are lots of co-manufacturing experts and facilities around the country, you can open an e-commerce store on any kind of platform, Shopify, for example, and get started. With that in mind, what we think about in terms of being successful in this space has a few elements and attributes related to it. First and foremost, you always have to start with a really good product, you know, the food has to taste great, the beverage has to be enjoyable, it has to taste great. So please understand that has got to be, kind of, table stakes, in our opinion.

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Beyond that, this movement, I would call it because it's not a fad, I think it's beyond a trend, this movement into clean ingredients, better for you in nutrition, and sustainability, which I'll come back to are three really important elements, in our opinion, to success in food and beverage. I talked a little bit about clean before with respect to the ingredient panel, the fewer ingredients, the better, the less processed those ingredients, the better. But that is really important. We just want cleaner food that we're ingesting. Better for you in nutrition, meaning there's something perhaps in a functional ingredient format that is helping my wellness, whether it's a cognitive additive, an attention-focused type of ingredient. Those are the things that I think are also important if you're starting to formulate.

The last thing is sustainability. And that means not just those ingredients themselves being sustainable, which points strongly, right, in the direction of more plant-based products, but even down to the supply chain in which you're sourcing those ingredients, and the packaging that you're using on the shelf, and vis-a-vis e-commerce distribution and fulfillment. All of those elements, where you can start nipping away at the heels of being a more sustainable company, I think is important. It's not valued by everybody, but it is being valued more and more by consumers. Finding the middle ground where the price and, kind of, value proposition around all three of these elements is the, kind of, winning formula in my mind, but leaves a lot of room for creativity.

So that's one way I think that a food or beverage startup is going to be successful. Consumers are really smart. They're discerning, as I said before. There are a lot of products out there vying for attention. Figuring out with smart folks around your management team how to break through on messaging so that you feel authentic and you're aligned with, my-- meaning a customer's beliefs-- is essential. And it's not easy. There is a lot of art to branding and marketing. But there are fun ways now to test different ways to get your messaging across and how effective it may be, particularly in all the digital channels available to brands today that are continuing to grow. I think really figuring out that story, staying consistent around the story, but being creative around the edges on how you distribute and disseminate messaging is another area that a successful company will stand out.

Erin: What kinds of trends are you seeing, specifically in the food and beverage space?

Sarah: There are a few things that we've kept our eye on, and by no means are they inclusive. But wellness, in general, better for you, in general, which, in my opinion, really just points pretty strongly in the direction of plant-based or even plant-forward. So I think the types of alternative proteins that have been developed over the past few years, giving consumers an option on something that feels, and looks, and tastes very close to the real thing is fantastic.

Anything we can do to, kind of, think about the environment and pulling some resources away from its deterioration is great. But I also think plant-based is better for us nutritionally, in the long run. It doesn't have to be only plant-based and that's why I bring up plant-forward. I like more of a mix. I like a bit of protein, but I like more plant-based ingredients in my food, specifically products because it just makes me feel better. Banza is a great example of a company in our portfolio that I loved as a consumer before we invested and I continue to adore as an investor, just doing a great job, making this product that tastes great, I feel better eating it, is plant-based and it still gives me great nutritional content.

A few others though. There is, you know, this growing trend of great functional ingredients as an additive to a food or beverage that help with some type of functionality. And I think a lot about that cognitive wellness aspect of where functional ingredients can be helpful, nootropics as one example of that functional ingredient. I just think that's great. I think it also points in the direction of alcohol alternatives or non-alcoholic types of beverages, which has seen a big rise and even more so over the course of last year as people continue to really focus on their wellness while at home.

Meal prep hacks. I love these. I think it's great and it can span a lot of different types of products. But would include spice blends that help enhance the flavor of the meal and maybe making at home sauces that help finish a meal. But anything that I think can help a family really mix up a couple of key ingredients that they have in the kitchen but can offer a different menu flavor, you know, and give them another way of participating in meal prep together, having family time, but keeping the menu fun and diverse is great.

And then the last thing that we're seeing in food and bev is not a type of food or a type of beverage, but more of a business model risk and that is subscription. And I mean both, I'm going to subscribe and get my fulfillment taken care of by this particular company because I love the meal kit that they're offering, but it can also be the subscribe and save type of subscription process where I'm getting three different types of products that I really love to consume in my velocity is strong, but I just want them on auto-refill. I think that's a really fun marketing and retention tool that these companies can use.

Erin: I want to end on some actionable advice for those listening. What advice would you give an entrepreneur who is just getting ready to pitch for their first round of funding?

Sarah: I had a couple of things here that I had been thinking about. The first is fairly basic, but it's worth repeating and that is come prepared with two things, a presentation, or as we call it, a deck. It doesn't have to be long. It could be 10 to 12 pages, but it outlines the business plan. The why this product needs to exist, the market opportunity, where are you having it made, how are you going to market, and then some type of financial information that speaks to why you're raising the amount that you're targeting, and how will you be spending it?

And that points to the second piece, which is you need some type of financial model that walks through how you plan to generate revenue, how you plan to manufacture or have the product manufactured, and where the expenses below that gross margin line are being spent, which are generally around team, investing generally a bit before revenue that you have to, kind of, afford that team number, but that's where venture capital comes in is to accelerate that process. And the other category is marketing so that you can both market brand awareness as well as market the product, you know, itself on the shelf digitally or physically. But that costs some money. So you need some deck that people can walk through and get a feeling for how you're thinking about your company, as well as some financial backup to explain how you're gonna make money and why you need this amount of capital today. A basic but it is critical. It doesn't have to look perfect, but it does have to be thoughtful.

Then, I would say secondly, always be fund-raising. And by that, I mean network, do various things to network, and put yourself in the way of potential investors. And that could be an angel investor who just has a passion for the type of product you're making to the institutional investors whose job is to put capital to work on behalf of their own investors. But you can view every opportunity that you come across meeting an individual of that ilk as a fundraising conversation and seed planting opportunity for either the round that you're raising now, but more importantly for the round that you will need to raise next. And my hope is that doing that spadework in advance will short circuit the next round of capital that you need to raise because it's a full-time job.

And I tell founders who are new at being a founder that you have two full-time jobs. One is running the business and providing the leadership that your team requires to keep executing against the plan. The second is you are always going to be fundraising until you reach that point of scale where it's not required because you're either profitable or you might have exited or found, you know, a significant investor who's going to give you a lot more capital in a growth or private equity style transaction, which comes down the road. But otherwise, you're generally always fundraising.

And lastly, be prepared for a lot of nos. But remember, you will find yeses, and learn something from, you know, every conversation, including the nos, and take that information in and start processing it and use it to make your business stronger, period. I think that, you know, we're all on a life lesson to learn and while it may take time while you're raising that first round, which will always be the longest, really learn from the opportunity, you know, learn from the journey and view it as that, and then stay positive.

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