At the beginning of every due diligence process I conducted while working in private equity (and at CircleUp, an equity based crowdfunding site), we would compile a data request for the target company—that is, a list of the 10 to 20 pieces of (generally) quantitative information that, if fully answered, helped us feel much more comfortable about the business diligence. The operative word being if, as I cannot recall an instance where a company was ever able to fulfill our data request.
From the company’s point of view, I completely understand this—your job as an entrepreneur is to sell more products; time spent filling onerous investor data requests is time taken away from growing the value of your business. However, while some data requests can be excessive, there are three pieces of data that every CPG entrepreneur should have at her fingertips at all times:
Gross margin, which is your gross profit/net sales, is a measure of how much money your company has left over after all the fixed and variable costs of production (e.g. material costs, production labor, fixed plant overhead, etc.) are subtracted from your net sales. In a branded CPG company, these dollars are absolutely essential because gross profit is what you have left to invest in your brand-new packaging, couponing programs, that awesome spokesperson you want.
If you don't have gross profit, you simply cannot invest in brand-building activities. And if brand is the most important thing for a successful CPG, no gross profit = no success.
Razor-thin gross margins just don't leave much room for error either. For example, if a company has $10 million in revenue and 20 percent gross margins and its COGS (previously $8 million) increase 30 percent, it would go from $2 million in gross profit to losing $400,000. As an investor who knows your company will need gross profit dollars to invest in brand-building activities, gross margins so thin that a 30 percent swing in COGS puts the company underwater just doesn’t meet my sniff test. If you are asked about your gross margin and you turn to your accountant or CFO, that’s a very bad sign.
Same-store sales growth
One of the most attractive things about the CPG industry is the recurring revenue it produces—a consumer tries your salty snack/baby food/pet food/skin cream, she is hooked, and then keeps repurchasing it every few weeks or months. Contrast that to selling cars where you have to acquire new consumers every year since the replacement cycle is 5 to 10 years.
The best measure of recurring revenue in the CPG industry is same-store sales growth—that is, what were your sales this year vs. last year measured only in the retail outlets you were distributed in during both time periods? Total sales growth is great, but eventually, the music stops and there are no more distribution points to turn to—you need to prove your brand can grow recurring revenue. Third-party data sources like SPINS (with which CircleUp has a partnership), AC Nielsen, IRI, Retail Link (Walmart) and Whole Foods Portal measure exactly this data.
Margin by product/customer
Walmart is 40 percent of your sales, and you spend your days and nights doing whatever you can to make them happy; if you lose them you’ll need to shut the doors, right? Perhaps. However, what matters more than sales concentration by customer is margin concentration.
Walmart may be 40 percent of your sales, but your margins on sales to them may be a quarter of those of the rest of your business, thus they contribute only 10 percent to your EBITDA. If Walmart went away, no doubt the loss would be painful, but losing 10 percent of your earnings versus 40 percent is the difference between shutting the doors and a big hiccup.
Customer-level margins also allow entrepreneurs to understand where to allocate their finite resources of time and plant capacity. A food company I used to work with had a customer that was 10 percent of sales but whose margins to our company were only 2 percent, and we were capacity constrained. So we increased prices by 10 percent, immediately "lost" this customer, but in the end our total EBITDA was higher because we replaced half the sales with business that was 5x the margin.
It’s a similar story for product-level margins. Understanding these allows you to better incentivize your sales force and fine tune your pitch to customers. Not understanding these is a red flag to investors.