What Led Larry Cheng To Invest Early in Chewy, Chamberlain Coffee & US Mobile

0:00They don't want to bring on capital to help scale their business when that capital loses money 70 % high. You're running your balance sheet to zero every single month. That's a stressful way to live. That was the largest e-commerce acquisition in history when we sold it. But when we first invested in it, we were the only in-person meeting that they had. The 80 % gross margin, highly recurring SaaS. The problem with reality is it works both ways. Our default philosophy is the opposite of the valley. It's not discipline, just our DNA. If you're successful, you will have a investment that might return more than everything else you've done combined.

0:33I'm Mike Gelb, and this is Consumer VC, where we break down what it takes to invest in and build scalable consumer brands and technology businesses. I know I sound like a broken record, but if you're enjoying this show, hit that subscribe button on whichever platform you're listening to the show on, whether that's YouTube, Spotify, or Apple, or a different platform. Also, sign up and check out the newsletter at theconsumervc.com. You'll get a weekly roundup of all the latest fundraisers, product launches, and just general consumer news. Also, you'll get new podcast episodes straight to your inbox.

1:07Please know that when you subscribe, you're helping us make more of this content. And I really do appreciate that. Our guest today is Larry Chang, who is one of the managing partners of Volition Capital. Volition Capital is a growth equity firm established in 2010 that focuses on investing in high growth, founder-owned technology businesses. Some of their investments include Chewy, if you've ever heard of it, or Chamberlain Coffee, Burst, and Grove Collaborative. Typically, they are the first outside check in the company, and they're currently investing out of Fund 5, which is a$675 million fund.

1:42In this episode, we break down their fund, their current fund, the stage, how they think about growth equity investing today, capital efficient businesses, which is a must-have for them in order to invest and a whole lot more. Without further ado, here's Larry. Thanks so much for being here. Thanks for coming on the show. How are you? I'm doing great, Mike. Good to talk to you. So great to talk to you. Let's start from the very beginning, at least in the beginning of Volition Capital's journey. What was missing from the market? Why did it make sense to start Volition Capital from the beginning?

2:12Yeah, I think the market for growth equity was nascent. So there's probably three segments of private equity. I think broadly sort of venture capital, growth equity being in the middle and leverage buyout being on a larger end. And growth equity, when I say that, it's talking about investing in companies that have revenue, customer traction, but have not taken the traditional venture path. They've kind of bootstrapped their way or been very capital efficient about getting to some level of scale and product market fit. So figure our sweet spot might be 10, 15, 20 million of revenue growing 100%, but having done that without institutional VC.

2:45And there is a founder out there who has bootstrapped this company. They own most, if not all of the business. They never raised institutional money. And what they don't want to do is they don't want to bring on capital to help scale their business when that capital loses money 70 % of the time, which is the venture capital model, which is you swing big, you lose 70 % of the time, but your big home run makes up for everything. That's not great for the founder whose entire net worth is in that business. It's captured in there, yeah. Yeah, so we talked to our founders about helping them achieve their dreams without risking them and helping them to scale to many times the size because every day they're running the largest business they've ever run.

3:26And so we kind of fit in that zone for a capital efficient founder who, after achieving some product market fit and revenue scale, is looking for that first media institutional round and a good partner to help them scale the business. Do you find, because those stats have to be pretty impressive in order for you all to take interest in a company, right? In that they have to grow year over year over what, like that like 50, 80 percent. Is that right? At least. Yeah, I would say the median growth rate is about 80, 90 percent at the time that we invest year over year. Okay, got it. So, I mean, I'd imagine that these founders, just because they're growing at such a great pace, probably earlier before you all stepped in, which I think the minimum threshold for you all is about$5 million in revenue, if that's right.

4:09Probably they might have already have had offers potentially from VCs just because their companies were kind of performing so well. What tends to be the reason why they actually reject traditional institutional capital at those stages then before where it makes sense for you all to get involved as they've kind of achieved that $5 million threshold? Yeah. So let me put this into two buckets. So the one bucket is what you characterized correctly. They had offers, they had interest, but they didn't take it and they scaled to 5 million plus. The other bucket is they just kept their heads down and they weren't engaged in the capital markets.

