The dog days of a downturn: Financial transactions in the nutrition industry hit a standstill

It’s not hard to find a dire headline about dealflow in the capital markets these days. Here’s one from Food Dive dated May 31, 2023: “VC funding for food and beverage plunging amid challenging environment, data shows.”

The data in question comes from Pitchbook, and it shows stark declines in venture capital funding, in terms of both number of deals and amounts raised. The fourth quarter of 2022 appears to have been something of a nadir, with 785 deals raising $800 million in comparison to $2.3 billion on 2,316 deals just one year prior.

“We’ve seen valuations coming down,” says Mike Dovbish, executive director at Nutrition Capital Network (NCN). “We’ve seen down rounds. Sometimes even those are too pricey, and fundraisers can’t fill out the round. I get pinged quite often from companies these days. They’re hungry for capital, even desperate.”

NCN data proves the point. Through June of this year, NCN’s databases have tracked 499 industry transactions across early-stage financings and later-stage M&A. This compares to same period counts of 669 and 641 each of the prior two years. That’s a lot of ground to cover in the second half of the year.

Looking at the six-month period between December and May, NCN data shows steady annual increases for financings that hit a wall in 2023, which saw a 19% decline. An analysis of dealflow by quarter shows the decline that began in Q2 of 2022 only accelerated through 2023. Financings are a clear indication of investor interest in the growth potential of the industry, and Q2 2023 saw that interest fall to pre-COVID levels.

“We’ve definitely seen dealflow freeze up over the past nine months,” says Dovbish. “Some of our members say it’s comparable to 2008–2009. Maybe it’s even a little worse, but at least at that level.” Dovbish has seen lots of investors at recent NCN events checking out the startups, but not a lot of investing.

How bad is it?

“It’s not a secret that the level of funding and quantity of transactions is down significantly from the boom we saw leading up to and through the pandemic, for a myriad of reasons,” says Madlen Karnatz, associate director of financial partners at SPINS. “Money isn’t free anymore, and brands are competing for every dollar they can squeeze from consumers, who have heightened sensitivity to costs.”

The macroeconomics matter here, as does a bit of historical context. “The key to all of this,” says William Hood, managing director and founding partner at William Hood & Company, “is that we’ve had a 12-year party, and now we’re suffering through a walloping hangover.” From Hood’s view, the stimulus that flooded the market on the heels of the Great Recession in 2008–2009 led right into another heaping dose of stimulus related to COVID. Not all of it was necessary, but it did finance a wonderful party.

Through the end of 2021, this stimulus fueled consumer demand, and drove record amounts of venture capital, record levels of M&A, and lots of interest from large corporate acquirors. But now? “This hangover is proving more painful and longer lasting than typical,” says Hood.

The depth and duration of this hangover ties directly to inflation, which rose to its highest level in decades before the Fed put the screws to interest rates, something many experts see continuing in the months ahead. Overlaying this domestic pressure on economics are the geopolitical uncertainties on the world stage. Russia’s invasion of Ukraine persists. U.S.-China relations are at a low point, with their militaries not even talking to each other. There’s also the recent banking crisis, triggered by Silicon Valley Bank and a handful of regionals that are now fully insolvent.

“It was pretty bad in ’08,” says David Thibodeau, managing director at Wellvest Capital, “but this is a different kind of market. There are all these contrary signals. Are we in recession or not? Have we fought back inflation or not? Are we about to face energy shortages or not? The world is not like it was a year and a half ago, and valuations have come way down.”

Given this state of affairs, is it any surprise that dealflow dropped off a cliff by Q4 last year? Some would argue it was a long time coming. The silver lining of any serious correction, of course, is that the market rightsizes and adjusts. Lofty valuations and sub-par deals get washed out of the system. Companies get used to higher interest rates. Investors bring down their expected internal rates of return. “By now, people have recalibrated,” says Thibodeau, “and we may see some thawing in the second half of the year.” There’s also the significant powder now sidelined on the private equity side, and the stockpiles of cash at strategics waiting for deployment.

But corporate America is signaling more pain. Experts like Thibodeau see corporate earnings growth clearly tied to price increases, with volumes going down, and this is problematic for any sustained recovery. Recent reports also indicate that the highest-end consumers are finally pulling back—even millionaires have their limits, it seems. “It’s a turbulent market, but we will come out of this,” says Thibodeau. “Deals are getting done, just not at the price valuations of recent years, and it’s tougher for lower-quality deals. Investors have gotten more careful. There’s less fear of missing out.”

