Xander Oxman and Brett Brewer

Xander Oxman and Brett Brewer Photo by Courtesy Photo

When online kids’ clothes retailer Wittlebee emerged from Santa Monica incubator Science in early 2012, it quickly garnered investor interest.

Only a few months after launching, the Culver City company announced $2.5 million in seed financing. Investors liked its subscription model; the company sends a box of children’s clothes in exchange for a $40 fee each month.

But now, investors seemed to have soured on e-commerce subscription businesses.

Wittlebee Chief Executive Sean Percival experienced that first-hand. After months of fundraising to little success, he stepped down from his post last month.

“The investment dollars are simply not there,” he wrote in an email to the Business Journal. “Investors are cooling down on all consumer and e-commerce investments in general.”

The market has been inundated with subscription e-commerce businesses, which have clustered in Los Angeles and the Silicon Beach area of Santa Monica. These companies tend to follow a similar format: Customers take a style quiz or indicate buying preferences and then receive a monthly selection of personalized items shipped to them for a flat monthly fee.

Other companies have found similarly dry coffers when they’ve gone out looking for cash.

Wine-of-the-month service Club W had a hard time fundraising for a seed investment in Silicon Valley. When the company eventually found Santa Monica firm CrossCut Ventures to lead its $3.1 million round, it moved its headquarters from San Francisco to El Segundo.

“We joke that we came in at the worse timing not just for subscription commerce but for wine in general,” said Xander Oxman, co-founder and chief executive of the online wine retailer. “I’ve definitely met other companies starting subscription commerce businesses that have expressed that they’ve gotten the same response in their early stage meetings.”

Cash crunch

Subscription commerce made a comeback in 2009 when Santa Monica retailer ShoeDazzle put a modern-day twist on the classic CD- or cheese-of-the-month model.

By 2010, BeachMint in Santa Monica began selling jewelry for a monthly subscription and JustFab in El Segundo was charging for a monthly shoe delivery.

Those online retailers raised millions of dollars on high valuations, causing a frenzy of copycat companies to spring up. Droves of startups positioned as thing-of-the-month clubs or something-in-a-box subscriptions have since entered the market.

But with the exception of JustFab – which expects to turn a profit later this year – subscription commerce has experienced growing pains.

ShoeDazzle eliminated its monthly fee last year. The move swiftly prompted the departure of its chief executive and a round of layoffs. Earlier this year, the company brought back a hybrid version of the subscription.

BeachMint, meanwhile, has lost some of its executives in recent months as it’s faced criticism for expanding into too many products too quickly.

Problems at the companies that pioneered the model have caused some investors to question the long-term success of the monthly fee. As a result, they’ve started putting away their checkbooks when subscription commerce startups come knocking.

“The space got overfunded and a lot of these early subscription commerce players failed,” said Brett Brewer, co-founder and managing director of CrossCut. “It’s out of vogue, especially in Silicon Valley. The consensus is, whoa, subscription commerce may not work as well as we thought.”

CrossCut, also an early investor in JustFab, has remained bullish on subscription e-commerce despite the prevailing attitude in the venture capital community. But Brewer said he’s still hesitant to invest in a startup that appears to have slapped the subscription fee on to its business plan.

The problem, he said, is that too many online retailers are trying to find ways to incorporate a membership plan because it’s trendy and helps establish a recurring customer base – something many e-commerce startups struggle to obtain.

“There’s a misnomer out there that you can apply subscription e-commerce to anything,” Brewer said. “Los Angeles got fascinated with it. That’s made funding much more difficult.”

‘Very normal’

Adding to the pressure for subscription commerce companies is the “Series A Crunch,” a problem defined not by a decrease in funding available but by a surge in companies raising seed investments. That means more companies are looking to raise institutional investments than there is venture capital money to dole out.

The Business Journal looked at more than a dozen e-commerce companies that have gone through local accelerator and incubator programs in the last two years. A number of them have raised seed funding beyond the money invested by their accelerators and incubators. But only one had also managed to raise a Series A round.

There could be a number of reasons those companies haven’t yet raised a Series A, but some might have felt the same e-commerce backlash experienced by Wittlebee and Club W.

Jeff Solomon, executive director of Venice accelerator Amplify, said he’s helped two e-commerce companies recently raise seed funding, but he’s seen the market tighten for Series A rounds.

“It’s difficult to get a deal done, period,” he said. “But there’s been some backlash around subscription. Right now there’s definitely a negative opinion about subscription and e-commerce.”

Some investors caution against blaming the venture capital climate for funding failures.

One needs only to look at JustFab’s giant $76 million round last summer or the $9.8 million that razor membership service Dollar Shave Club raised in November as proof that subscription e-commerce is still finding investors.

But firms that took big bets on early subscription successes appear to be waiting for those investments to play out before they look to a new crop of e-commerce companies waiting in the wings.

Mark Suster, a partner at Century City firm GRP Partners, said it’s natural for venture capital money to follow the latest trends.

Take, for example, Groupon Inc. in Chicago, which spawned dozens of daily deal copycats. Many of them received funding while Groupon was growing, but investors would likely turn up their noses at such pitches today.

“When a category becomes popular, a lot of money pours in,” Suster said. “Then people wait to see what the results are and they start looking at other categories. Naturally there’s a cooling off period where capital shifts to the next big deal. It’s very normal.”

Going forward

But in the meantime, cash-strapped startups such as Wittlebee will need to look for alternative funding options.

With Percival’s departure, it’s not clear what will happen to Wittlebee. The company, which had more than $200,000 in March bookings – revenue from monthly subscriptions and one-off purchases – is still operating but is in need of a new chief executive.

A spokeswoman for Wittlebee incubator Science said that “investors and board members are evaluating their go-forward opportunities.”

Percival said the subscription model made sense early on because kids quickly outgrow their clothes.

One of Wittlebee’s biggest challenges is that it began by selling other companies’ clothes, including American Apparel Inc. and Threadless. But to raise margins and grow the business, the company needs to follow the path set by other retailers and begin producing its own line of clothes.

Percival said he considered a sale or merger, which would have given the company the money it needed to continue evolving. But when those strategies didn’t pan out, he decided it was time to step down.

“Once those options had run their course I couldn’t keep building,” he said. “We didn’t have the capital to do so and my passion was simply no longer there.”

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