4:45And I would say that for a lot of folks, they underappreciate how large that second bucket is. It's the founder who's not in a venture hub, who's never raised institutional venture capital, who saw some problem and decide to sort of build this business on their credit cards and a couple of early customers and scale it. And they were heads down and they weren't looking for capital and they're not connected to the capital markets. And so I would just say there's a good chunk of folks that are in that bucket, that second bucket. And the reason they haven't taken capital is because they're not wired to take capital, they're focused on customers rather than capital.

5:23In the first bucket where they scaled is, I mean, I actually think it's a highly crudent thing to do, to take capital early in a business, pre-product, all the multiple rounds of seed and so forth, you're going to give up a lot of ownership for those dollars. And if there's a way to bring on customers rather than take that seed around, you might have to save 20 % of your cap table, right? And every time you do that, we save on that dilution. So that's another reason why they're just wired to build the business more prudently rather than outside capital right out of the gate. So, but how would you then engage in those types of, in that second bucket, how then do you engage with those types of companies?

6:03Because if they're not interested in capital, they maybe had offers, but just decided not to engage. That's just not them. They would prefer to bootstrap. Why then would they even take your calls? Yeah, well, some do, some don't, to be fair. We reach out. We have analysts and associates and a team of folks here that we recruit early in their careers to reach out to companies. and they're reaching out to thousands of companies every single week. And so to be fair, there's a number of companies that simply will not take capital and never. They're totally committed to bootstrapping. God bless them.

6:43We're totally supportive of that. But for others, you get to a certain scale and you're running your balance sheet to zero every single month. And that's a stressful way to live. And then your entire net worth is also in this business, which is totally concentrated. So it's another stressful way to live. And they realized, you know what, if I took a little bit of capital, it would give me the chance to invest in the business and to scale, to have a larger outcome. Sometimes there's secondary involved in these transactions where we give the founder some liquidity. And both of those can kind of hit the release valve a little bit to help the company scale more quickly, especially if you're working with a partner who has the experience to help you scale.

7:23So it's probably a combination of those things. Are these then, since they decided not to take institutional capital, in the kind of first innings, maybe pre-revenue or pre-seed, let's call it, that they decided to bootstrap. how do valuations then in this age of your investing, is it typically, is the founder in a lot more of the driver's seat when it comes to what the valuation is? Is it not as great for the investors, for capital advocators like Volition, just because they bootstrapped themselves? Obviously, running your balance sheet to zero every month, that's extremely hard to do. So there might be also leverage on your side as well, Volition Capital.

8:08But walk me through how you you think about valuations at your current stage? Yeah. So, I mean, it's a range because there's some companies that all the growth equity firms know about and all the venture firms know about, and everyone's competing, and it's in the hottest sector, and that's going to be priced really high. But then there's definitely companies on the other end of the spectrum where we're the first investor they've ever talked to and they've ever met. And maybe they're in a sector or a geography or a business model that is not hot. But they've built a really nice business. And some of our biggest home runs have come in that zone of, while the business is performing well, there's something about it that the market doesn't love.

8:50And for example, Chewy was one of our best outcomes, our best investments, a pet-to-e-commerce business. And you might find this surprising because that was the largest e-commerce acquisition in history when we sold it. But when we first invested in it, we were the only in-person meeting that they had. And it was not out of lack of effort from their side to raise capital. It was, but why? Why would a company that grew from when we invested 70 million to a multi-billion in revenue have no interest at the beginning? Well, it's because it's a low gross margin business and it's in the pet food category, which had failed miserably in the dot-com bust.

9:29And so that was something that scared everyone away. So, you know, we're not looking to check every single box, we're willing to take some risk on certain things and be contrarian within our focus area. And sometimes that leads us to less competitive opportunities, where at this stage, we would value them usually on some sort of revenue multiple or if they have some sort of revenue multiple. How do you think about margin? I mean, because Chewy's pet retailer, retailer, yes, very, very skim, slim margins, very, very tough businesses overall, right? And then, of course, you have the dream SaaS businesses, right?

10:06Where the margins are 70%, 80%. These are kind of the darlings of venture, if I may say. How do you think about margin as part of, obviously, the profile of a company that you might find interesting? Yeah, so that's a great point. I would say at a highest level, we are margin agnostic. But if you were lower margin business, you have to scale to be much larger, obviously. But that highlights a point that everyone in Growth Equity would love, including us, the 80 % gross margin, highly recurring SaaS business that churns no customers, upsells 20 % every year with 120 % net retention. Everyone would want that.

