January 13, 2022

Sex Sells But You Can't Finance It

The adult industry is bigger than Hollywood yet it largely lacks access to basic financial services. Cutoff from banking, payments, and venture capital, it is remarkable the industry exists at all. We explore why the adult industry hasn't had access to financial services and the barriers still left to overcome today. We find that the industry is changing - the barriers are falling and funding is coming.

Hey friends -


It's a multi-billion dollar industry. Pornography is the largest in the "adult industry" - bigger than Hollywood - but it also includes subsets like sexual wellness. Wellness includes condoms, sex toys, and all varieties of consumer accessories.

Pornography has generally earned its reputation as high-risk business for financial services companies. A bank or payments company takes on risks including that a website hosts illegal content or that subscribers will dispute a charge. While good statistics are unavailable, it appears that porn has historically been beset with higher rates of shutdowns, chargebacks, and other expensive problems.

Sexual wellness doesn't experience these atypically high rates of problems yet is also treated as a high-risk business. They’re often cut off from financing, payments, and much of the financial system. It's an extraordinary failure.

But that's starting to change.

In this week's letter:

  • Sexual wellness: a multibillion-dollar opportunity that financial services is unlikely to keep ignoring
  • Alcoholic hamsters, not so safe deposit boxes, and more cocktail talk
  • A new age gin refreshes the always-great Negroni

Total read time: 10 minutes, 36 seconds.

An Industry Cut Off

The hurdles for sexual wellness businesses are many and large. Almost the entirety of financial services is structurally opposed to financing or servicing wellness companies.

Start with financing. Traditional options for a startup are either venture capital or bank loans. Both usually refuse to fund sexual wellness businesses.

Venture capital raises money from wealthy institutions and individuals and uses limited partner agreements to inform its investors what the firm will invest in and how the firm will operate. Standard terms include a vice clause - a specific restriction on "vice" businesses including the adult industry generally. Sexual wellness gets lumped in. As a result, most venture capitalists cannot invest in sexual wellness.

Banks are no better. Sexual wellness is treated as a high-risk by virtue of association with other actually high-risk adult industry businesses. Banks generally avoid engaging with high-risk companies lest they invite the watchful eyes of regulators.

Those few businesses that manage to access financing, or more likely self-fund their operations, experience yet another set of challenges when they try to accept payments. Visa and Mastercard materially restrict the use of their cards to purchase anything associated with the adult industry and place significant operational burdens on the few businesses they accept. American Express prohibits purchases entirely.

Most of the brand-name payment processors - including Stripe - follow suit. They include the entire adult industry, including sexual wellness, on their lists of prohibited businesses. A few payment processors do service the adult industry, but they charge prohibitively high rates. Whereas Stripe may charge a business customer 3% of each transaction, a processor in the adult industry typically charges 15-20%. Good luck building a business when the processor takes 20 cents of every dollar you earn.

Stripe’s prohibited businesses list.

It's more of the same with alternative payment systems like PayPal. They too prohibit the use of their services.

This is all quite weird. We have regulations to reduce the risk of dirty money finding its way into the system, including requirements to risk-rank businesses by their likelihood to perpetrate illegal activities. But sexual wellness isn't a high-risk business.

In the highly competitive world of finance, industries that can generate significant investment returns attract equally significant capital. Sexual wellness is a rapidly growing $30 billion market and yet the capital inflows are minuscule by comparison.

It's a fundamental breakdown of the core purpose of financial services - to facilitate the flow of capital from those who have it to those that need it. There's something else going on.

Systematic regulatory abuse

Starting in 2013, multiple government agencies collaborated on Operation Choke Point, an unauthorized effort by the Justice Department to target lawful industries with costly investigations designed to drive them out of business. The targeted industries included porn, sexual wellness, and just about everything else associated with adult industries.

The mechanism for causing pain was simple - go after the banks and payment processors. If businesses can't access capital, they'll cease to exist. From the Justice Department in 2014:

We are changing the structures within the financial system that allow all kinds of fraudulent merchants to operate [with the intent of] choking them off from the very air they need to survive.

To say this is a wild abuse of the justice system is a gross understatement. It is nothing more or less than the government creating a novel interpretation of the law to serve its own purpose without regard for constitutionally guaranteed rights. In 2014, the House of Representatives Committee on Oversight and Government Reform came to the same conclusion:

The Department's radical reinterpretation of what constitutes an actionable violation under § 951 of FIRREA fundamentally distorts Congress' intent in enacting the law, and inappropriately demands that bankers act as the moral arbiters and policemen of the commercial world.

The program nonetheless continued until 2017 when it was shut down by the new presidential administration.

The reverberations of Operation Choke Point go beyond the stymied access to capital for the duration it was in place. The initiative institutionalized regulatory uncertainty. Why take the risk as a bank or payment processor that you could unexpectedly be fined for engaging with an industry that appears perfectly legitimate? Why as a venture capitalist would you fund a business that could be cut off from the financial system?

That type of damage takes years to undo. It's only recently, five years after Operation Choke Point ended, that we're beginning to see capital flow to the industry.

