6.20.2011

Stumptown Steps Up

I wrote a post about the investment that Stumptown recently raised back a week or so ago.

No... that's not the honest truth.

I wrote a post a week or so ago about how the response to the Stumptown news from within the coffee community illustrated perfectly many of the reasons that I no longer worked in coffee - and which in general took the coffee profession to task for its lack of professionalism and seriousness in business.

But that's another whole topic -- cause I decided it was the wrong thing and the wrong point.
So I decided to wait - and to see what shook out from all this.

So now I have an idea of what people are saying, have said (and probably are going to say). I think I see how this has played out. And I'm going to share my thoughts.

I have a somewhat unique perspective on this deal.
  1. I used to work at Stumptown.
  2. I used to work at a Corporate Venture Fund.
  3. I'm a serial entrepreneur who has started multiple (externally funded) companies (two of which were sold to other companies).
So, I think I have a perspective that might be worth hearing.

Now, first, I need to put a few caveats first (just to be clear)...

  1. I am not writing this based on any sort of "insider information" on the deal. My relationship with TSG is purely second hand, and while I'm still a friend of many folks at Stumptown (including Duane) and a fan of the company and its coffee I'm neither involved with the company nor involved in the deal in any way. In fact, my guess is Duane and the Stumptown family are going to probably wish I'd not said anything.
  2. This is purely my opinion based on the points listed above under Perspective. In other words - I'm writing this as pure speculation (like everything else written in this thread -- and for that matter in the various press pieces covering this deal to date).

For me, there are two key things about this deal.

First - this is a huge validation for the high-end sector of the speciality coffee market. The fact that a fund like TSG is making a bet on Stumptown at this time says that they see significant potential for growth in the whole sector. This sector has long been ignored not just in the investment world (of course) but in the larger coffee world as well (the "less than 2% of the market" comment has been made a million times). For the other companies that have also been building the space, and for consumers of high-end coffees, this is great news. Sadly - as far as I know this has not be covered in the press. Given that it should be the main story, that makes me both sad and frustrated.

Second - that being said, there is one group of people out there who should be very nervous about this deal. And no... it's not Stumptown customers or Stumptown employees. It's competitors of Stumptown. In looking at the stated and rumored goals (open more retail locations in NYC, open business in Chicago, open business in SF) you can model this out to mean that (if successful) Stumptown will be at least doubling the volume of green coffee they are buying within 24 months. Where is that coffee going to come from? From other high-end roasters. And who will they be selling the roasted coffee to? That's right - customers of other roasters. And who will be working in these new roasteries and new retail locations? Yeah... you get the idea. Combining Stumptown's brand, relationships and expertise with a whole big stack of new capital... yeah, if I were running a competitor I'd be nervous.


Now... after talking to folks and reading all the crazy shit that's been out there - there are a couple things that I feel like I need to comment on. Again... these are just my opinions. But... well... I think I'm probably more right than most people.

  • the idea that Duane is going to "cash out" and leave in a year or two is something that only someone who doesn't know him could ever come up with. The man has no hobbies. His entire life is coffee and Stumptown. He truly loves what he does - and he loves Stumptown. In the time I worked at Stumptown he never took a vacation longer than a 3 day weekend that I can remember. There is absolutely no way that he would (or perhaps could) do something else (and that includes not working). As a result, I feel like we can absolutely assume that his motivation was something other than "cashing out" -- which fundamentally changes the structure and tenor of the deal (given that it changes the motivation).
  • everything I hear says that Stumptown was doing better financially than it ever had before. In other words, financial hardship (another common motivator for capitalization deals like this) was not the driver.
  • given this, I have to assume that the motivation was in fact capitalization for growth and opportunity. This makes sense to me. Duane used to always say he wanted to bring great coffee to everyone in the world who loved things that taste good.
  • now, while it's entirely possible that TSG was talking to other roasters in order to pursue a roll-up strategy, it's perhaps more likely that this was simply a pricing and competition exercise for TSG. I know it sounds sleazy but many serious investors do it. I've done it. Yeah... it causes bad feelings if the companies that are not the investment target take things personally and feel like they were either used or jilted in the process. That's life. That's business.
  • as noted at the start, my relationship with TSG is purely second hand (I have friends who know them, who are at companies that have worked with them or co-invested, etc). That said, once I heard about the deal I asked around and came back with 100% positive responses. And - just to be clear - in the PE world that is not common. In fact, an associate I know at one of the most highly regarded early stage VC funds said that TSG was his dream gig. And the reputation that Alex Panos had amongst these folks was equally impressive.
  • so... Very good investment firm puts money into thriving growing private company because that company wants to grow rapidly in an expanding new market. Pretty damn common, yeah? And I think we can at this point say that the usual rules, metrics and models of a deal like that probably also apply to this particular deal, okay?

To be frank, I'm kind of shocked that Stumptown was able to scale as it did without investment. As far as I know, they were the largest high-end speciality coffee company that didn't have outside investment. I'm guessing that this exact success was one of the main reasons TSG was so attracted to them.

Of course, the deal is also a validation of Stumptown. And that is an important point. No good investors are going to put money into a company based on its success and then destroy what has made it successful.

