Fourth Quarter Finance Review: Has “Carnage in Consumer” Hit Bottom?

In good times, a rising tide lifts all boats – but right now, the hunt is on for seaworthy vessels, according to investors.

Otherwise, judging by the last quarter of the year, it’s clear that the financial doldrums are going to stay for a while for brands: fewer M&A transactions by big food companies and fewer limited partners wanting to invest in consumer funds means that there’s less money to go around, and it’s going to fewer brands.

“Because of a lot of the carnage in consumer, LP capital has been tough to come by, and that flows downhill,” notes Encore Consumer Capital Managing Director Robert Brown.

Consumer funds continue to experience those doldrums, the result of a shift into the public markets that took place as fund allocators – think pension funds and other big pools of managed capital – had to rebalance their portfolios in the wake of stock market dips a couple of years ago. There are fewer new funds, and existing ones have been slower to close, investors report.

“Many of the same things that we’ve seen happening for companies, are happening for funds as well,” said John Burns, founder of Relentless Consumer Partners and a long-time investor in consumer brands.

Because capital has been slow to flow to those funds, compressing deal flow, brands that once had outsize valuations have faced the prospect of the dreaded “down round,” – although existing investors often block those potential deals because they don’t want to accept a loss in their own portfolio valuations.

How bad has it gotten?

“This has been the worst two years of capital funding in this industry that I can remember in more than 20 years of covering it,” said Nick McCoy, Managing Director at investment bank Whipstitch Capital.

Indeed, investment frequency and capital have both dropped immensely in just two years. Consumer investment tracking service FABID recorded less than half the deal activity in the 4th quarter of 2023 – about 50 – compared to the the 4th quarter of 2021, which saw about 110 (FABID represents a snapshot of publicly reported deals, looking at regulatory filings, press releases, and other sources). In fact, more deals were done in the 4th quarter of 2021 than the last two quarters of 2023 combined.

As a result, many brands that needed capital to ‘extend the runway’ to profitability haven’t been able to find enough to keep going. In recent weeks, several companies – Bro Dough, Ocho, Rowdy Energy, and Trimino have publicly announced they were going out of business. Others, like Rhythm Superfoods, filed for bankruptcy, while brands like Beanfields and Tessamae’s sold after having experienced major economic difficulty.

“Without wanting to sound too much like a downer, a lot of the transactions we saw late last year were out of desperation, not out of growth or opportunity,” said Ben Brachot, the Managing Director at Dwight Funding, which provides growth financing to brands in the form of asset-based loans. “There are just too many companies that can’t necessarily survive on their own.”

Many of the funds and their investors come into food and beverage looking for the returns that come from selling brands to “Big Food” strategics like Coke, Pepsi, General Mills, and others. But those companies have actually started to move away from some of their previous investments as of late, either shutting down acquired brands or slicing them off for sale.

“The exit market has really dried up,” Burns said.

Investors point to two reasons for the decline in M&A. First, their profits and share prices were up, because the pandemic led many publicly traded companies to lean on distribution advantages and shift the focus to a streamlined set of products in order to get them into stores, while the inflationary trend of the past two years allowed them to raise prices.

Second, the kinds of companies that Big Food brands were purchasing weren’t great fits. Take Coke, which shut down both Honest Tea and Zico, and has been pilloried for its inability to sustain growth at Body Armor and Glaceau. Or PepsiCo, which has largely moved to onboarding through distribution, and actually only bought Rockstar in order to clear up space for other distribution partnerships. Mars has tinkered with KIND, while Kellogg has seen RX Bar stall and Hershey hasn’t made hay with any of its snacking pickups, from Krave to Barkthins to ONE bar.

Strategics are still eyeing brands, but they’re looking for larger companies, with larger followings and lower risk. Potential growth is secondary to margins that are sustainable even after the transaction and scale that a strategic can bring. That’s led investors to slow down their own push, and look for brands that are focused on similar goals.

“Good teams continue to attract investors,” notes Liz Myslik, Managing Director at VC firm Loft Partners. “There’s still competitive bidding for those brands that really offer a highly differentiated product offering – one that is really valued to consumers at a price that is compelling, and a margin that allows them to have a sustainable business. Those elements continue to be in high demand, and innovation will always drive value, growth, and investment.”

At CAVU, like many other consumer funds, the eyes of the fund managers have wandered over to makeup, body care, even pet care (where both General Mills and Mars have been buying growing brands). That shift started to happen as interest in food and beverage M&A hit a frenzy, in late 2019 and 2020. It capped a decade-plus in which deep-pocketed tech and crypto investors looked at food and beverage as a place to diversity, without necessarily understanding the dynamics of a business that doesn’t have the “infinite scalability” of software as a service.

During the second decade of the 2000s up until about 2021, according to CAVU’s Brett Thomas, “From allocators to investors to brands, they were all living in a euphoric world with valuations. Behavior had to change, and there’s no better teacher than when things don’t go right.”

One other element to the Gold Rush of the previous decade was the low interest rate environment, investors say. That left funds able to leverage their existing cash with cheap capital, and let strategics borrow for less to fund acquisitions. As the Federal Reserve Bank has raised interest rates in an effort to fight inflation, it has also cut that source of cheap cash for private equity. Meanwhile, it’s also made basic lending harder to come by for brands, who face higher interest rates on loans – if they can even get them.

In recent months, inflation has started to stabilize, and the Fed has started to discuss rate cuts – although they remain in the hazy future. As a result, the stock market has skyrocketed. At some point, investors say, the same rebalancing that caused allocators to retreat from VC and Private Equity might bring them back, but maybe with a little more rationality from the investors and the brands, governed by the discipline now demanded by big company shareholders.

“A lot of the tourists have gone home,” Myslik said. “The market is normalizing again. The upside for brands of having stabilization of the investment environment means you’re selecting from a group of partners who have the expertise to help you grow your business.”

Meanwhile, expect the lean times that extended through the last quarter to continue at least until later this year. Nick Giannuzzi, a co- founder of Humble Growth, one of the few new funds in the consumer space that opened last year, is also one of the best-known service providers to the industry. He said he’s looking for a turnaround later in 2024, but that may not be soon enough.

“Just the Fed holding rates even is a good sign. I know dropping it will stimulate M&A,” he said, adding, “Even though the tides are coming back in, a lot of these companies aren’t going to get help.”