LONDON, United Kingdom — After the dramatic burst of the technology bubble in the Spring of 2000, venture capitalists steered clear of e-commerce companies, along with most other 'dot-com' businesses, for many years. Particularly frightening was the spectacular failure of Boo.com, which burned through $135 million of funding in just 18 months.
In fact, so sceptical were investors that when Natalie Massenet sought funding in the early years of Net-a-Porter, a business which was already showing early signs of promise, she was unable to raise money from traditional venture capitalists and instead turned to friends and family.
What a difference a decade makes. In 2010, Net-a-Porter was sold to Swiss luxury group Richemont for over $500 million. Just last week, following a 37 percent rise in revenues, fashion e-tailer Asos reached a record market value of $4.16 billion on London’s AIM exchange. Perhaps it's not surprising, then, that venture interest in fashion-tech is now booming.
Over the past few years, large sums of capital have been pouring into young fashion-tech companies like Moda Operandi ($46 million), Nasty Gal ($49 million), ShoeDazzle ($66 million), BeachMint ($75 million) and Gilt Groupe ($236 million). In the last month alone, Farfetch raised another $20 million, while Rent the Runway closed a $24.4 million round, both with the participation of powerhouse publisher Condé Nast, bringing the total amount of financing that investors have committed to fashion-tech companies since the start of the year to over $150 million — all at sky-high high valuations. By comparison, Net-a-Porter raised just under $10 million dollars in total.
And, while some companies are successfully raising more money, others appear to be stalling. When Gilt Groupe raised its last round, the company, which only recently crossed over into profitability, was valued at over $1 billion. But the company has since laid off a substantial number of staff and shut down several business units. Indeed, it's still unclear whether the company will go public this year, a stated goal of the company's chairman Kevin Ryan.
London-based Luxup abruptly ceased trading at the start of the month and has reportedly liquidated its operations in Hong Kong and London. BeachMint is struggling. Styleowner appears to have stalled. Lookk.com has shuttered. FashionStake was absorbed into Fab.com. And the list goes on.
Indeed, with the exception of Net-a-Porter and Asos, there have been very few big exits. Yet the money keeps coming. Are we in the midst of a fashion-tech bubble?
"Yes, too many companies don’t have a business model and don’t understand this industry," Lawrence Lenihan, managing director of FirstMark Capital, an investor in Pinterest, Ahalife and Sneakpeeq, told BoF. "We have to stop backing stupid, business school whiteboard businesses that are ignorant of the industry and lack heart, soul and beauty. Moreover, companies that have gotten some degree of success have been so overcapitalised and their ultimate returns so overestimated that those investments will never create a return and will detract from the returns that founders and early shareholders should have gotten,” added Lenihan.
Many investors also lack a deep understanding of the fashion market. “I wouldn't say there's a bubble, but I do think a lot of funding has gone into businesses that haven't been well understood by investors. As a former VC, I know how hard it is to operate across multiple verticals," said Chris Morton, founder of fashion curation platform Lyst and a former associate at Balderton Capital (formerly Benchmark Europe). "When we were raising our seed round, some well-respected tech investors kept drawing comparisons between Lyst and online travel platforms," he continued. "They didn't really grasp the fundamental differences between buying a sweater and a plane ticket.”
Others are more sanguine. "There is no fashion-tech bubble. The fashion industry needs more tech investment, not less," said Robin Klein, venture partner at Index Ventures and non-executive director of Farfetch. "Some substantial fashion tech companies have been built, demonstrating the value that can be created online; companies like Asos, Net-a-Porter, Nasty Gal and Farfetch [all of which have been backed by Index at the venture or growth capital stages]. Valuations may seem high, but all of these companies are growing extremely fast. Asos sales are up 37 percent — which high street store can claim that? There are a lot of new tech fashion start-ups that aren’t going to succeed. But that's true of all venture [investments]."
