Software eats dinner: Why VCs are pouring cash into food startups

By Erin Griffith , written on November 29, 2013

From The News Desk

Startups are seeking to change the way we buy groceries, eat out, host dinner parties, pay for drinks, and cook our meals. OpenTable proved there's a lucrative business in reservations, earning its investors a solid return. Now, with the Web 1.0 flameout Webvan a distant memory, a new, massive wave of food startups are seeking to cash in on the way we eat. Investors are paying attention.

The question is, what do they know about food? Venture capital is well-suited to invest in software. The easy scalability of a software startup, where you build the product once and sell it to everyone, means companies can grow abnormally fast compared to their analog counterparts.

But it's strange to see high-growth venture capital injected into old-school analog industries, particularly one as old-school as food. Food-tech even has its own Lumascape, created by Brita Rosenheim of Rosenheim Advisors.


It's crowded out there.

In the first nine months of this year, food-related startups have raised $798.1 million in venture funds. That includes everything from online ordering to loyalty rewards to recipes and restaurant marketing.

Meal kit services like Blue Apron ($8 million), Plated ($3.5 million), HelloFresh ($17 million), Fresh Dish ($500,000), Greeling ($5.2 million), ChefDay and Munchery  ($7.92 million) are popular. Peer-to-peer platforms like Kitchensurfing ($4.5 million), Kitchit, and Feastly connect private chefs with dinner party hosts and hungry diners. Relay Foods ($13 .3 million) and Abe's Market ($9.08 million) do online grocery ordering; Good Eggs $10.5 million) connects you to local farmers. ChowNow ($4 million) and ($768,000) offer ordering platforms for restaurants. Red Book Connect helps restaurants schedule inventory and training; Shiftgig ($3 million) and Easy Pairings offer hiring platforms specifically for food service. Food52 sells fancy kitchen gear alongside its recipe and cooking blog (undisclosed size of round). The list goes on.

There's a certain attraction to investing in a food-related company. "Everyone has their own relationship with food," Rosenheim says, "so everyone thinks they're an expert in it."

The flood of funds raises big questions: Do investors really know anything about this industry? Are these companies really good venture investments?


I bet you think our margins suck

This June, Plated delivered the finale presentation at TechStars NYC's demo day. Nick Taranto, a Marine and ex-banker at Goldman Sachs, eagerly (almost aggressively) showed off his company's impressive early traction. Unlike the other startups in the program, Plated had already closed a seed round of funding. It had launched six months ago and seen its user base grow by 50 percent each month. Obvious questions about business model, profitability and viability lingered, though. After all, no one in this tech-savvy audience knew much about the food industry.

"I bet you think our margins suck!" he declared, following it with something like, "Wrong. Our margins are awesome!"

Taranto might have been quoting Dollar Shave Club ("Our razors are awesome!") He later told me that Plated's margins looked a lot more like e-commerce margins than food industry margins. The food industry deals with inventory that goes bad after a few days, and 95 percent of grocery store margins get chewed up (pun entirely not intended) by spoilage, he says. Plated eliminates that with its subscription-like model where orders are placed in advance.

Further, he claims, Plated's growth curve since launching resembles a software company more than it does a typical food business.

No matter the resemblance, his idea was a tough sell to investors 18 months ago. "A lot of investors had been burnt by food," he says, again, no pun intended. The company's first round of investor meetings drew incessant comparisons to Webvan, but upgrades in shipping infrastructure around the country have made a company like Plated more viable than dotcom blow-ups past. Investors have become more interested lately.

The crucial difference between Plated and a software business is a matter of getting operations right. "You can't just scale up the Dynos on Heroku when you need more capacity," he says. "The cycles are longer." The Plated equivalent of "scaling up the Dynos" is asking a farmer if he can sell you more ground beef this week, and buying more packaging and labels for it, and buying more boxes for it, and shipping it to more places. The logistics and infrastructure are more complicated than a typical software business.

The biggest challenge for a VC-backed company in the food industry is efficiency, says Phin Barnes, a partner at First Round Capital Partners. His firm has invested in Blue Apron, another meal-kit company that launched slightly before Plated. Food startups require a "grind-it-out" kind of entrepreneur that can really execute, not the behoodied visionary Mark Zuckerberg stereotype we're used to.

Barnes believes the returns on food-related startups will be as high as those of software companies, but that many more companies will die trying. "If Blue Apron wins, and you were to look at how much money got poured into competitors that lost, that amount of money will be much greater than, say, a social app. The money poured into losers (in the social media category) will be far less. But the returns (for food companies) will be as good if not better."

The meal kit category has already experienced a few of those blow-ups. In January, Pop-Up Pantry closed its doors after five months of operations. The company had 1300 subscribers and raised $1.3 million in venture backing. But its delivery costs proved higher than expected. It's easy for things to go bad with food.


Fun ideas

Part of the reason VCs are investing in food is because traditional food investors aren't. Since Marc Andreessen famously declared that software would "eat the world," tech has increasingly crept into the food industry.

And food is a huge industry. I'm sure plenty of startups toss a big flashy number like "$10 trillion in the United States alone!" into their decks. Valuations are getting frothy: very early stage companies in the general food category are garnering valuations of up to $10 million.

Barnes noted that the size of the opportunity is one of the biggest draws: "In that everybody eats, it's one of those big markets like healthcare. So there is interest just because it's so huge."

Applying new software and technology to a big, old industry is a tantalizing proposition for founders dying to disrupt (er, improve) the world . "We're basically taking a lot of antiquated methods and processes and applying the power of the Internet and tech to them," says Noah Karesh, co-founder of a platform for cooks called Feastly.

Venture investors are investing because the food industry's traditional investors -- private equity and hedge funds like Encore Consumer Capital or TSG Consumer Partners  -- are hesitant to dive in with no big proven wins.

Feastly, a peer-to-peer platform for connecting chefs with eaters, experienced that divide firsthand. "All of the people who traditionally invest in food and restaurants are still looking at the models that they know," says co-founder Noah Karesh. "They still are having problems with these new models and unconventional ways of looking at the food industry. They still don't get it." Feastly participated in the accelerator and raised a small seed round of funding from angel investors.

Traditional investors aren't the only ones skeptical of investing in food-tech companies. "There are a lot of very fun ideas in this space but I'm not sure that makes it a good investment," Rosenheim says. Groupon showed that the hyperlocal market, for example, proved to be far more challenging than anyone expected. Anything that deals directly with restaurants is tough, she says.

Often founders don't think about the problem from a restaurant owner's mind. "They care about, 'Did the food show up? Did the people show up?'" she says.

Besides, the size of the opportunity is a lot smaller when startups realize they can't do it all. Too many attempt to win with mobile payments, and mobile payments split with friends, alongside photos of food, and automatic calorie counts, and restaurant reviews. There's a "throw everything at the wall and see what sticks" syndrome.

As this category matures, there will be a few big winners, but not before a few big blow-ups, which will have venture investors retreating in fear. Until then, food companies are having a moment.

VC's Bill Gurley and Chris Dixon have quoted a classic VC adage that says to raise money when the market is hot:

— Bill Gurley (@bgurley) July 27, 2012 For food-related startups, that time is now. Bon appetit!

Illustrations by Hallie Bateman