Sexual Wellness Gets Funded

Most sexual wellness businesses are self-funded. Despite the odds, a small handful successfully raised outside capital in the past year.

Dame is a sex toy startup positioning itself upmarket and selling luxury branded products - the average price for their products is around $125. Direct-to-consumer makes up about half of the orders and 70% of the revenues, although that may change soon. They've signed multiple distribution partnerships including with Nordstrom. Inventory sold out a week after the Nordstrom launch.

That "sold out" pattern has been typical for the company. Their headline product sold out in 72 hours in 2020 and then sold out again three more times that same year. Sales doubled in 2021, and the company is already profitable.

Even with the remarkable successes, the company only raised $4 million in funding in 2021. Over 10 investors participated in the round, the largest of whom has only raised $15 million themselves. A startup with similar success in almost any other industry would command more money at a higher valuation from more prominent investors.

Foria has similarly positioned itself as a luxury brand but sells CBD-infused oils, lubricants, bath salts, and related goods. The startup grew sales from 2016 to 2020 at almost 90% per year. Yet they too have only raised limited funding and from smaller, less known investors.

It seems it is possible to break out and access funding more typical for highly successful startups. Hello Cake’s $4 million seed investment round included well-known venture capital firm Lerer Hippeau. Maude’s pre-seed investment was led by XFactor, the seed included RRE, and the company has since raised a $5.8 million Series A. Both startups offer a much wider range of products at less premium price points.

But even these numbers are relatively small by industry standards. Average seed investment rounds were $4.6 million in 2020, larger than the seed round raised by any of these startups.

Average seed rounds for startups generally are bigger than the biggest seed rounds raised by most sexual wellness startups.

There has been a benefit for the industry as a whole from the limited funding - it has created a rich playground for novel business strategies.

Business model experimentation

Some similarities run throughout all of these sexual startups. They're all positioned as sex-positive, regardless of sexual orientation or gender. That's reflected in not just the language, but their use of models. All have blogs or weekly emails educating consumers on not just products, but also a wide world of sex.

Beyond that, the market positioning diverges.

Dame and Foria position themselves as luxury brands. They sell a limited range of products at $100+ price points. The website design and marketing language reinforce their positioning.

Hello Cake has taken the opposite approach - bright colors, many products, low price points, and playfully immature language. Maude is somewhere halfway in between with a broad product set, low price point, but a website experience more reminiscent of a luxury brand.

Where Foria emphasizes the not-yet-proven benefits of CBD and THC, Dame instituted a clinical board made up of physicians to advise on their product development. Hello Cake goes in a different direction entirely using customers reviews to pitch their products, and Maude yet another one with celebrity endorsements. As quoted to Instyle by Maude investor and advisor Dakota Johnson of Fifty Shades of Grey fame:

Oh, this is going in everybody's stocking. Are you kidding? It's the perfect stocking stuffer. You think your uncle hasn't wanted a butt plug his entire life?

Such approaches - luxury branding, playfully immature language, and headline-worthy celebrity quotes - may be the only way to get noticed. There remain significant challenges to getting the word out and building a business.

Significant hurdles remain

Traditional marketing channels are largely a non-starter for most sexual wellness businesses.

The most popular places to advertise direct-to-consumer products - Facebook and Instagram - are off-limits. Parent company Meta prohibits "sexually suggestive" and "sexually explicit" content. The prohibition extends to "activities that are overly suggestive," which ensnares most sexual wellness content.

Google's various platforms are not much better. The company permits "sexual merchandise" to advertise, but only through Google Ads and Google Search Network. That means no YouTube. That's a significant restriction given the volume of content produced by sexual wellness startups as they educate consumers about their products and sex-ed generally.

Non-digital channels are similarly challenging. It took two years and a $150,000 lawsuit for Dame to win the right to advertise in NYC subways. Among the prescient points in their lawsuit is the divergent treatment of male and non-male targeted advertisements. A side-by-side makes this abundantly clear.

Bonus points for Dame making subway puns.

The MTA prohibited the ad on the left from running. The ad on the right was approved. Other ads featuring poorly clothed women advertising "breast augmentation" and an 888 number to call if you're "Still A Virgin?" were also approved.

Digital channels are no better, as another side-by-side makes clear.

This was the among least egregious of the Hims ads.

Both were Instagram ads. The ad on the left was taken down for violating terms of service while the ad on the right continues to run as of the time of writing.

Marketing is just one hurdle. Even launching an online store, of which there are over 12 million, can be a challenge. Shopify's terms explicitly prohibit "sexually-oriented items (e.g., adult toys)" from using their payment services. While these terms may not necessarily be strongly enforced - all four startups covered earlier use Shopify - it poses a tremendous threat to business. Who wants to start or operate an online store that can be shut down at the whim of Shopify?

But there is a bright side to all of these challenges.

Big Risks, Big Rewards

Despite all of the challenges, the sexual wellness market is conservatively estimated to be over $10 billion and growing more than 5% per year. 85% of industry revenues are attributable to sex toys.

