How He Buys Multi-Million Dollar Brands with Fan Bi, Founder/CEO of The Hedgehog Company

0:00Maybe we should be actually valuing these businesses differently. It was a lavish, lavish party for a few years, produced by... Do the founders make actually any money? No, I mean... Three to five million dollars. I could get to a million dollars in revenue and be worse. The entry continues to get lower. Any successful brand is going to have 10 copycats in the next year. How do you think about... To start a need on this business? Well, the real answer, hopefully never. Hello, I'm your host, Mike Gelb, and this is the Consumer VC Podcast brought to you by Propeller Industries, the leading strategic finance and accounting partner for venture stage companies.

0:34On this show, we discuss the intersection of venture capital and consumer innovation. And if you're enjoying the show, please subscribe on YouTube or whichever platform you're viewing this content. If you want the full experience, subscribe to my newsletter at theconsumervisa.com where I send fundraising updates and you'll receive new episodes straight to your inbox and a weekly recap of all the consumer deals that are happening. All content and episodes are for informational and entertainment purposes only. It is not investment advice. Our guest today is Fan Bai, who is the founder and CEO of Hedgehog.

1:08Hedgehog buys$3 million to$15 million revenue brands that have been built over five plus years and are not yet profitable and typically VC backed. Some of the brands include Rockets of Awesome, Felix Grey, The Reset and Baboon to the Moon. Fan also founded Blank Label, which is a formal men's apparel brand. we discuss his introduction to entrepreneurship and what he thought was compelling about men's fashion and starting a men's fashion brand what multiples were used for early digitally native brands and how that's evolved and changed why he started hedgehog and the types of opportunities he saw when he was seeing the change and how brands were being perceived by venture capital and we also talk about margin EBITDA is this a period of growth how he's thinking about this current period of time when it comes to his own brands.

1:59What are some of the white spaces he's looking at, as well as categories he's finding attractive when he thinks about buying brands, and much, much, much more. This is a wonderful conversation. Thank you so much, Fan, for coming on. Without further ado, here's Fan.

2:18Fan, thank you so much for joining me here today. How are you? I'm doing great, Mike. Excited to be here. Long-time listener, first-time caller. Thank you. Thanks so much for listening. Thanks for listening. I know that this has kind of been on both of our agendas to do this for some time now. And really excited that we finally got time here today. This is great. Yeah, likewise. It's been a very dynamic, busy year for all in consumer. So I'm pretty excited to be here today. Yeah. this is a really interesting kind of point in the market for, um, for a consumer. But, um, before we kind of get into that, um, I want to sort of, I want to talk a little bit about men's fashion and, and, and your kind of first foray into building brands and, um, and kind of specifically focusing on men's fashion, which of course, uh, starting a blank label more than, um, 10 years ago.

3:09Um, why talk to me a little bit about how that came about and why you also like pick that category to initially? Yeah, sure. Um, you know, it's, uh, when I started Blink Label, I wanted to be Andy Dunn. Um, and, um, I was like, here's a great looking, well-educated, beautiful head of hair um starting a business in a category that i could be a customer of um what a great role model and i still think that today by the way um and um but yeah in terms of men's fashion it was just like it was a it was a pain point that um i could understand myself like um wore um so yeah i had a custom men's clothing business um i i bought custom clothes we wanted to make it more accessible with the internet instead of this what traditionally was a more studgy, had to go to a men's shop, kind of felt intimidating.

4:15And so, yeah, that was our first business. And what Andy and Bonobos had also shown was that you could build a business of large enterprise value and specifically get a software like or technology like revenue multiple uh and i thought this sounds great uh i could get to a million dollars in revenue and be worth three to five million dollars um and um from tier one vcs from the smartest people in the world um and and i think you know we can take this all the way to the end which is like I was one of a thousand or ten thousand or maybe a million ships that got set sail I think Benobos was found in 2007-2008 and for the following five ten maybe 15 years this idea that you could be a smart person with a relatively easy which isn't to downplay Benobos product but you know it's definitely not rocket science and it's not heavy, heavy IP a smart person could launch a product raise money from the smartest people in the world at revenue multiples and experience a nine figure outcome which Benelma successfully did over three times revenue to Walmart losing tens of millions of dollars a year and what an incredible and inspiring story that's what that was the path that i thought i was on that i could build this uh men's clothing business something that i could be a customer of myself um that and i would be able to exit for a revenue multiple uh and we can get to the chase and tell you that ultimately that didn't happen well when when did you kind of feel and you know i think when vcs i think i want to say And we talk about this a lot, but when VCs were underwriting, as you said, in the early 2010s, late 2000s, maybe mid-2010s as well, that they were viewing these types of businesses, like the DTC brand business, meaning that that was the original channel, as software businesses, even though it wasn't software businesses, these are ultimately inventory-based businesses, right?