The vast majority of people have no idea what Private Equity or Venture Capital are, how they work, what the goals are, what the motivations are, or what the people working in those fields are like. They are sharing opinion based on a combination of ignorance and misinformation. To compound matters... they tend to have an automatic and innate distrust or dislike of these investors and take the results of ignorance and misinformation and filter through this distrust / dislike. Investors like this are professionals. They're not stupid.

Given all that I have walked you through above, I think we can assume that the thinking behind this deal is simple.
    Stumptown has kicked ass to date
    It has done so with no external capitalization (straight bootstrapping)
    The entire market sector is primed to grow over the next 5-7 years
    Stumptown is best positioned to take advantage of that
    Let's accelerate Stumptown's growth to take advantage of these circumstances.
    This will result in Stumptown being the dominant player in a newly expanded market sector at the end of this time period.
    To do this, let's use external capital (investment) in order to massively expand Stumptown's geographic footprint.

At least... that's my perspective and (unfounded and speculative) opinion.


Oh... also... I used to write for the NYTimes.
I believe strongly in journalistic ethics.
Suffice it to say that there are people who have been involved in the coverage of this "story" who should not only be ashamed but should not ever be considered in any way "journalists" of any sort.

7 comments:

Kevin Knox said...

This is the best thing I've read on this topic - and so refreshing after all of the negative, sensationalistic coverage in local Portland rags and elsewhere.

Thanks for writing it.

chris said...

Thanks Kevin. Honestly, I think it's just that I have some perspective (both professionally and emotionally) that a lot of folks don't have right now.

Prof. Schooliosis, the Crooked MixMaster said...

Chris,
My feelings exactly on your first point. This is what I've said to people who have asked me about it. In many ways, this is a win for quality coffee and companies dedicated to it on every level.

caffe d'bolla said...

Chris,

A well thought out and smartly written piece about Stumptown's great catch.

It will be interesting to see how this plays out in the next couple of years, especially if Stumptown lands firmly in Chicago... and LA.

Hopefully, I hope this competition between the big boys of Specialty Coffee brings greater awareness of good coffee to the general populace.

S. Hersh said...

That is a really interesting and informed point of view: thanks for posting. I don’t come to this with the same specific experience with VC, and while I do have an “oar in the water” in the coffee business, it is a mighty small oar to be sure. Still I have some thoughts:

Personally I wouldn’t worry about VC running Stumptown aground. The scalability of the coffee business has been proven many times. Historically, the scaling up of coffee business has created challenges to quality and individuality just as it has in other agro-based industries. While Stumptown as a brand can flourish, the new expectations of ROI may change the nature of the company at least as much as the infusion of funding for development may help it grow.

Among many things I probably can’t see, I notice two tensions/pressures that seem worth mentioning:

1. Unlike the wine world, the entire super-specialty coffee world is still largely over the heads of consumers. Some may notice that the products taste better, but there is very little awareness of origin, processing, and roasting along with many other critical factors in the production of top-notch coffee. Whether or not a critical mass of consumers will “catch up” to the degree that people like George Howell and others have long hoped, is anyone’s guess. In the mean time cold brew coffee with it’s pleasant flavor but relative lack of distinctiveness sells as well as anything in a high end coffee shop.
2. Coffee as a commodity remains highly volatile. Where consumers accept volatility in the wine market, they have not yet been conditioned to accept volatility in the coffee market which means the risks inherent in volatility must be largely absorbed by the industry.

If the expectation of relative price stability continues to be pervasive in the retail coffee market it will create challenges for all segments of the coffee industry, but especially for the high-end specialty market where price swings can be so profound. Those companies that are leveraged will feel these challenges more and sooner than companies that are not leveraged. Further, if consumer expectation continues to favor product reliability, the industry as a whole will be further dis-incentivized to production of individual micro lots that hold so much aesthetic interest right now.

So while the coffee business is scalable, it remains to be seen the extent to which the specialty coffee business is scalable. Surely the folks at TSG must have contemplated all of this and more. Do they anticipate a coming change in consumer expectation? Will customers begin to embrace (and be willing to pay for) differences of terroir processing and roasting? Does TSG expect to tailor the development of Stumptown’s growth to respond to current consumer expectation or do they plan to lead the way for change?

At any rate it would seem that it is a time when all who are leveraged in the coffee business should be wary, with or without the emergence of Stumptown “on Steroids.” For small, specialty companies who carry little debt the continued growth of Stumptown, Intelligentsia, and Counter Culture may create enormous obstacles to the acquisition of top notch micro lots. But without a change in consumer demand it is difficult to imagine a company with hungry investors waiting, continuing to stay focused on, and devote resources to micro-lot coffee production, with it’s limited scalability and current marginal ROI.

chris said...

It's important to differentiate VC (venture capital) from PE (private equity). They are very different businesses with very different models and very different practices. Conflating the two tends to lead to poor analysis and conclusions.

S. Hersh said...

Without a doubt I have no basis on which to make a precise or meaningful distinction between those two forms of capitalization. Would you have the patience to clarify how the distinction affects the potential pressures on Stumptown that I articulate above? Or perhaps the whole analysis can be called into question on multiple points. All of that is of potential interest...