When the personal care brand Aesop knew it was ready to expand into overseas retail markets, all funding options were on the table.
Partnering an established international brand made some sense; it would have given the small but established Australian company an automatic leg up into the somewhat fickle and brand-conscious world of international retail fashion and beauty.
But that option wouldn’t ultimately suit Aesop. For one thing, the company had already groomed its own unique look and feel over the years, something that would be difficult to fit with a portfolio of brands. When Dennis Paphitis established Aesop in Melbourne in 1987, he envisaged bottles and concoctions that would create an aesthetic somewhere between minimalist pharmacy and 1930s barbershop. Paphitis remains the majority owner of the company.
More importantly though, chief executive Michael O’Keeffe says that allowing an overseas company to take an equity stake in the business at such a critical growth phase could have narrowed Aesop’s medium- and long-term possibilities. O’Keeffe was concerned about giving a third party the first right of refusal before it was able to make its own mark on the world.
That was three-years ago and approaching the banks was quickly ruled out as a viable option to fund growth.
“Banks ask for personal guarantees and the backing of hard assets,” he says, two things the owner and executive either weren’t willing to give up or didn’t have.
So in December 2010, Aesop agreed to sell a 40 per cent stake to a Harbert Australian Private Equity fund. In the more than 2½ years since, the company has opened 20 new stores and now has a presence in the United States, Britain, France and Asia; it has doubled its revenue; and it recently acquired distribution in Hong Kong.
As many heads of middle market companies who have been through this process will attest, what private equity really brings – well beyond the injection of capital – is the discipline and structure necessary to develop into a decent-sized business.
Harbert was instrumental in setting up a board of directors and O’Keeffe now had reporting lines and accountability.
“As a CEO of a business you can feel quite alone, now decisions aren’t just made by me, they are made by the board. All of a sudden it felt like a real business,” he says.
Private equity firms bring a big focus on strategy in terms of where the business should be, as well as a sophistication and strong focus on corporate governance, Deloitte Private corporate finance partner David Hill says. “That’s a good thing for a maturing business,” he says.
Hill points to private equity firms Archer Capital, CHAMP Private Equity, ADVENT Private Equity and RMB Capital Partners as a few of the main Australian funds focused on the middle market.
But of course, business owners have to weight up the pros and cons of bringing in private equity with other methods of funding growth.
From an academic standpoint, bank debt should be the business’s preferred choice of funding because at about 7 per cent, the cost of the debt tends to be cheaper, Hill notes.
“The problem with bank debt is you either can’t get enough, or you can have too much and you are vulnerable to bankruptcy,” he says.
A common issue among growing middle-market companies – as O’Keeffe points out – is that banks in Australia generally are unwilling to consider the business as an asset in and of itself as security for a loan. Even against cash flow as reliable as MasterCard receivables, Tyro Payments chief executive Jost Stollmann says Australian banks aren’t interested in extending lines of credit.
In a common chorus harked by middle-market executives, Stollmann says, “I am unable so far to get any loan facility that is not linked to a private collateral … [I would like to see] banks as partners actually spend some time investing, understanding a business and lending against an understanding of the business, instead of stitching up mortgage, house, wife and dog.”
Swisse Vitamins chief financial officer Adem Karafili, who had the same experience as O’Keeffe, Stollmann and others, says his company previously had a relationship with one of the big four banks but recently changed its relationship to an international bank that approached the business, offering financing secured against the cash flow and brand of the business.
“They didn’t want any security from the directors or their houses or anything like that because they figured the debt would be easier to recover than someone’s house,” Karafili says.
“It’s been a breath of fresh air, especially dealing with people [to whom] we don’t have to spend years trying to explain how we do business.”
A good brand always can be leveraged as collateral for a loan for a growing business, notes Denis McFadden, who started the hairdressing franchise Just Cuts 21 years ago.
“We get 50 per cent against the brand and then the franchisee has to find the rest,” he says of his discussions with banks.