6:46and should be valued like inventory-based businesses. It's just a new channel. But I think we got caught up with the distribution and thinking that the distribution was a thing when it's like, okay, these are still product-led businesses. These aren't software businesses. When did your mind, did it kind of switch for you from like that? Because it seemed like from the beginning, like seeing what Bonobos had done and seeing that maybe other brands as well were kind of being thought of as like software businesses and kind of being also invested from like very tech heavy or software focused, you know, VCs.

7:23When did that kind of shift for you and you kind of start feeling that kind of shift that, wait, this is not, this is actually not, maybe we should be actually valuing these businesses differently. Yeah, look, I understand why in the early generations, So let's call it between 2010 and 2015, there was all this capitalization into direct-to-consumer e-commerce businesses. Because if you scrubbed out the names and you said, hey, here's something that feels infinitely scalable, that has 75 to 80 % gross margins and can get to$100 million in revenue within three to five years, I could equally be talking about a software business or an e-commerce business.

8:17and ultimately like the nuance is what makes those two things really really different um but all of those kind of facts could still be true um and but it's all the nuance that you know um and the complexity of the make you know beyond that that makes it not work um to answer your question it's like when so we never reached the scale uh we we never kind of broke out about the scale um and after several years we kind of looked at trying to exit um And when we first went out to market to try to exit, I thought, okay, so here we are, like several million dollars in revenue. We'll just, yeah, cool.

8:57I'll take my 3X off the shelf. Thank you very much. Yeah, you'll pay$20 million. I was just waiting. And then people were like, what are you talking about? And I was like, well, you know, I just want my Binobo's exit, my 3X revenue. you and like it doesn't like like young blood doesn't work like that um and um and that's what i was like oh shoot uh so how does it actually work and um again in our corner the ecosystem in the small to low limit market so let's call it in the like five to thirty million dollar revenue range in the like zero to four or five million dollar EBITDA range like the default is an EBITDA multiple uh that there really isn't revenue multiples in the in the low small and and today even in the mid market um and so then we have to go oh shoot like how do we produce enough ebitda that we can actually get an ebitda multiple because at the time we're kind of ebitda neutral um and that's when you go from playing checkers to playing chess you're playing checkers when you're just focused on net revenue and growing net revenue.

10:14You're playing chess when you're saying, oh shoot, it's not just one line item on my P &L that are you paying attention to. It's all 40 line items, storage fees, credit card processing fees, delivery costs, returns, cost of running all your channels, each G &A line item. And you're like, okay, now I need to like bump all of these things a couple of points, um, to be getting a, you know, 10 to 20 % EBITDA margin to be getting a three to six X EBITDA multiple. And, um, and, um, so yeah, it was a very sad realization when, um, um, I went from an, a revenue multiple well to, um, which is really just a fantasy in my head um to an EBITDA multiple world and like the EBITDA multiple world you know playing chess as you say versus checkers I mean this was also kind of like like traditionally because it's not like you know M &A for consumer brands it's not like this is a new thing right in the past like 20 years it magically happened like this was the traditional model it's just that um because you know d2c brands were were kind of thought of software it was kind of we we only really thought of it as from like a revenue standpoint like that was kind of like the marker that you kind of aim for right um uh but of course from like a gross margin perspective you know pretty different um overall um unless maybe you're like maybe unless you're like beauty and personal care which is which maybe looks actually similar um but um but for the most part um pretty different from like a from like a ghost market perspective and i think that too um and so like it's not like it was like you know a new thing going to the ebita thing about ebita it's just that for like ddc brands it was like oh wait we actually are we are actually maybe closer even though it's you know a different model in that we're actually selling a lot more majority direct rather than wholesale but we actually look a lot more like um in terms of how our our in terms of value, it's a bit more like a wholesale business rather than like a DDC business.

12:24Yeah, no, that's exactly right, Mike. There was a lavish, lavish party for a few years introduced by some very nice investors. They only had the finest champagne and everyone got very drunk. But yeah, you're exactly right. I think that we're maybe at the tail end of coming to that realization that it is very much like it was before. And, but yeah, during this period where there was all this investment that went in and pricing these startups on revenue multiples, everyone just shifted to, oh, that's going to be the way that the world works. And I'm going to be able to get my revenue multiple on the exit.