Deals are indeed getting done. Gregg Bagni is a partner at White Road Investments, the venture arm of Clif Bar. His team closed on two deals last year—1620 Workwear in apparel, and Thousand in bike accessories—and expects to close on another next month. White Road’s approach might be suited to the current market, he says. “It’s bad out there for the typical private equity or VC firm,” says Bagni, “especially in natural products. We operate more like a family office, so we’re in it for the long term. We held Wild Planet for 12 years, and we’re glad we did.”

Bagni also speaks of a hangover depressing the current market, with inventory levels growing too high during the COVID heyday. “Everybody got high on COVID goofballs,” he says. “These brands raised lots of money when it was plentiful. Then COVID hit, and business boomed. Then the bottom falls out, they’re sitting on inventory, and they have to raise capital.”

The logical outcome here is downrounds. Bagni points to a deal coming across his desk recently with annual revenue of $14 million and a valuation of $6.75 million, less than 0.5x sales. “That’s a bad buzz,” says Bagni. “If you’re sitting on cash and have any interest in distressed properties, you’re about to roll right into nirvana.” In other words, there’s no time like a down market to buy competitors, retailers, inventory, a factory, or even customers.

Across the investment chain

This downturn is broad and pervasive, but different audiences will experience it in different ways. “We’ve just had the worst quarter—Q1 of 2023—that we’ve seen in the last ten years,” says Hood. “Volumes are way down, and it’s spread across the market, from the large, mega deals to middle market and smaller deals. Everyone’s impacted.”

The IPO markets remain essentially closed, though Dovbish points to the fast-casual restaurant chain Cava as a bellwether of possible brighter days ahead, given its recent IPO. Thibodeau points to August and September of 2021 as the turning point, a period that saw crazy levels of activity, with up to 30 IPOs per week. That’s all gone now, as is the SPAC market, a more speculative new offering that had its proverbial moment in the sun.

Venture capital flows in sync with these exit channels, so there are glimmers of activity, but only for the well-heeled and well-positioned. “Deals that were funded easily in 2021 are not getting funded today,” says Hood. “Venture capital is open for business, but only in highly selective ways, with tougher terms and pricing.”

Shifting to private equity, firms have plenty of capital available to invest, but sellers remain stubborn about lowering prices from those pre-correction levels. “Private equity wants to do deals right now,” says Hood, “but they can’t find sellers at fair terms. The expectations haven’t come down enough.”

At the larger end of the chain, strategic acquirors are also out shopping, but carefully and slowly. The focus on existing brands within the corporate portfolio takes top priority, with recession still lingering on the horizon and inflation still wreaking havoc on supply chains. “It will be two years on the sidelines for private equity, by the end of this year,” says Hood. “I remain quite positive about the long-term prognosis here. This is temporary. We’ve seen it before. In fact, a shakeout can be quite healthy for markets.”

Supplements specifically

Closer to home for NBJ readers, the supplements category seems to be weathering this storm better than most. NCN data shows 12 financings and 7 M&A transactions in 2023 year-to-date. Nineteen total transactions compares quite favorably to recent full-year totals, for supplements, of 25 in 2022, 35 in 2021, and 30 in 2020.

“The consumer is proving highly resilient for now,” says Hood, “but we’ll have to wait and see if there’s a real recession coming.” Causes for optimism would include a robust hiring climate, consumer demand that has held through 18 months of inflation and rate hikes, and the mega-trend toward health and wellness as a top priority.

That said, the category does face headwinds like it hasn’t seen in many years. On the demand side, the industry still faces necessary normalizations coming off COVID, with growth expected to return to the mid-single digits. 2022 was the first year to test that, and while unit sales might have slipped, higher pricing led to stable sales performance overall.

The shorter-term headwinds of resetting expectations after the extraordinary results of the COVID years couples with ongoing challenges to the supply side as well. The build-up in inventory for raw materials and co-manufacturing is still working through the system and creating noise that clouds that category’s prospects. “We’re hearing from our contacts that the disruptions are settling down,” says Hood, “but this is the first time in 20 years that the dietary supplement industry has faced challenges on both the demand and supply side.”

A different kind of supply and demand is also at work in the number and kinds of opportunities.

