LAS VEGAS — A perfect storm of evolving consumer sentiments and research-driven innovation is fueling today’s $50 billion pet food and treat category. The emotional connection between pet owners and their four-legged companions, rigorous quality and safety standards, and the industry’s relative resistance to economic tensions are all defining factors of this industry. These unique nuances are what makes it a beacon for private equity investors looking to tap into high-growth categories.
“Every time we believe there's a level of interest that can't be exceeded, new entrants turn up,” said Seth Kaufman, co-founder and partner at BSM Partners, Bentonville, Ark. “…I think the amazing thing about pet food is the level of passion among consumers. The willingness of consumers to translate their passion into high value purchases and the durability of those businesses when you look across the industry is titanic. It checks almost every possible box of interest for private equity firms, and there are a number of firms that have had tremendous success time and time again.”
The steady growth and tested resiliency of the pet care industry is being recognized with a flood of private equity interest. However, some of the same nuances that make this market so lucrative are also the most common stumbling blocks for profitable investments. Understanding these subtleties — including the science behind pet food, trends driving innovation, market viability, and operational limitations — is often the difference between a smart, mutually beneficial investment and a foolhardy venture.
Pet Food Processing sat down with Seth Kaufman and Nate Thomas, co-founders and partners at BSM Partners, at SuperZoo 2022 to discuss the current private equity interest in the pet industry, common pitfalls for long-term success, and advice for firms looking to enter the pet space.
Not your average CPG
While this market is ripe for investment activity, that does not mean it’s the right path for every brand. Thomas noted it’s not uncommon for a company founder to get “thrown out” of their own business after being acquired by a private equity firm.
“Generally speaking, that's not a result of the founder; it's a result of the due diligence process that was probably not done very well in the beginning,” he added.
According to Kaufman, those who aren’t familiar with the pet industry often tend to oversimplify the market. A pet industry brand may look a lot like any other CPG brand on paper, he said, but it’s a much different ballgame in practice largely due to industry-specific nuances. A lack of understanding — or an unwillingness to learn and adapt — can make or break an investment.
“We believe those levels of nuance require expertise,” Kaufman said. “There are several challenges inside of pet that are much more difficult to navigate than traditional consumer package goods.”
One of these nuances is the consumer. Pets cannot make their own purchase decisions, much less voice their opinions on the nutritional products chosen for them. This necessitates a different strategic business approach — one that is unique from other CPG categories and prioritizes the emotional connection between pet owners and pets.
“One of the things that we’ve always been pretty amazed with in pet care is many consumers seem to be more concerned about their pet’s nutrition than their own,” Thomas said. “…Pet owners are more passionate than other consumers. It’s what makes this industry really special: passion.”
Another important distinction that separates pet food from other CPG categories is nutrition itself. Ensuring product claims are truthful is of the utmost importance, and while weeding out false or unsubstantiated claims can be an arduous process, it’s better the truth comes out before a purchase is made. According to Kaufman, these discrepancies oftentimes go unnoticed until after the purchase is completed, which can cause a mess for the private equity firm involved.
“So many of the pitfalls come on the nutrition side, where founders make certain assurances, but they're not based in science,” Kaufman said. “Those assurances are taken at face value, but we in the pet care industry have a moral obligation to ensure them, because you can't get feedback from a pet.”
It’s this moral obligation that truly separates a pet brand from the CPG category at large. This also speaks to the fact that pets are generally limited to just one type of food, so all essential nutrients must be delivered through a singular diet.
“We find time and time again that the promises that are made are not lived up to, and that fails every moral obligation,” Kaufman added. “Especially when you look at the level of consumer engagement and the passion that people have, it's really the lack of alignment between those two things that we view as a moral failure.”
Developing an understanding of this industry also requires an understanding of operations — especially, as Kaufman pointed out, in today’s volatile supply chain environment. Private equity investors are ultimately looking for a return on their investment. This necessitates thorough vetting of a brand’s promises against supply chain volatility, as well as its growth projections against operational or addressable market limitations.
“Understanding your supply chain is one of the most critical things, as well as understanding the capability of the manufacturer, whether it's yourself or someone else,” Thomas said. “If there is a factory involved, make sure you understand what that factory can produce and how it performs. Understanding the actual assets that you’re getting into is critical and, again, this is where you want to bring experts in to do that.”
Private equity firms would do well to understand a brand’s long-term growth plans and how they stack up with current and future manufacturing capabilities. Thomas noted the importance of having a clear succession plan for production, especially for brands working with co-manufacturers. The due diligence process should include questions like, “Will your current manufacturing partner continue making this product for you?” and “Are there other co-manufacturers you can work with if this falls through?”
“If there's only one factory that can do it for you and you don't want to build your own factory, you may be in trouble at some point,” Thomas added.