Still, winning exits have been few. "Many companies have been funded; not all of them will succeed," said Frédéric Court, general partner of Advent Venture Partners, lead investor in Farfetch. "The number of exits has been limited. Apart from Net-a-Porter and Asos, both of which never raised venture capital, we have not seen big exits in the fashion-tech space, except a few local flash sales companies like Hautelook (sold to Nordstrom) or Brands4Friends (sold to eBay)," he continued. "The lack of exits combined with the vast number of very early-stage start-ups in the space will generate many failures in the short-term," he predicted. "But this is the natural Darwinian process of the start-up world. Refinancing in the space will be hard in the short-term and the 'bubble' will deflate… until it comes back!"
So what separates winning investments from those that will fail?
"The companies that win are the ones that develop innovative business models that provide long-term value to both its consumers and the brands it works with. This may sound obvious, but I don't think it's always appreciated," said Morton. Indeed, there's simply not enough demand to support the masses of new fashion e-commerce companies that have launched in recent years. Only those with a clear point of view and a compelling, scalable and defensible business model stand a chance at long-term success.
"First and foremost, successful businesses need a clear revenue stream and a value proposition beyond price, value and service," said Rachel Shechtman, founder of innovative retail concept store Story and an entrepreneur immersed in New York's fashion-tech scene. "They also tend to tap into existing consumer behaviour or familiar tendencies, rather than introducing new ones."
As for the kinds of business models that are most likely to deliver returns, "number one, companies that make things — brands!" said Lenihan. "Number two, companies that help companies that make things reach and service their customers. And, number three, infrastructure that enables companies to understand and reach their customers better, no matter where in the world they exist."
Court agrees: "My favourite newcomers are online brands and marketplaces. Take Nasty Gal for instance. Here is a digital-driven fashion brand that is selling affordable clothing direct, at gross margins probably well over 60 percent, without fixed retail costs and with a very low acquisition costs thanks to a superb use of social media. Another favourite is Farfetch — in which I am also an investor — which is building a global fashion and luxury e-tailer with no inventory, global reach and a uniquely curated and broad product offering."
"Importantly, a key feature of all these winners is an exceptional entrepreneur at the helm, with a vision and the ambition to build a large, differentiated business," added Court. Klein concurs: "Generally our approach is to invest in people first, and markets and models second. In fashion, we’ve found that entrepreneurs with an especially deep knowledge of the industry, particularly at the luxury end, seem to do very well.”
However, certain business models are not holding up to venture capitalists' expectations.
"The companies that will find it hard to survive are those that have relied on cheap money to fund customer acquisitions expensively," concluded Mr Court. "As an example, I am thinking of a number of subscription-based start-ups that have raised significant capital to invest aggressively on marketing, essentially on inflated 'life time value' assumptions. These companies will have to adapt, pivot or die," he added, referring to companies like BeachMint. "Another example is the vast number of companies that rely on user-generated content and want to build businesses as affiliates to e-tailers. This model only works at massive scale, like Polyvore, and many small sites will not make it."
"I do feel there is a fashion-tech bubble," Carmen Busquets told BoF, while adding that there are still opportunities to make meaningful returns. "I feel the companies that will deliver the best returns have a good team with a track record in the industry. It's a perfect time to incubate concepts with the right founder and team, but I recommend making small investments and negotiating a board seat. And if it works you have the opportunity to keep investing, control the board and really work together with the founders. That way, you can still make ten, fifteen or twenty times your money in seven to ten years," she advised.
Ms. Busquets would know. She was the founding investor in Net-a-Porter, and amongst the first professional investors to see the value in online luxury e-commerce more than a decade ago after the first bubble had already burst and before venture capitalists poured money into the space.
"The other winning formula is investing in companies that have already proven themselves," she added. "The valuation will be high, but they are already making a profit, or at least breaking even, and they need money for expansion. This way, you can still make three to six times your money in five years, which is not bad either."
Editor’s Note: This article was revised on 25 March, 2013. An earlier version of this article misstated the name of the German flash sales start-up that was acquired by eBay in 2011. It is Brands4Friends not Brands4You.
Disclosure: Index Ventures, Frederic Court, Carmen Busquets and Lawrence Lenihan are all part of a consortium of investors which has a minority stake in The Business of Fashion.