'Businesses will shut down': The coronavirus threatens to crush direct-to-consumer businesses' wild growth

• The coronavirus is wreaking havoc on consumer businesses, but is especially threatening to digital-based startups that raised a lot of money on the promise of rapid growth.
• The economic shock from the coronavirus adds to existing pressures on these companies.
• Beauty and apparel are especially hurting, but some sellers of home and essential products have seen sales upticks, sources said.

Arfa, a direct to consumer brands startup, planned to launch a new personal care line called Hiki. That all changed as the coronavirus shut down industries and consumer spending.

So Arfa's founders huddled with board members and investors and decided to do something drastic: Give the products away for free, to hospitals and health care workers. Regular customers are also being offrered two Hiki products for free, in exchange for customers being kind to others.

"Our mission is to make people feel more comfortable in their skin," said Ari Wengroff, cofounder of Arfa. "So encouraging human connection at an intimate level when a lot of us are feeling isolated is a strategy we believe is going to work."

Not every DTC firm has the capital to be able to give product away, however. For others in the space, which had been booming in recent years, the pandemic's impact could be the final straw.

• Direct-to-consumer companies, many of which grew by taking advantage of cheap advertising rates on Facebook, have seen those costs go up.
• At the same time, their conversion rates have gone down as more competition enters the category. Online mattress company Casper seemed novel when it started in 2014, but now there are more than 100 "bed in a box" sellers.
• Many of these DTC companies are venture-backed and built on a fast-growth model. The barrier for new funding is now higher as funders scrutinize founders more closely after seeing massively venture-funded bets go awry like WeWork and Uber. And the inability to have face-to-face meetings hampers deals.

"Funding will become harder. Businesses will shut down. A lot more investors will circle their current portfolio to make sure they can weather the storm," said Mike Duda, managing partner at hybrid accelerator agency and venture capital fund Bullish, whose investments have included Warby Parker and Peloton.

'Nobody's buying anything'

A primary function of DTC startups has been to test and learn fast, said Heather Hartnett, CEO of Human Ventures, a VC fund and startup studio. You can do that when there's a steady stream of people purchasing, generating data. But as people stop shopping, that data goes away.

DTC insiders say companies are slashing their advertising by as much as 80% as their sales, especially of nonessential items, have plunged and advertising risks landing flat or being tone deaf when people aren't in a buying mood.

"I've seen apparel go completely in the gutter as well as beauty," said Nik Sharma, who consults to DTC startups. "No one's really buying anything."

In addition, early-stage companies are more likely to have the added vulnerability of relying on a single factory or distribution center to make and ship their products from, which puts their entire business at risk of freezing if the facility has to shut down due to the coronavirus.

Some startups are already feeling the strain of the pandemic on their logistical operations. Gautam Gupta, partner at M13, a venture fund that invests in early-stage consumer companies, said that he was aware of at least one San Francisco-based e-commerce beauty company that was forced to shut down its distribution centers because of the "shelter in place" rule rolled out in the city this week. If such a rule was mandated elsewhere, like in New York and New Jersey, it would have disastrous consequences, he said.

Hardest hit are DTC companies with brick-and-mortar stores including Everlane, Glossier and Heyday that are closing their stores as part of a wave of retailers shutting their doors and thereby an important avenue of marketing to customers, said Andrea Hippeau, principal at Lerer Hippeau Ventures.

Startups scramble to stay connected with consumers

Some are scrambling to find ways to keep connected with consumers even if they might not be in a buying mood. Baby food startup Tiny Organics, a Human Ventures portfolio company, is doubling down on the amount of online content it publishes, Hartnett said, in what she calls a shift to "direct to community."

Frida, which sells products for newborn babies and their parents, diversified its supply chain to avoid the issues that those reliant on Chinese manufacturers had when the coronavirus spread there and has been overstocking inventory in case of future workforce stoppages or mandatory quarantines.

VC investors are advising their portfolio companies on how navigate the challenge. Hippeau said she was telling startups to conserve as much as possible. Jon Keidan, founder of Torch Capital, said that he was advising DTC companies to reduce salaries across the board to preserve people's jobs.

And some categories are seeing a boost. Companies that sell products for the home, online grocers and meal kits, stress relief, fitness and meditation companies, survival products and a toilet paper delivery service are doing well.

Bullish portfolio company Nom Nom, a dog food maker, "had three of their best days," Duda said. M13 portfolio company Daily Harvest Daily is having its biggest week ever, said M13 cofounder Courtney Reum.

But those may be the exceptions. Many DTC startups, which were the big growth spot in consumer products, now face a big reality check.

"In general, we think that without true product differentiation or a unique distribution advantage, DTC has become a lot harder and the COVID-19 outbreak may make matters worse," Gupta said.