June 24, 2014


In one of those odd coincidences Monday’s edition of Canada’s newspaper of record presented two articles detailing the struggles of two Canadian clothing industry entrepreneurs seeking to reclaim leadership of their (now publicly traded) companies. The articles underscored the tradeoffs between, on the one hand, the capital and publicity an IPO can bring and, on the other, the desire to maintain control of a corporation’s strategy.

The first article was on seemingly ubiquitous vendor of yoga and sports clothing, Lululemon Athletica Inc. (LULU – NASDAQ). The second related to American Apparel Inc. (APP-AMEX), the rather more controversial vendor of non-sweatshop cotton clothing.

Neither company is trivially-sized. Emerging from its roots in British Columbia Lululemon has grown to command $1.6 billion in sales, 7600 employees and a market capitalisation of $6 billion. It boasts and impressive 11.8x EV/EBITDA multiple. The smaller American Apparel generates $0.6 billion in turnover, employs 10,000 staff and, despite challenged finances, has an enterprise value of $350 million. It trades at less than 1/5 the price to sales ratio of Lululemon.

Lululemon’s founder, Mr Chip Wilson, owns 28% of the company. Last month, displeased with the company’s direction he attempted to replace two members of the board of directors and stimulate a course correction. Rebuffed he has reportedly engaged with investment bankers to discuss, amongst other things, taking the company private. Other alternatives include selling his stake, but the notion of his partnering with private equity to return the company to his control was sufficient to send the shares up 4%. This jump in the share price was despite criticism from some customers when Mr Wilson was reported as saying that Lululemon’s clothes don’t work for some women. Many complained, but some investors credit him with having driven the company’s growth and evidently found the unique and idiosyncratic nature of Mr Wilson’s vision more appealing than the more traditional approach to apparel retailing favoured by the board.

American Apparel’s founder, the vastly more controversial Mr Dov Charney, is a Canadian who moved to Los Angeles. Having IPO’d the company he retains a ~25% equity position. His firm’s branding is decidedly more edgy whilst he has been the subject of controversy. Mr Charney was recently removed from his role by the board in the wake of behaviour and allegations that the Globe & Mail termed “serious but unproven” and that one analyst quoted in the New York Times referred to as “sordid”. He is now demanding re-instatement. This dismissal may result in a notice of default or, perhaps more likely, a financial restructuring. The company had engaged in a costly expansion, struggled with opening a new distribution centre and been accused of having lost touch with youthful fashion. The founder’s status (to quote the NYTimes again) as a “ticking time bomb” cannot have helped.

It would therefore appear that in one situation a board is reacting to repeated accusations of behaviour they see as completely unacceptable and in another there is a difference of corporate vision. At what point then does reputational risk trump the energy and deeply personal vision of a founder? The American Apparel case would appear to produce some easy answers, the Lululemon one much less so.

One factor that few entrepreneurs appreciate as they approach an IPO is just how governance-minded boards of public companies can become. In some companies where control is distributed and boards feel more entrenched, governance can assume an almost fetishistic character and box ticking of governance”to do” lists can supercede the oversight of critical issues such as strategic vision, matching capital structure and strategy and monitoring performance. Of course, as American Apparel’s board may well argue, there are times when the interplay of governance and reputation is of the first order.

In contrast, whilst private equity can be very exigent it generally does so in the context of a much more bilateral relationship (founder/management to private equity controlled board) and generally quite well understood operating metrics (some mix of profitability and growth). Done correctly, public equity requires a complicated balancing of strategy, results, disclosure and governance. If boards of public companies become over-weighted in the governance function then corporate performance can suffer. If governance is ignored then public relations disasters on the scale of American Apparel can ensue.

The choice of board members in a run-up to an IPO can therefore assume more importance than founder/entrepreneurs might initially think. Experience and temperament may have more value than governance expertise.

There are numerous examples of boards feeling the need to demonstrate that they have “moved on from the era of the founder” (so to speak). There can be times when this is appropriate and other times when boards simply do not get it. Founders can sometimes breathe new life into companies that were drifting (Apple is surely one of the best known examples).

At Cheverny we believe founders should approach an IPO with both attention and caution. A strategic adviser without conflicts of interest can add significant value in helping weigh the pros and cons of seeking multiple voting shares, the selection of underwriters, capital structure and board mandate/composition.