10:49And so do we. But there are great businesses that are considered low gross margin. When we invested in Chewy, its gross margins were 15%. That took them out of like 98 % of funders. And so we understand how to make money at a 15 % gross margin business. And we certainly know how to make money on a 90 % gross margin business. and you have to think about scale and market size relative to absolute gross margin dollars available for that company. How do you also balance just from a margin perspective? I mean, Chewy's is probably, I would imagine like the thinnest margin maybe that you've maybe invested in just because it's a retailer, but just also thinking about even physical products that you invested in like Chamberlain and also Burst, which those are, just because through the nature of being physical products, there's always margin.

11:41There's always gonna be probably less margin there. I know that I'm generalizing here, but probably less margin than like your typical kind of pure software company. How do you balance that in your portfolio? Because and also in terms of outcome, because product businesses like I'm just saying about Chamberlain and also Burst, they typically aren't, you know, winner take all as well. Businesses too. I mean, they're also pretty competitive. I mean, I'm just thinking coffee is just I can't imagine how competitive coffee is, to be honest with you. uh and then um and then also electric toothbrushes and also electric um i mean it's funny even i mean electric toothbrush is just thinking about it it seems like there's only like a few handful of players maybe that's just from my consumer perspective what i see at costco but um but it doesn't seem like there's a lot of kind of it it doesn't seem as much fragmented that's what i'm trying to say uh but i could be wrong about that how do you balance this though that's the physical products where the economics look quite different to software?

12:46So the dynamic with consumer, particularly consumer product businesses, if you're in the zone of like a sub 50 % gross margin business, obviously that's something that absent very super strong SaaS-like retention, you're working with a smaller LTV. And so your acquisition economics and your acquisition strategy from a customer perspective needs to not be as reliant on paid acquisition because then those acquisition economics through Facebook, Meta, Google, whatever, if those change, that can screw up your entire unit economics of the business. And so we tend to look for companies that have more, I would say, alternate approaches towards acquisition.

13:31Burst being their affiliate channel is they work with dental hygienists. That's still the driver of their business where dental hygienists are the ones that are kind of repping Burst's products, both online and in the office. You have companies that rely more on a complete referral, like Super 73 when we invested, their primary acquisition source was literally either current customers telling their friends or literally prospects stopping a customer on the street, this is an e-bike business, by the way, and say, hey, that bike's amazing. And that was the channel. So we call that K factor. It's a viral coefficient and where you can see combined sort of virality with a lower margin profile, that math can work.

14:23So if you have an edge in customer acquisition, like thinking about Chamberlain Coffee, for example, who Emma has a very big edge when it comes to customer acquisition. Does the product actually need to taste good? Does the product actually need to be incredible if you have such a great edge when it comes to customer acquisition? Ironically, yes, we learned that through Chamberlain Coffee. At Chamberlain, we launched a product, a ready-to-drink product in Walmart and very early in the company's life. And it was a very healthy, ready to drink coffee. And it was almost too healthy. And so people flooded into Walmart because of Emma's influence, obviously, and visibility.

15:14But they didn't love the product. And I would say it was a product that was more geared in hindsight towards a sort of a natural grocery channel. and so we moderated the product and remodged into walmart and um and that helped so you yeah you you the the the problem with morality is it works both ways and if the product's not good that's going to work against you well i mean like talk to me a little bit about even even chamberlain or or or even another example talk to me a little bit about the about the diligence side and it'd be separating the product itself when it comes to the edge when it comes to customer acquisition.

15:57How do you think about both sides of it when you're actually thinking about making a consumer investment? Probably two buckets again. One is your paid acquisition strategy. How diversified is it? How consistent are the economics? How have economics changed as you've scaled? So a great portfolio in that first bucket would be three, four, five channels. It's Facebook, Google, influencers, TikTok, social, whatever. You know, you have a mix. You see consistency in acquisition, a CAC in acquisition economics as the company has scaled. And it's not spiking all over the place. So there's consistency and diversification there.

