Deals

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

Nestle SA is the latest startup shopper to validate a bad habit.

The Swiss multinational agreed on Thursday to buy a majority stake in artisanal coffee chain Blue Bottle Coffee. The transaction, which reportedly values the California-based company at more than $700 million, justifies the investment for its hodgepodge of investors. The Nestle deal gives at least some of Blue Bottle's backers a return of more than 20 times their original investment.  

Some of them are wealthy individuals in the technology industry; that's fair enough. As consumers ourselves, we're grateful for their decision to fund delicious pour-over coffee. But professional investment funds including venture capital firms True Ventures, Index Ventures and Google Ventures also wrote big checks to Blue Bottle in something of a departure from their mandate.

Those firms invest in young, risky companies that need lots of money to grow and ideally sell or take them public down the road with a goal of reaping a large return, say 10 times or more the cash they put in. And they need need home runs because a lot of young tech businesses fail; the business model is all about making risky bets in exchange for big potential returns if they find and nurture the next Google.

High-end coffee chains like Blue Bottle do need capital. And, yes, the more cash they have the faster they can expand. Blue Bottle started with five coffee shops in 2012 and may end up with more than 50 by the end of this year. But that doesn't make Blue Bottle or companies like it a textbook venture-capital investment for tech-focused firms.

The potential return is simply not enough. Blue Bottle may be a fast-growing, highly profitable company -- although Gadfly has previously warned that growth can be less than meets the eye at such not-quite-tech startups. But it's also not the type of company that backers of tech startups are tasked with nurturing. 

Yet every time one of these venture capital firms branches out of its wheelhouse and succeeds -- as illustrated by Dollar Shave Club's sale to Unilever NV or the purchase of Bonobos by Wal-Mart Stores Inc. -- it validates this approach. But that doesn't mean tech startup investors should keep investing in companies that don't fit their profile. Why did venture capital back the grilled-cheese sandwich chain Melt? Why has it backed plant-based burger-maker Impossible Foods and indoor cycling company Peloton?

Off the Beaten Path
Tech-focused venture capitalists arguably shouldn't be investing in these types of businesses, but successful exits that generate sizable profits may simply encourage more of the same
Source: Company filings, news reporting
*This has since been written down by $197 million ^Subject to change

The former CEO of Melt told Bloomberg News's Brad Stone: "We originally thought that technology would provide us with an exclusive that would prevent others from making grilled cheese as good or fast or as inexpensively. ... The reality is that while it was great, it didn’t motivate people to have a grilled cheese.”

Blue Bottle ended up a winner, and some of these other off-the-fairway venture investments might succeed, too. But that doesn't mean venture capital firms should keep breaking their own business model to fund coffee and grilled cheese -- even if they believe in the brand and the entrepreneurs that they're backing. 

Laser Focus
Venture capitalists have every right to invest across sectors, but they should consider expanding their mandates if they're going to migrate away from areas of expertise
Source: Preqin

To pursue such deals, tech-focused venture firms should consider launching separate, specialized funds that give their investors the ability to decide whether they want exposure to coffee, mattresses or eyeglasses. Or they could consider investing in these non-tech deals from their personal accounts. 

To be sure, nobody seems too focused on the lines blurring. Mike Volpi, a general partner at one of Blue Bottle's early investors, Index Ventures, told Bloomberg Gadfly that investors have never taken issue with its decision to go off script, and not just because Blue Bottle coffee is served at meetings.

No Complaints?
Investors in venture capital firms haven accepted investments in seemingly unrelated companies such as Blue Bottle Coffee in part because of decent returns. This could change.
Source: Cambridge Associates LLC
*Data as at Dec. 31, 2016

He said the firm has discretion to invest in anything that's technology-enabled, and that ever-so-slightly does apply to Blue Bottle -- think digital strategy and customer acquisition through social media, though it should be pointed out that the chain doesn't even have a loyalty app. Plus, the firm has the right of first refusal over sizable deals that its employees are considering investing in from their personal accounts, apparently regardless of how minuscule the technology component is. 

Straying from an investment mission can be fine if it's a rarity. The trouble is that each one of these high-profile maverick victories gives those moneybags the confidence to hunt down more and even bigger off-target investments. When that happens, the inevitable result is more failures like Juicero Inc. No one wants that.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The Wall Street Journal in 2012 reported a round of investments in Blue Bottle valued the company at less than $30 million. 

  2. Buyers should also beware: Nordstrom Inc. wrote down a chunk of its investment in Trunk Club. 

To contact the authors of this story:
Gillian Tan in New York at gtan129@bloomberg.net
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net