Over the past year, we’ve seen a significant rise of companies in the dark store space. Dark stores, which are fulfilment centers such as micro-warehouses in urban centers, stock goods that a traditional convenience or grocery store would. By utilizing data and technology, they calculate where their warehouses should be located, and what goods to stock up on.

From Online Grocery Shopping to Dark Stores

Dark stores seek to fill the needs that online grocery shopping has left unsatisfied. For example, online grocery services typically take 2-12 hours to deliver orders, and depending on the location, order, and time the order was placed, even longer. Dark stores work by employing technology and data models to deliver the most popular items in an urban area, within fifteen minutes. Additionally, the SKUs change based on customer preference, but the selling point remains the same: a fast turnaround for delivery helps grocery shopping evolve into an on-demand utility.

Dark stores are increasingly popular among investors too. Some of the best investors in the world have recently written nine and ten-figure checks for them, helping propel startups into unicorn and in short time, decacorns. In fact, leading dark store companies have raised over $8.0 billion in capital over the past several years, based on our own findings. We expect this trend to continue as increased online shopping trends endure during and beyond the pandemic.

Risky Business Model

In order for a successful dark store model, there must be a network of physical real estate in place to ensure quick delivery. Dark stores are most often between 250-5,000 square feet, and spread across a city. Dark store “micro-warehouses” are surging across New York City as startups plan to open hundreds of new centers. So what’s the problem?

Startups often deploy venture-backed capital to sign real estate leases, and enter into multi-year agreements. This locks in cash flow, and is not only costly, but leads to an asset-liability mismatch. Why? Lease agreements typically last several years, but dark stores must fulfil a set number of orders every month to break even on their real estate costs. While signing a lease with venture-backed money could be considered one way to scale quickly, expand one’s footprint, and build out their network, there’s one glaring problem. This was the same model deployed by coworking providers and short-term rental operators, and contributed to their decline.

Lessons from Coworking Industry

While part of the initial success of coworking providers was due to the ability to develop new locations quickly and provide users with flexibility, the model hasn’t proven itself long-term. The same lease arbitrage model that assisted entrepreneurs who sold short-term but bought long-term to benefit from the difference, collapsed during the pandemic. With a decline in revenue and lease payments still due, venture financing dissipated. The result was that most of these businesses defaulted, renegotiated their leases, and eventually closed for good.

How Dark Stores Can Avoid This Fate

In the case of coworking and short-term rentals, the mismatch between cash inflow and outflow, along with too much reliance on venture financing, was a devastating combination. Dark store operators need to find an appropriate balance of growth and operating leverage on their balance sheets. While commercial vacancies are at all-time highs, it provides prospective tenants with a chance to negotiate revenue share or management agreements with landlords to decrease the amount of contractual cash owed each month.

Critically, dark store operators must develop an individual propco entity to hold real estate leases, funded by non-venture backed funding. The venture-backed core operating entity, or opco, would serve to build out the product and tech, while the propco could align the sources and use of capital. The propco could potentially find alternative sources of capital as well.

Closing Thoughts

While the venture capital world is fast-moving, in the case of dark stores, slowing down could be the best solution. With ever-changing consumer needs, the first to act on building a network effect will most likely see the results. However, dark store operators need to look back at previous asset-heavy industries, and learn how to grow sustainably, rather than quickly.

Kunal Lunawat is a Co-Founder and Managing Partner at Agya Ventures. Prior to Agya Ventures, Kunal built technology and product at Hannover Re, a leading reinsurer based out of Germany. Kunal started his career as an investor at Blackstone, where he was part of the firm's real estate private equity practice. Kunal grew up in Calcutta, India and was inspired by his father, who is a first-generation real estate developer. Kunal holds a BA in Economics from Yale College and an MBA from Harvard Business School, and currently lives in New York City.