16:42And then in the second bucket, it's referral, a very strong referral base. and brand. So those dynamics, that's something we diligence through customer survey work. We literally ask customers. We ask them, how many times have you referred this? How many customers have you brought in? We survey prospects. We say, hey, does this seem like a fit for you? Would you buy? How often would you buy? And so forth. So there's diligence on both ends of that just to understand whether this product has really found a scene and how viral that scene will be. do you have to like a product in order to invest in it oh me personally um no i i don't drink coffee so or anything not just not just coffee it could be it could be anything it could be anything no it doesn't i i care more about what the customers say and um and and so yeah as much as i like i think the entire world is looks exactly like me i i know that's not the case how um how do you think about and what should be your definition of capital efficiency i know that when i was kind of reviewing and and and thinking about what would be great great great kind of points or or or topics to um uh to to ask you about one of the kind of um seems like cornerstones of volition capital is really about capital efficiency and that's one of your kind of criterias in order for for you all to make an investment or not make an investment how do you about capital efficiency when it comes to companies that you're sourcing and that you're looking at?

18:15And then how do you think about capital efficiency as well once you're actually in the trenches and you've already been post-investment? Yeah. So pre-investment, we define capital efficiency. I mean, the umbrella is you really haven't raised your first institutional round, large institutional round. So most of our Most of our companies have raised, I would say, less than$10 million because then you get into the institutional wealth. Are they profitable then just because they haven't raised from institutional? Many of them are, but some of them are not. They've raised a seed around. They've raised friends and family.

18:52Seem like I did millions of dollars. They're not burning a lot. So a high majority are sub-10, and a good chunk of those have raised almost nothing. And so they would have to be profitable. Of course, there are businesses that have gone, there are SaaS businesses that have gone to 50 million of ARR. If you do that on 15 million of capital raised and 8 million consumed, that's capital efficient for SaaS for sure. So obviously, there's some variability in how we think about it depending on the business scale. Post-investment, capital efficiency is really at the highest level using your dollars accretively.

19:28repeatably. It's not that we don't want to invest and it's not that we're unwilling to run a business with losses. It's just that that investment has to be tied to strong unit economics, strong lifetime value, strong retention, those types of things. And our default philosophy is the opposite of the valley, which is you take our investment and it's not like our default is to raise the series B, C, D, E, and F. The default is make the business work on the round that you have raised, don't put yourself in a scenario where you need to raise a defensive financing because you're running out of cash.

20:04But if the company has warranted it, you raise additional capital because it's a creative. So what you'll see in our portfolio is a bifurcation where a good chunk, two thirds, 70 % of the portfolio, the total capital raised will stay very close to the initial capital from our investment. Wow. And then for 20 or 30 % of the portfolio, we think they've earned it. and they might raise 100 or 200, you know, significant dollars thereafter. And just to be clear, both are going for it, but one is doing it with capital and one is doing it without it. And so that's... Yeah, no, that makes sense. I'd imagine for, I guess it depends on the consumer, but in the consumer business, I'd imagine that if it's a physical product business, I'd imagine it probably leads into maybe being the first and last capital from Volition Capital, that it's not as much the like raising 200, 300 million, maybe I'm wrong there.

21:02Yeah, like it's, we are, I think most of our businesses have, as I mentioned, stay very close to that first round, that round of investment that we've made. And certainly when I think about our consumer businesses and our SaaS business, I can't say that there's a huge distinction between which ones raise capital and which ones don't. Sector-wise, it's just that if the economics or a creative, we know how to scale capital into those and if the market is there and so forth. But you can build highly valuable businesses by just compounding a business capital efficiently and let time be your friend.

21:39I know that you mentioned on the sourcing side, it's a lot of kind of outreach. You have your whole team outreaching the companies, you know, thousands of companies a day. Do you get inbound? Do you ever like, I'm just thinking just because, I mean, I imagine you get inbound, but in terms of the actual companies that you actually go on and make an investment in. Since you're growing at that rate, I'd imagine you are maybe less likely to get inbound from these types of companies. But I'm just kind of curious in terms of what the ratio is when it comes to outbound and inbound as looking at not maybe total number of companies, but looking at companies that you actually invested in.

22:15I would say that over 90 % of the companies we invest in are not just outbound. They are outbound outreach from an analyst or an associate. Sometimes I might reach out to a company or I come across a company. And so there's a small, small percentage that's inbound. And in those cases, there might be sort of an inbound investment banker that's working with them. But most of them are analyst associate outreach. And what's a typical... I know the kind of starter is at least$5 million, I would say, that they have to have in revenue. What's typically the amount that you deploy initially per company?