“We go through these cycles,” says Thibodeau, referring to the growth pipeline of prospective targets for investment in natural products. “With lots of transactions over the last several years, there just aren’t as many companies in that strike range to be sold. Smaller companies need to build up. It ebbs and flows, and, right now, we’re in the ebb.” Put another way, as one wave of supplement brands scales and sells—think Olly, SmartyPants—it takes a minute for the next wave to reach that $30 million or $50 million or $70 million in sales. Many experts would point to companies like Ritual and Seed as contenders in this next wave.

The data might not be there for such deals, at least not yet. “The vitamins and supplements categories were amongst the strongest performing segments throughout the pandemic,” Krantz says. “Now, looking at SPINS tracked sales in the last 52-week period ending 5/21/2023, nearly every category in the department is declining, compared to the prior year when nearly every category was growing. With that, deal attractiveness in this segment has been relatively low.”

Karnatz does point to two exceptions here, as performance nutrition and protein are both up, +37% and +14% respectively. “These two segments have been bright spots for investors,” she says, “as sports nutrition has gotten a boost from consumer lifestyle trends, like the increased prioritization of protein and power of social media and influencer-boosted brands like Ghost and Prime.”

What’s attractive right now?

The name of the game now is back to basics: profitability with cash on hand. “Now more than ever, investors are prioritizing data in their due diligence processes and going back to basics to evaluate the attractiveness of deals on the market,” says Karnatz. “They are seeking profitable brands with stable input costs, strong manufacturing partners, strategic yet manageable distribution points (preferably in brick and mortar), and consistent velocities outperforming or meeting category averages.”

Investing is a risk-management game, and in downturns such as this, taking on risk becomes a tougher pill to swallow. “I’ve been saying for a long time now that profits will matter, and now they do,” says Thibodeau. The shakeouts in plant-based and alternative proteins—Beyond Meat’s stock price is a great indicator here—prove the point. Good companies with good margins, good fundamentals, and real differentiation around a unique selling proposition remain attractive to investors, as always. The easy money going into technology solutions around food are squarely in the crosshairs now. These are big bets on the future with delayed prospects of profitability. The future takes time to unfold, and it adds risk during a market phase in which investors want risk off their books.

“What’s working right now?” says Bagni. “Companies and firms that have cash. We very rarely invest in businesses that are losing money.” He speaks to the particular challenges now facing e-commerce startups, where the realities of 40% margin spends on marketing are normal. “All of a sudden, that high trade spend in natural food seems affordable,” says Bagni, “but even there, very few retailers are willing to pioneer your brand right now.”

Margins and cash become critical right now, in a time where inventory and receivables are likely to see pressure. With customer acquisition costs high and returns on ad spend low, online sales get challenged too. Bagni points to a common scenario wherein a brand’s ROAS of 4 might now look like 1.8. “The smart brands have already rightsized by now,” he says. “They’ve stashed some cash. If there’s anything left over, that’s when you consider a new product or line extension, but only if you can take it to $1 million in revenue.”

How long will this last?

Sentiment ranges about the timing of this downturn, but consensus opinion would keep us in the doldrums through the rest of 2023. “I think we’re another year out,” says Bagni. “It will take that long for inventory to clear and for consumers to gain more confidence. And the political climate is only going to get more uncertain in the election year coming up.”

Hood moves that timeline up a smidge. “This is more about patience,” he says. “I think we’ll all feel a lot better in Q1, Q2 of next year, with the greenshoots of that emerging in Q4 of this year. 2024 is the back-to-normal year.”

Karnatz at SPINS expects deal volume to remain low for the rest of this year, and Thibodeau is the most optimistic of the bunch, but only by a bit. “Barring unforeseen disasters, like Europe going to war or interest rates going to 8%, we’ll start to see improvement in late Q3 and Q4 of this year,” he says. “We’re seeing it in our conversations right now. Dealflow is increasing. We’re getting busier.”

There’s also the question of what a recovery will look like when it happens, and how long it will take to fully take root. “I think we’re very close to the bottom here,” says Dovbish, “but I don’t know if anything drastic will change this year. It normally takes a while to reset on the upside. Even after 2008-2009, things picked up, but there wasn’t an immediate turnaround. We weren’t back to normal until 2012. It takes a couple years after the bottom to start rocking again.”

Editor's note: This article first appeared in Nutrition Business Journal’s finance issue. Sign up for NBJ’s bi-weekly Analyst’s Take newsletter for more industry insights.

Marc Brush is an industry consultant, working with brands in food and nutrition to develop market intelligence and improve their product positioning. He is a frequent contributor to Nutrition Business Journal, where he once served as editor-in-chief.