Issue #63: How Do Retail Startup Investors Get Liquidity?

How Do Investors In Retail Businesses Make Money?

My first foray into the entrepreneurship world was with Hillside Ventures, an early-stage VC fund I started. Through that experience, I learned valuable insights that have been tremendously helpful in my entrepreneurship career today. In particular, I learned what an investable business is, how to look for one, and how to make a company one - all through the lens of an early-stage company. Despite the simple questions, there are very complicated answers. Whether you are a founder, operator, or investor, these data points are essential for decision-making. You have to work backwards to say, along the way, who is going to give me money for this. Especially, which future investors are going to give me an exit-sized check (typically $100M+).

In the retail brick-and-mortar world, the list of funds or other players that can facilitate an exit-sized check is smaller than the software industry. Despite retail being a massive business, it is way more fragmented, with much smaller margins. This means the standard for exit-sized check is much higher. In light of the many early-stage retail businesses raising significant money, like PopUp Bagels, I wanted to break down their investors’ path to liquidity. This piece will dive into the players for getting liquidation, through the lens of some of my favorite retail startups, like PopUp Bagels and Just Salad, from the largest to smallest liquidity event opportunity.

Liquidity Method #1: IPO

An IPO (initial public offering on the stock market), represents the biggest opportunity to gain liquidity for early-stage investors in retail startups, similar to many other industries. However, the bar is so much higher than software companies due to the margins being so much less. In terms of retail IPOs, here are some recent examples of the threshold:

• Chipotle (2006) - Over 500 locations and $40M+ in net income

• Sweetgreen (2021) - $2.5M AUV and 16-18% restaurant level margins

• Cava (2023) - 263 locations and $500M+ in revenue 

Plus, these retail brands had been operating for a decent chunk of time prior to the IPO, longer than the time horizon of some software IPOs. For instance, PopUp Bagels was around for 4-5 years before receiving its first institutional capital, Just Salad has been around for 20 years and just hit a $1B valuation recently. In retail, there is no such thing as an overnight success, and the time horizon is just pushed out further for liquidity.

Liquidity Method #2: Franchises

While retail businesses don’t have the same margin profiles in terms of margin %, they still generate solid margin dollars (you can’t pay your bills in margin %!). This financial profile allows retailers to generate returns for their investors earlier than other businesses. The franchise model is built into the industry already. Basically, a franchise is an agreement between the brand and an operator. The brand licenses the special sauce of the retailer to an operator where the brand is not located, and in return, the operator gets an out-of-the-box playbook for a concept. Through this arrangement, there is a financial arrangement where the brand receives high-margin revenue, and the operator gets the profits from the concept location(s). Most restaurants and even other concepts operate on this model as it is a win-win for all involved. PopUp Bagels has already started franchising, and I assume, eventually, Just Salad will consider it, even though many of the fast casual peers have not started to do it yet. Ultimately, starting franchises is a high-floor, low-ceiling opportunity to get liquidity. However, it is a very specific type of investor interested in these types of businesses.

Liquidity Method #3: Private Equity

A while back, I did a deep dive into Roark Capital, the private equity firm that has amassed a portfolio of top-tier retail brands. Most recently, they bought Dave’s Hot Chicken for $1B and are planning to scale it to over 1,000 locations, from its current number of 270. Acquisitions are not done on revenue, but it is interesting to see, because of the margin profile, a company doing $1B in system-wide sales (it is a franchisor), got acquired for $1B. It just goes to show the high bar retailers have to clear. I understand the lower margin depressed sales price, but it just feels like there are some great opportunities for returns here. Maybe that's why I write about this weekly! At the end of the day, private equity is another liquidity pathway, but it is not necessarily the end game for the company, just a middle ground. Eventually, it will either be resold or IPO’d, as the PE firm needs to get returns. Just take a look at Brazilian Steakhouse Fogo de Chao and its investment timeline:

• 2006 - Brazilian PE firm GP Investments made its initial investment

• 2012- GP Investments sold its shares to PE firm Thomas H. Lee Partners

• 2015 - Fogo de Chao filed for an IPO on the Nasdaq stock exchange

• 2018 - Fogo de Chao was acquired by Rhône Capital, removing it from the public markets

• 2023 - After speculation of another IPO, Bain Capital acquired the restaurant chain for a reported $1.1B

As you can see, a lot of movement for a 60-location chain, albeit one with a high average unit volume per store. Still, for those going this route, a challenge is that PE will only be intermediate liquidity, unlike the long-term consistency of being public or being a franchise.