23:03I would say in that, call it$20,$25 million, is probably middle of the zone. These days, as we've gotten a little bit larger, it might move up in the 30s. But I would say our range is sort of 15 to 50 is pretty covered most of it. Have you found that this strategy has been a lot? Well, I guess I should just back up and just ask, what's your opinion of this current market as compared to maybe the Zerp years? has it been easier, I would say, to get into companies or has it been a much more investor-friendly market for you? Or I'd just love to hear about how deals come together now versus in that era.

23:56I would say, I'm not going to say it's easy. It's never super easy. But yeah, in the low interest rate environment in the years that we've come out of, what you had was tons of capital in the private equity markets, tons of capital in the venture markets. And so everything was, many things were getting priced up. And what has happened in the last few years is the largest funds who paid the highest prices have now seen those portfolio values retrench. And their capacity to raise capital also retrench. And also LPs aren't getting as much distributions because there's not an IPO market. M &A is softer.

24:39And so money's not going back, which makes capital raising even harder. So there's been a softening of fundraising. And that brings everything into more moderate zone. So in that sense, it's easier to guide companies to be capital efficient. It almost seemed hyper conservative five years ago. And I would say the top end of the market has come down. like your top SaaS companies four, three, four, five years ago, they might raise it 50 to 100 times ARR. Those are not happening anymore, at least to my knowledge. And so that has sort of retranced into a normal zone. But deals are still competitive and there are certainly still companies that we see like a 5, 6, 7, 8, 9, 10 term fees.

25:27Yeah, that makes sense. how during the zero interest rate environment where it seems like deals were just flying high. I remember talking to one investor who says, I just can't keep up. Like these founders want term sheets and like a week long turnaround and they already have other offers. It's like totally, totally bonkers. With your strategy of capital efficiency and then predominantly companies that don't have institutional capital that have raised earlier rounds, which I'd imagine the types of companies that you look at actually probably, I would think, had offers. I know that, as you said, there are two buckets of different companies, but if you're going at that rate, I mean, that's been, and with the market as hot it was, I mean, I'd imagine a lot of venture firms might be interested.

26:19But talk to me a little bit about how you're able to, with the strategy, maybe survive the zero interest market rate? Because it seems like your strategy in terms of the capital efficiency, it all sounds like what a lot of venture is kind of preaching out today, but wasn't really... And maybe they were preaching out it then, back in 2018 to 2021, but maybe weren't acting, maybe kind of not walking the walk. But during that time, how were you able to stay disciplined? it? You know, it's not discipline. It's who we are. So it's just our DNA. Here's a simple piece of math for you. If you take a business and you invest in it, and that business compounds by 40 % a year for five years, then you've generated a 5x outcome.

27:10That presumes there's no dilution and there's no change in multiple between entry and exit. And so I would say about a third of our historical outcomes realize X that's happened north of 5X, which is a very good return. And so we view capital efficiency as a way to not just protect returns and protect the value accruing to shareholders, including the founders, but to create value. because taking tons and tons of dilution and raising a large and lots of preferred stock can be a way to actually lose value. And so we don't view it as an outright good. In the Zerp environment, yes, our capital efficiency mantra sometimes was not a great fit for certain sectors and types of founders.

28:00And no harm, no foul. If a founder wanted to go down that route, we wouldn't be joining them for it. and we're not a huge fan of like press releases for financings. What does that even mean? Like that just means you took the loose thing. So we just had to find the right founders that mixed with our strategy and that was the secret sauce. You mentioned how part, well, one of your biggest wins with Chewy, how that part of how that kind of came about was because there were, it was a sector that was not interesting to the market. It was kind of an unsexy sector with pet and also retailer, which is funny.

28:49I went to the Global Pet Expo a couple of weeks ago, and oh my gosh, it's just littered, no pun intended, which is incredible, incredible brands and some really cool innovation that's happening. And it's interesting now that, you know, 10 plus years ago, how that was not kind of interesting or sexy at that time, which now it's just really, really kind of changes tune. But what would you say right now are kind of the unsexy markets or sectors for VC that you're seeing? How about consumer products? Yes. It's the most unsexy place. It's extremely hard. You know, I'll just, I'll walk through some of our companies that were unsexy at the time.