13:12And I think it's important to distinguish, like, it's one thing having a valuation of revenue multiple from an early stage investor. And it's a whole different thing having an exit on a revenue multiple or having an exit valuation. And the large driving part of that is like early stage investing comes with a bunch of securities, governance and terms. And probably the most important one being preference, liquidation preference, and that they might be investing at a two to three X revenue multiple in terms of ownership, but they also get the downside protection of, they might get one to three times their money out first before anyone else gets paid.

14:00And that's, and that allows to inflate the valuation a little bit because they get the downside protection. But that is not, it's almost apples to oranges versus what your actual exit valuation. Yeah. And I think, and I think, I mean, That's a great point. And I think too, you know, I think sometimes if you're a founder, you might get, you know, excited that, okay, hey, we got maybe less dilution or we have, we raise, when we think about what to negotiate on the term sheet, oh, we're going to negotiate and have our valuation be sky high, right? But really, like, that's really, that's not, But it might not be reality, to your point.

14:46When you actually do exit, it might be lower than that. It might be roughly that. And maybe you've actually achieved a lot more success when it comes to revenue and maybe even EBITDA. But at the same time, you might not get as much money or not nearly as much because of what the actual preference is. And if also they have preferred stock or what have you, there's a lot of other... parts to actually negotiate from there. You shouldn't only be looking at, obviously, what the valuation is, but also what the actual liquidation preference is as well. So that's a great point. Yeah, no, I was just going to reiterate that I think that in today's market, where there's been a lot of compression in pricing, people are paying more attention to the liquidation preference that they had that they probably glossed over um more than ever before so when you when you first started hedgehog was um obviously you already had um your own brand with um blank label but um how are you able to maybe raise um the first round of funding or Or at what point did you have to, or were you kind of self-funding as well through your business when it came to acquiring additional brands?

16:16Yeah, we raised money pretty early on in Hedgehog's life. As you said, we already had a couple of brands in the portfolio. So there was something there already. And then ultimately our investors believed in the strategy that we could go and acquire more brands, produce EBITDA from turning those brands around and grow this platform. We've raised money a couple of times, a couple of times on equity, a couple of times on credit.

16:52And we're kind of being, we're capitalized pretty early on in the hedgehog journey. and and in terms of like targeting you know brands um i know that you know your your website and i think we talked to talked a bit about more um uh talked this uh talked previously about this and also i've heard you talk about other this on their podcast but this kind of messy middle where um maybe it's uh the company's venture backed it's um understood that it's not really going going to receive like venture type returns. But can you talk to me a little bit about the actual, how you identify what quality brands are in terms of what the actual range is?

17:33I'll comment on that question in two different ways. So I think that there's two components to it. One, which is, yeah, I think the messy middle is really, really tough. If you've raised money, which almost certainly means you have liquidation preference and coupled with almost every brand that we see has some credit profile just the proliferation of credit in the last couple of years so you've got the way the capital stack sits you've got the lender who's the most senior you've got the preferred and then you've got the founders or common below that and the way that prices compress so much um there's it's questionable as to who gets value like obviously again the lender being first um and so that becomes a really tough space we have a lot of founders that are working on their businesses for often several years that are now all of a sudden saying like i might be out of the money here i could get an exit but the exit just the way the prices are working are happening at a point that like i wouldn't see anything from this uh and we're seeing that a lot uh that's a really tough tough spot to be in um in terms of like what we look for in a quality business or what we think is a quality business i think um there are a few major components one which is gross margin profile at the top of the pnl like it's um actually i'll start even beyond uh above that which is like revenue quality like is there anything sticky about the revenue uh i mean that's the great thing about software businesses and why software businesses there are at a revenue multiple and at a 10x revenue multiple it's because it's revenue quality is really really high like that is it's like a great software business their revenue is like an investment grade bond like people aren't churning from that uh you are going to get paid um for a consumer discretionary e-commerce business really volatile so like is there any revenue quality is that through subscription repeat um beyond that we're looking at like product margin and then like less cost of delivery so what we think about is true gross margin like we really need true gross margin again net of cost of delivery to be north of 50 points that probably means that you've got product margins landed north of 70 points.

20:04And most businesses we see, and we've seen hundreds of P &Ls, do not have that. They started, because a part of the original D2C promise was you would get, you'd go direct to consumer, and you'd cut out the middleman, and you'd kind of target 50 % product margins. The problem is the 50 % landed product margins It actually gets you around 30%, maybe even 25 % gross margins when you include credit card processing fees, returns, receiving costs, freight costs, storage. And a 25 % gross margin business is almost impossible to make work in e-commerce. So gross margins is really important. And then it's kind of operational complexity.

