Unicorns often exist in an alternate reality in Silicon Valley. They run wild here, and people are addicted to them. Founders are obsessed with raising large amounts of money in hopes of creating a unicorn. Even DTC founders are obsessed with who raised the most recent mega-round. According to CB Insights, DTC brands have received a cumulative $3 billion in venture capital funds since 2012 and $1 billion of that was allocated in 2018. As these DTC brands raise more money at higher and higher valuations, they are branded unicorns. However, I would argue that for DTC companies, the downsides of raising “too much money” outweigh the upside.

First, DTC start-ups simply cost less to operate than typical software companies. There are fewer high-cost software engineers and there are decades of manufacturing services and infrastructure investment making prototyping inexpensive compared to tech companies. Second, alongside unicorn status comes a continued expectation of rapid growth, which is largely unsustainable for consumer businesses. It has taken P&G 183 years to build 22 billion-dollar brands and it does not have a deca-corn ($10B+) brand, which do exist in the tech world. Effectively, there is a natural ceiling for scale in DTC. Finally, the more money raised, the higher the “floor” is for a successful exit. If you raise $100MM from investors, you need to exit for $100MM just to pay back the investors. The same exit, having raised only $50MM, would leave some profits on the table, even in the event of a down round. As the floor increases, alignment between shareholders begins to separate. Downside scenarios like acqui-hires and down rounds become financially equivalent to a shutdown to all but a few shareholders since most will receive zero returns in both scenarios. Effectively, the teams become incentivized to “go big or go home” regardless of the probability of success or if the company/category can handle that level of growth or scale.

On Monday, Will Gornall of the University of British Columbia and Ilya Strebulaev, authors of the Stanford abstract “Squaring Venture Capital Valuations with Reality,” went viral in the finance world. The premise of the paper is that “a lot of private tech unicorns were not worth what they said they were worth.” They developed a valuation model for the venture capital-backed companies and applied it to 135 US unicorns (private companies with reported valuations above $1 billion). They reported that unicorn post-money valuations average 48% above fair value, with 14 being more than 100% above. Our obsession with DTC unicorns results in an unhealthy addiction to praise. So much so that public criticism—even constructive criticism or healthy unbiased skepticism—is often omitted.

Recently, I read the very first article that was skeptical of Glossier, arguably 2018 and 2019’s most darling unicorn and poster child for DTC, in Business of Fashion. A few days later, a few more articles followed in other publications such as Bustle, The Cut, and Elite Daily. Business of Fashion reported, “One year ago around this exact time, hyped beauty brand Glossier released a teaser of a mysterious new range. Fans went wild, trying to guess what the minimalist skincare company would come up with next. But, if recent news is anything to go by, the result—a sub-brand called Glossier Play—was underwhelming.” Business of Fashion reported that Glossier is pausing its sub-brand Glossier Play due in part to the Glitter Gelée product, which has a non-biodegradable plastic glitter, counter to the brand’s claims of sustainability. Customers also questioned the excessive packaging as products were wrapped in foil, inside a box, inside another box alongside a full sheet of stickers. Bustle expanded the product-specific concerns to the core value proposition of the company: “So how did a brand that seems to get everything right go so wrong? Was it the criticisms about non-biodegradable glitter and wasteful packaging? A feeling that the products already existed elsewhere?”

These are hardly “take-down” articles, and I think they bring a healthy, albeit belated, dose of reality to DTC business news. Typically, these articles appear only after a very public stumble, fall, shut-down, or distressed acquisition process leaks to the press. There are few reasons for the hype reporting, acknowledging that private companies have minimal legal obligation to report their operations:

1. DTC brands’ shareholders only share what they want to share with journalists. Journalists get their info from sources, often trusted and influential investors and founders with significant social capital. As a result, journalists only have access to a small percentage of the facts of these start-ups when writing about them.
2. We want to celebrate and compare founders, but don’t have any consistent KPIs on private companies besides mega-round announcements.
3. Early-stage VCs can genuinely claim victory, since their ability to fundraise is often based upon their most recent fund performance (IRR). The youth of their last fund, typically only 2-3 years old, means that the IRR is driven by unicorn-driven write-ups, not exits; effectively, it is artificially high and doesn’t account for companies that will fail. Despite flaws, IRR is the most universally accepted metric for comparing young, illiquid funds. In the world of venture and private equity, it is commonly understood but rarely spoken that the only important measure of an investor is his or her ability to raise their next fund. As a result, the motto is “You are only as good as your last fund.” For early-stage venture perhaps it should be “You are only as good as your last unicorn.”

In the last two weeks, Casper’s stock plummeted after its IPO, Brandless, shut down, Birchbox declared that it is laying off 25% of its global staff. There is consensus that DTC brands like Away, Outdoor Voices, AllBirds, and Glossier would face valuation challenges in public markets today. (I’m not commenting on whether Away, Outdoor Voices, AllBirds, and Glossier are good brands or not. That story is TBD, and it will play out soon.) Now, a pullback is unfolding in precisely the companies that have drawn the most hype. Despite being singled out in the tech headlines, it’s not just Softbank lavishly bankrolling and trying to manifest unicorns like Casper into existence. VCs in SF, LA, and NY have been “Softbanking” DTC brands on a smaller scale. A $10MM-$60MM Series A for a DTC brand is the new norm. Recent large Series A examples include Brandless ($16MM), Honest Company ($27MM), Harry’s ($65MM), Curated ($27.5MM), and M. Gemi ($14MM), and countless others.

Is it really worth applauding a DTC brand that raises millions in VC funding, and spends millions on customer acquisition to artificially achieve growth? Putting aside that the vast majority of these companies are not profitable, that high growth isn’t sustainable, and costs of customer acquisition across major digital platforms are rising, Roy Bahat, an investor at Bloomberg’s venture arm in San Francisco, said, “At some point, one rock after another will fall away from the cliff and we’ll realize we’re not standing on anything in many, many companies.” Lots of venture funding and plans for rapid scale aren’t working anymore. However, early-stage VCs don’t seem to care. They are operating in their own unicorn-dream reality. Even if the market reacts badly to their portfolio companies, these VCs have made money by investing at the early stage in these companies that became “paper” unicorns. It’s an alternate-reality manifestation that paid off for them. Danilo Campos, a software engineer and technology educator, poetically tweeted, “In the absence of regulation, the only check on these people is press and public opinion.” While skepticism, inquiry, and examination may threaten the existence of unicorns, they keep us in check.