In one-way or another, most growing businesses in the middle market will have entered into a relationship with a lending institution. Hill notes, that in addition to providing capital, the bank relationship can be a good thing for discipline early on.
“If you have reasonable debt funding and you miss a payment, you have to look in the mirror before you go to work and make the most of it every day,” he says.
The founder of Jetts Fitness, the successful 24/7 gym franchise, Brendon Levenson, knows all too well that feeling described by Hill as he recalls the moment he realised he had gone through most of an overdraft facility he had brought over from a previous business to fund the frenetic pace of gym openings.
He says it was “pretty scary” walking into his office one day and discovering he had eaten through $99,000 of a $100,000 overdraft facility. “It’s not a good position to be in when you’re looking at an overdraft that’s almost done.”
“Within two or three hours, we found that our debtors’ list was getting a bit out of control – we were focusing on growth and all the things that you are doing in a fast-growth environment and just letting some of our franchisees treat us as a bank. We tightened that up ... and learned discipline and that stayed with us from that day.”
Now with 178 franchisees across the country, Levenson can use Jetts’ cash flow and balance sheet to get a good debt line to fund the next growth phase. Still, the overdraft memory sticks with him and Levinson knows not to take on more than the business needs.
Hill acknowledges that middle- market businesses generally go through a “progression of financing”, starting with “friends, fools and family” at start-up stage, then angel funding, venture capital, bank debt, corporate debt, private equity and, potentially, a listing on the stockmarket.
Not before a business is in the realm of $100 million turnover or $10 million EBITDA will it consider an initial public offering, Hill says.
First Australia, then the world
Lorna Jane’s financing journey led the women’s active wear clothing brand to private equity 18 months ago and its next progression may lead the company to another private equity investment, this time in the US.
In March last year, CHAMP Ventures announced it had taken a majority stake in Lorna Jane to catapult the retail brand’s push into the highly competitive US market.
The company’s chief executive, Bill Clarkson, says the business has reached a size that is likely be too big a bite for Australian private equity to consider taking on.
“We are at the cusp of being at another level – anything over $200 million is no man’s land [in Australia], it’s another game,” he says.
Clarkson says he wants Lorna Jane to become a global brand. “We are going to the US with our record, we want to attract a bigger private equity company with a similar strategy,” he says.
Companies up to $US1 billion are considered middle-market in the US.
Lorna Jane’s initial journey to find an equity partner started in a similar way to Aesop’s in that Clarkson and his wife, founder and creative director, Lorna Jane Clarkson, initially considered a trade sale.
He says they talked to the likes of the Apparel Group, Athletes Foot and Pacific Brands.
“They were going to tell us how to run the business; we wanted to run it ourselves, we didn’t want a retail company telling us what we were doing wrong,” he says.
But unlike Aesop, Clarkson says the company didn’t need the money to grow as much as it was a way for the founders to “take some money off the table”, which he says has allowed the pair to be able to think bigger about the future growth of the company.
For Clarkson, private equity “made a lot of sense” because he says CHAMP is in the business of making money, “we were in the business of being customer centric, it was a perfect yin and yang.”
Clarkson says he has a candidate for a new private equity investor that specialises in companies in the $US200 million to $US500 million range.
One thing Aesop’s O’Keeffe stresses as important in the context of bringing on a private equity investor is to consider the timeline they operate by.
“Once you sign up with private equity you know another transaction will occur when they look to sell their stake.”
Most private equity firms hold their investments for three years and sometimes stretch that out to as long as five years.
O’Keeffe raises the issue that once you accept the investment, you will be locked into taking action three years later. “It doesn’t lock you into a full exit but it creates a medium-term option for something else to happen,” he says.
The next step for Aesop is most likely a trade sale, O’Keeffe says.
At this stage, he says, the company’s founder is thinking about his own exit options and Aesop is in the process of talking to a potential long-term trade partner, where the brand could sit within a portfolio of other brands.
When is a potential sale likely to happen?
“Well, the three year mark is coming up,” O’Keeffe says.