20:51We see a lot of subscale businesses that are running lots of channels. And I know that Omnichannel is the buzzword of 2022, 23, probably the buzzword of 24 in e-commerce. We actually think that that's really risky. And we actually, the more channels for us in often case, the worse the acquisition opportunity is because that just requires a lot of brainpower, a lot of heads and a lot of marketing support to run. We see$5 million revenue businesses that are on their.com, running Amazon, running marketplace, running retail, running international. And that gets very expensive. All else being equal, we'd much rather that business doing the same velocity just in.com and then leaving the others as upside once you've got more scale.

21:56So there's some of the attributes that we look for.

22:24over a thousand startups and high growth businesses across consumer products, consumer tech, and enterprise. Some of the brands that they've worked with are Liquid Death, Olipop, Hims, Farmer's Dog, Away, MoviePass, and Giphy. Propeller also provides specialized support for fundraising and M &A with transaction advisory services. Propeller's TA team of former investment bankers and investors can step in on more of a project basis when pursuing full-scale financing and M &A. There's a link to Propeller Industries in the show notes if you want to learn more information in your in your mind um let's say d2c is a starting point for a business when do you think it makes sense roughly that actually a d2c channel or a d2c brand should actually expand to additional sales channel yeah i mean look the real answer is hopefully never because D2C is actually a great channel.

23:19If you can be butcher box and do 600 million D2C only, amazing. Orthodic Korean, sure, yeah. If you can do nine figures only direct, it just makes your business much easier to run. I think you're going omnichannel sometimes because you really have to, sometimes because it's like what your product like if you're in a low AOV product if you're in a high shipping cost product direct's probably not a good channel for you uh if you're in like a one-time only purchase with no replan like probably like retail might make more sense than dot com um so yeah I mean I think like we still love e-commerce for all like all of the reasons that the original tech investors loved e-commerce, which is in theory and in its best cases, it is incredibly scalable.

24:25But most products don't tip that. Most products you need to open a second channel, build brand awareness. And I think that obviously it makes sense in a lot of categories where if you can get a partner like Target where you're getting good sell-through and you're not necessarily making great margin on it, but it's developing brand awareness and you're getting replanned at the dot-com from that, then, yeah, again, I think it can make a lot of sense. I think it sets also a lot of brands up to stumble because we've experienced it ourselves. We have a lot of brands that have opened doors and you just don't get the sell through.

25:07And that can get tricky. Well, let's touch on what you said about how the DC channel is scalable. And obviously, this depends what scale means to different people in terms of from a revenue standpoint. But I think a lot of brands are, and a lot of investors are pushing for brands to go more omnichannel because, of course, you have this middleman in meta, Google, and it's becoming a lot more expensive to actually achieve scale. So how, and I know that you're very bullish on the DTC channel that you can kind of reach scale. And of course, you know, we've seen it with ButcherBox. We've seen it with Let it Greens.

25:54There's some great examples of companies that reach scale. But how do you also think in terms of your brands and also when you're analyzing brands, how do you think about like online CAC overall? Yeah. I think they were only so it really needs to have good channel fit and so it's not so much that we think that DTC is better than retail, that's not what I'm saying at all, it's more DTC is more expertise and we look for products that have products and brands that have better channel fit so for us that's largely the best part of D2C is replan. If you can acquire a customer and get them regularly coming back, whether that's through subscription or it's a seasonal replan, that can be a beautiful business.

26:51And arguably, that's really the only D2C business that can really work if you include the meta tax. If you're in a category where it's expensive to acquire a customer because it's hard to explain that you're a low AOV product with high shipping costs with no replan. That's a terrible D2C business. But we've seen a lot of those. And so it's more about product channel fit. And again, our expertise happens to be more in more in dot com. So let's dive into that in terms of what the ideal product channel fit is for DC. Obviously, you've named off a few different attributes that actually make a very good, compelling DC brand, high AOV.

27:53You have to have higher than 50 % gross margins. But where does that fall into specific categories for you that you then find attractive when it comes to that you're able to actually scale, that our companies are able to reach scale in your mind on DTC? Yeah, I mean, I think return and repeat orders, replenishment orders is really where the magic of D2C is. And so what are the categories we see that? This is no secret, but like supplements is obviously a great one. we happen to think that apparel just because most apparel brands you're buying multiple items some kind of seasonality push, colorways, etc I understand that a lot of people don't like apparel because of the high return rate but we think the LTV tail makes up for it, more than makes up for it and but yeah, repeat rate is a really big driver of what we think can make a D2C business work.

29:09How do you also analyze the actual product itself and when it comes to the IP or differentiation? Does that as much matter to you? Or how do you kind of think about that aspect when it comes to building a brand? And as well as, is it a right fit as well too for the D2C channel? Yeah. Look, I think that the age of launching a product that's just a skin on something from Alibaba is probably over.