Even these numbers seem improbably small. Take subscription-only OnlyFans for comparison, a startup launched in 2016 to enable "creators" to sell their video content directly to consumers. The company has over 150 million registered users and has paid out over $3 billion to its 1+ million creators. It seems exceedingly unlikely that a single company facilitates billions of dollars of payments to creators and the entire sexual wellness industry is only 3x larger.

Far more likely is that the market size is grossly underreported. Who could blame the business owners from whom the statistics have to be collected? When media attention results in your bank or your payment processor cutting off services, why would you invite unnecessary attention?

For those willing to stomach the risks, there are massive opportunities in sexual wellness. The tides are shifting.

Small venture capital firms, including the aptly named Vice Ventures, have recognized that this is a market protected from the bigger firms with whom they normally compete for deals. As the startups they fund grow, and these smaller venture capital firms normalize the investments, larger firms will follow.

Startup banks have a similar opportunity to service sexual wellness companies while the shadow from Operation Choke Point continues to deter the more established names. It's a particularly attractive market to serve. The historically tenuous access to financing has required sexual wellness businesses to be highly profitable in order to survive. That's exactly the type of customers newer banks need to attract if they're to be successful.

There are also opportunities for the payment processors. Payment processing has emerged as a hyper-competitive market over the past decade, including high-flying Stripe, a startup valued at $95 billion. Payment processors make money as a percentage of the transactions they facilitate, typically around 3% of each purchase. Adult businesses are the exception and deal with processors who charge 15-20%. The startup that provides cost-effective payment services to the sexual wellness industry stands to make a lot of money.

Similar opportunities have played out in adjacent industries that were also taboo until recently. Signature Bank and Silvergate took risks banking cryptocurrency firms - the services they provide are now crown jewels for their respective banks. Cannabis is following closely behind with billions of dollars of venture capital funding, medical and/or decriminalization in 39 states, and full legalization in 18 states. We're already seeing the first wave of massive cannabis-focused financial services firms, including payment services firm Dutchie valued at $3.75 billion.

The historical failure of financial services to service the sexual wellness industry won't be the future. The opportunities are too big to ignore. The risks are small and the hurdles to building a business are falling by the wayside. Give it a few years. We'll see multibillion-dollar sexual wellness startups emerge and a robust ecosystem of financial services startups that serve them.

Cocktail Talk

  • Large private companies may soon have to report financials similar to if they were public. The number of public companies in the US is down 50% since the mid-90s and continues on an almost uninterrupted downhill trajectory. That limits investor access to promising companies where they could generate meaningful returns. Among the major reasons? The ever-increasing costs of being a public company imposed by over-enthusiastic regulators. Rather than burdening private companies, what if we made it attractive to be a public company again? (WSJ)
  • Citadel Securities made headlines in 2021 as the primary market maker for Robinhood, a stock trading app. Robinhood gets paid by Citadel for routing investor trades their way, an arrangement known as payment for order flow. Regulators are now exploring banning such arrangements. Citadel made headlines again this week for accepting $1 billion in venture capital funding, including from a major cryptocurrency investor. As one revenue stream dries up, I expect Citadel will expand into marketing making in another asset class - cryptocurrency - where the regulations are further behind. (WSJ)
  • Would you store your valuables in a Not So Safety Deposit Box? Probably not, but it turns out that's exactly what deposit boxes are. Few regulations govern depositors' rights and banks retain little-to-no liability for maintaining the contents - including if they accidentally empty the contents of your box and fail to return it. (NY Times)
  • Hamsters love getting drunk. Or at least they love trying to. They'll happily consume a daily volume equivalent to a human drinking 1.5 liters of 190 proof Everclear. It's likely as a result of their diet. In the wild, they stash seeds and fruit in preparation for the winter. Over the many months of cold, these food stores ferment and leave the hamsters with alcohol-rich foods until the weather gets warmer. I only wish I could have been on the review team for whichever grant funded the research. "You want to do what? Feed a bunch of rodents booze and see what happens?" (The Atlantic)

Your Weekly Cocktail

A classic updated with a new age gin.

Tamworth’s Negroni

1.0oz Tamworth Garden White Mountain Gin
1.0oz Campari
1.0oz Dolin Rouge Vermouth

Pour everything into a mixing glass. Add ice until it covers the alcohol. Stir for 20 seconds (~50 stirs) until the outside of the glass is frosted. Strain into a rocks glass and enjoy! (Optional: I prefer mine straight up, but this works equally well on the rocks.)

Tamworth’s Negroni

I have a particular love for Negronis. They’re a go-to pairing with pizza and other fatty, acidic meals. Incredibly simple - just three ingredients in equal proportions - the Negroni is both a great cocktail in its own right and a wonderful starting point for so many others. While you can use any mass-marketed gin, the Tamworth Garden White Mountain Gin turns this drink into something special. It’s a gin that showcases the best of the ongoing gin revolution, balancing the often overwhelmingly pine flavors of many gins with floral and citrus notes that make it a far more complex liqueur. Remarkably, it shines through even when paired with Campari’s extremely bitter citrus flavors.


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