Aside from various disruptions seen across a number of industries, including pet nutrition, the passion and emotional investment of pet owners makes the supply chain for pet food and treat products “truly different than other industries,” Kaufman said.
“Especially when you get into specialty ingredients, and especially when you’re looking to uphold a brand promise, there are really critical risks around the scalability of supply chains, and we continue to see private equity firms make mistakes and then struggle because growth projections are made that can’t possibly be validated — other than in a spreadsheet — because the supply chain simply isn’t there to support it,” he added.
“A lot of times, people don't realize that what they've done got them here, but won't get them there,” said Nate Thomas, co-founder of BSM Partners.
Understanding the supply chain for specialty ingredients, including vitamins, becomes increasingly important as the industry continues to shift toward functional, solution-based formulations targeting specific need states and health concerns. This circles back to what makes the pet food market so unique; if reliability on certain ingredients solidifies key brand claims, supply chain instability compromises on those nutritional promises and could tarnish a brand’s reputation.
This concept rings true for both supply chain viability and scalability. Kaufman noted he has seen brands with a “secret sauce” make growth projections that are unrealistic given the available supply chain for key ingredients. Additionally, it’s important to understand the addressable market and where limitations may present themselves. If a brand is promising significant revenue growth, private equity firms must be aware of those claims as they relate to the size of the addressable market.
“We see it both in the market sizing as well as in the supply chain, where those things don't scale in the way that spreadsheet projections would have you believe,” Kaufman said. “It takes a level of domain knowledge and due diligence discipline that we fail to see time and time again.”
All this makes due diligence a crucial factor and a common pitfall for private equity investors.
Due diligence or die trying
Financial due diligence is a given for any venture capital investment, but understanding a brand’s place in the market and how that position is supported from a technical perspective is equally important, yet often overlooked.
“We believe that conventional financial due diligence is a necessary but not sufficient condition for success in the pet care industry,” Kaufman said. “Even firms that have had repeated success from a private equity investment perspective can miss the boat on this.”
This is where technical due diligence comes in. Technical due diligence involves everything from operational acumen and supply chain feasibility to market availability and consumer perception of a brand.
Global conglomerates such as Nestlé and Colgate-Palmolive have successfully navigated these complex nuances by establishing and maintaining separate entities for their pet nutrition brands, Purina and Hill’s Pet Nutrition, respectively. Backing these pet food businesses with pet industry experts is one way to ensure the needs of consumers — both pet owners and pets — are met both on paper and in practice.
“Everyone's going to fatten their cow up for slaughter, but that doesn't necessarily mean it's going to be good fat,” said Nate Thomas, co-founder of BSM Partners.
“If I was going to give advice to a private equity firm that wanted to get into the pet care industry, I would say they need to seek experts in that industry to understand what's really going on, to understand where profitability is and what you should avoid,” Thomas shared. “Everyone’s going to fatten their cow up for slaughter, but that doesn’t necessarily mean it’s going to be good fat. The due diligence process is one of the things that a private equity firm must be aware of, and something that, in our estimation, generally is not done very well.”
In short, private equity firms looking to enter the pet food space should lean more heavily on technical due diligence to inform investment opportunities, as well as hire vetted industry experts to advise current and future business strategies.
“Everyone makes an investment with an intention to grow it massively,” Kaufman said. “That’s another reason why private equity and other investment firms are so keen on pet food, because in good times and bad times, people love their pets, and that passion, that level of engagement drives spending behavior. The human animal connection is magical, and consumers’ purchasing decisions reflect that magic.”
Picking a partner
BSM Partners is a full-service consulting firm serving the pet care industry through a wide range of business services, including engineering, innovation, operations, research, nutrition, veterinary and quality assurance, as well as leadership transformation. The firm also offers strategic consulting services for entrepreneurs and established brands alike.
For example, BSM Partners recently launched its Young Entrepreneur Mentorship Program as part of its emerging startup services, in which 15-year-old Ava Dorsey, founder of Ava’s Pet Palace, has been selected as the inaugural participant.
“We provide strategic guidance, strategic support, investor relations, and all of the technical skills that brands need to extend their reach and to really achieve the scaling goals that they need,” Kaufman said. “That's our primary purpose, and so we've begun startup services in an effort to broaden that. We are able to leverage our network of connections with people that we've known for years to help provide the key growth opportunities that clients need to achieve their mission.”
BSM Partners provides technical due diligence consulting to help brands identify private equity opportunities based on factory capabilities, nutritional claims, supply chain viability, and a slew of other qualifiers for success in the pet nutrition space. This service also helps private equity investors with risk mitigation.
“We feel a very strong obligation to our industry,” Thomas said. “We like to have the ability to connect our clients with investors if they need that. From our standpoint, probably the best way to partner with us is to pull us into your due diligence. If we make those connections, then we can add value.”
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