29:50And today, the product innovation, real product IP is really critical for anyone starting a brand. because we're brand buyers and again our playbook and philosophy at Hedgehog is much more about hey let's make let's turn a growth business that was losing money into a profitable business small but mighty it's like where we've largely already de-risked when we're buying a 10 to 15 million dollar revenue business we've largely de-risked if there is market demand for it And so with that scale, assuming that there is inherent in that demand that there is some IP, of course, we do new product development on top of that.

30:41But yeah, if we were starting a brand today, that product differentiation hotel would be very, very high. Because otherwise, I think any successful brand is going to have 10 copycats in the next year. and barriers to entry continue to get lower to start an e-commerce business. So no, absolutely. I know that you kind of, when we talked about the predicament that some of these founders are in, in that, hey, if my company isn't nearly as valuable as I thought it was, and also like the exit potential out there, I might not see a dime because of course you have, the debt, inventory financing, or marketing spend.

31:30There's a lot of obviously providers out there for both. And of course, you have maybe your VCs or angel investors that maybe have

31:42preferred liquidity preferences. When you acquire a company, um does since i'd imagine a lot of the companies that you acquire um are venture backed um i know like a few of them are um have do the founders make actually any money from from from the acquisitions um uh from when when you acquired yeah um great question look it's um we always try to get the founder something um and it's um You know, we've seen some really bad outcomes where founders have been running their brands for a decade and they have personally guaranteed debt in the business. And not only are you ending with nothing, but you're ending a 10 year journey with a big liability.

32:37And those are kind of the really sad situations. um yeah we always try to get found or something um and it's um but yeah it's a really really compressed environment out there um um hard to get deals done um a lot of brands that are down from last year from the year before um really tough I know we talked a little bit, but like, what in your sense is the kind of market pulse today? I'd imagine that in terms of seeing opportunities, there's more opportunities than ever for like a hedgehog in terms of the acquisition side. But if you can kind of share a little bit about how you think about the market right now in the world of consumer, that'd be great.

33:29Yeah, I think that consumer deals are obviously still happening from both an equity standpoint as well as an exit standpoint. I'd say that what we've noticed and kind of had gleaned from our investor friends and peers is you just need to be a 10 out of 10 brand to be kind of raising money. and that's maybe a little bit different to years in the past where you could have gotten away with being an eight or nine out of ten, maybe even a seven out of ten. But there's just much more scrutiny across all your metrics and so it's just much harder. It's still happening but much, much harder. And so if you're not a 10 out of 10 brand, it's easy to get into this doom loop of, okay, we're not growing, so we should conserve cash.

34:24We should invest less in marketing, which means that we're going to grow even less. So that can be very tricky. But it just means that the bar is much higher. Now, also, exits are obviously still happening. And online commerce is still growing. And there are still the standout outcomes where positive top line growth, positive EBITDA growth. And sometimes you also just catch lightning in a bottle where there's just great product market fit and still strategic transactions happening. But again, I think that we're not going to get the, It will be a long time before we see the Dollar Shave Club Bonobos exits of three to five times revenue multiples of EBITDA losing businesses.

35:24And transactions today are much more, yeah, there's an implied revenue multiple, but there's also significant EBITDA growth. You know, double, like eight figures of EBITDA growing double digits year over year. and those are just incredible businesses that should have their kind of breakfast at premium. Do you think that there's a lot of kind of chatter and I like your kind of your example of, okay, we don't maybe don't have as much capital on hand as we did because we can't, maybe we're not a 10 out of 10 brand. So we need to maybe cut marketing spend. And I guess the goal ultimately then in that kind of realm, if you're kind of not growing at a pace or kind of cutting spend, it's more like a destined to become profitable.

36:16And there's, of course, a lot of chatter around profitability and trying to become profitable and what have you. But do you think that advice really is for the brands that aren't 10 out of 10, the brands that actually aren't able to that aren't able to raise capital? Is that only advice for those brands or is that advice as well for the 10 out of 10 brands? Yeah, I think if you start with the end in mind and realize that you're most likely going to be exiting for any but on multiple, just design your business around that. And it's still possible that someone will pay a rational price if you're growing quickly.

37:05But I think really hard to plan around that, which is what I think most people do. Most people assume that someone's going to pay an irrational price. But if you can be a profitable business that's growing, time is on your side. and you can afford to get lucky. You can afford for someone to come along and pay an irrational price. You can afford to have a tailwind where you have an amazing 18 to 24 months that will give you a really big exit premium because of your growth velocity.