Liquidity Method #4: Acquisition

It has definitely flown under the radar, but did you know that from 1998 until the IPO in 2006, who was the majority shareholder in Chipotle? Yes, it was McDonald’s! Pretty rate to see a retailer with multiple banners under it these days, unlike in the software or CPG industries, where there have been a lot of conglomerates that have benefited from the efficiencies of multiple brands under one umbrella. You see this with Restaurant Brands International (RBI), which owns Burger King, Tim Hortons, Popeyes, and more, but outside of RBI, it has not been replicated. For instance, when McDonald’s was launching CosMc’s, I wonder if they explored a Swig or Dutch Bros acquisition. Less for PopUp Bagels, but definitely for Just Salad, I could see them being a popular acquisition target for any fast food company looking to evolve. You never know, maybe Dunkin will buy PopUp Bagels. In theory, there should be a ton of acquisitions in the retail space, but it does not happen super frequently. Does anyone have any thoughts as to why you don’t see much M&A in the food space?

Levain Bakery Expands Menu - Aims To Be Full-Service Bakery

I live very close to Levain Bakery, which can be a blessing and a curse. However, some of the upsides are definitely the ability to get some excellent late-night indulgent cookies and find out about menu releases before they are super publicly announced. I cannot find anything online in the form of a press release, but based on menu snooping on DoorDash and this sign I saw outside, it seems that Levain is testing a non-indulgent food menu. The items include Tomato & Parmesan Flatbread, Tomato, Arugula, and Burrata Sandwich, and a Black Forest Ham and Provolone Cheese Sandwich. It makes a lot of sense to me. Despite people’s focus on health, full-service indulgence is still very popular, but to a point. Since they are already open all day anyways, they may as well have more of a variety beyond just cookies. People eat a lot more sandwiches in a week than they do cookies. It is not a huge lift on the operations or supply chain side either. Overall, just a very smart move that makes a ton of sense as they continue to expand.

Instacart Pushing Retailers To Price Match Online and In-Store

If you order something for delivery, it typically tends to cost more, whether you realize it or not. This price increase is the exchange for the value of your time you got back, not shopping for your groceries, and instead, you are able to do other things. However, the marketplaces where many of these orders happen on are trying to push prices to match in-store, as customers are searching for value. Given the added expenses of fulfilling online orders as well as the costs these marketplaces charge retailers, there needs to be more of a cost for these services. Still, the push has been to get prices matched, with Instacart being the latest platform to push it, according to the CEO. On the plus side, retailers who do this price matching can get more orders, but at the end of the day I believe this trade-off is a losing one because it will be a race to the bottom, which will lead to less profitability. I don’t have a good answer for how retailers can circumvent this price matching, but it's definitely something to watch in the retail industry.

Instacart Launches Partnership With Vroom Delivery

Instacart may have started as a marketplace to shop local grocery stores, but its most profitable segment of the business is its advertising arm, Carrot Ads. Through Carrot, brands can bid on search terms and other types of advertising to get their products in front of customers. Carrot Ads has been so successful, in fact, that they have more demand than supply of places to put the ads. This demand outstripping supply has happened with other marketplaces, like Amazon, which partnered with Macy’s to put ads from Amazon’s network on Macy’s site. Enter Vroom Delivery, a software for convenience stores to help manage their eCommerce business. They want to allow their convenience stores to have ads on their site, but it may not have been worth them starting up an ads business themselves. So, they partnered with Instacart’s Carrots Ads to put the ads from the network on Vroom Delivery sites. I expect to see this type of partnership more and more (although it already happens a lot!). It will be interesting to follow along.

Additional Links:

1. Aldi revamped its social media strategy beyond just highlighting low prices, and it works (read more here)

2. Ghost kitchens are struggling after being the next big thing in restaurants - here is why (read more here)

3. Kroger launched a new private label brand focused on protein (read more here)

4. Whole Foods is focusing on organic products as a way to reach more Gen Z customers (read more here)

5. Kroger is utilizing paper coupons and low prices - broadly announced - to attract price-sensitive customers (read more here)

6. Claire’s is planning smaller format stores to turn the business around (read more here)

7. How are brands optimizing for search via AI chat bots? (read more here)

8. Walmart spent $400M more on general liability claims last quarter than expected (read more here)

9. 52% of shoppers are shopping to relieve stress in the United States, according to a survey (read more here)

10. Sephora launched creator-led storefronts (read more here)

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