by Chip Wilson
Another retail giant on our radar was the Gap, but it seemed nearly impossible to get a real read on what they wanted. As a public company, the Gap had to be very cautious about with whom they met and what they reported. The whole thing was secretive to the point of being unproductive. They couldn’t discuss concrete terms or put a single word on paper.
When the Gap finally made an offer, it was inadequate. $200 million for a full buyout, which was much less than valuations we were getting from private equity.
I was frustrated because I felt it was a bad move by the Gap. The Gap was sucking on all cylinders. It was a commodity product, and the stores were underperforming. I thought they were too big. Their stores looked like bowling alleys. I thought if the Gap would replace half of all their oversized five thousand square foot retail stores, which had the best retail locations, and insert, in their place, three thousand square foot lululemons, the Gap would be victorious. The Gap would be stronger because they could better focus on their “best-in-class” product, and lululemon would be able to grow exponentially in one year.
I was bursting to tell Gap what I thought they should be considering. I wanted them to buy lululemon for $500 million. A rapid roll-out of lululemon would be a home run for them. I believed that lululemon would have brought a lot to their organization, beyond that which I felt I could personally contribute.
Over the years, the Gap suffered because they became driven by numbers and metrics instead of staying in touch with their core customers. I surmised the “new” digital e-commerce people were telling Gap’s leadership to make more of the same thing because, at the time, commodity products were e-commerce’s bestsellers.
I wanted the Gap to drop half of their merchandise and focus on innovation and selling only their best products. To me, innovation is delivering to the customer that which the customer does not yet know he or she needs. I felt if the Gap brought in lululemon’s product development, buying principals, and shared store space, the Gap would quickly be worth $20 billion more by 2012. The Gap didn’t know how to morph. It was resting on its laurels.
Interestingly, just after this, the Gap brought on a Canadian—Glenn Murphy—who had run Shoppers Drug Mart in Canada. A nice Murphy decision at the Gap was buying the e-commerce and catalogue-based company, Athleta, to move Gap into the future. I always wondered if the commodity thinking of Gap management would trickle its way down to Athleta. Because merchants, not designers, ran the Gap, past sales metrics told them that they should target a frumpier, cost-conscious older market that didn’t sweat.
In any case, as of 2018, Glenn Murphy is now co-chairman of lululemon. More on this down the road.
Vetting Private Equity
There was a lot more appeal in a deal that got us less money but found us the right partner. That way, I could maintain a strong position in lululemon and find the right private equity people who could provide me with foundational guidance to build a billion-dollar company.
The things I wanted from a PE agreement were fivefold:
Expertise in US real estate locations
Help in hiring world-class upper management
To maintain a 70 percent interest in the company
Advice on future needs and processes so lululemon could skip usual growth roadblocks
To have $40 million to fulfill the goals my wife and I had set in 2002
By the summer of 2005, I was determined to find the right personality fit in a potential private equity partner.
Generally, interested private equity parties made a trip to Vancouver to have a look at our operations and meet our team. When they arrived, if things were going well, I’d take them up the Grouse Grind. Grouse is a local Vancouver ski mountain with a very popular, rugged hiking trail—the Grind—running up its side. If you’re in reasonable shape, it’s about an hour climb, straight up.
The Grouse Grind was a great way to measure culture fit. People were showing up at our office in suits, ties, and dress shoes. For someone not from the West Coast, or someone who doesn’t understand the Silicon Valley surf, skate, snowboard culture, a suit and tie is mandatory. On the West Coast, the suit and tie uniform subconsciously says you are not in control of your own life. As an aside, recently, I wondered with great fascination whether Mark Zuckerberg would show up to his congressional hearing in Washington, DC wearing a suit or not. I am sure his PR people were adamant Mark toe the line so the political powers would appreciate his respect for their customs.
When I suggested a hike, some of these visitors acted as if it was a root canal. Not a great sign. But there were others who jumped at the opportunity to do the Grouse Grind. Doing a strenuous hike with someone was the first part of seeing if they might be the kind of person with whom I wanted to work. We had to be authentic. It was my way of meeting people in lieu of a round of golf.
“At one of our first meetings with private equity,” Sean Morrison, my broker says, “Chip was wearing flip-flops and shorts. If it was anyone else, I might have said ‘How about throwing on a jacket and pants,’ but that’s totally not who Chip is. Lululemon was and is a lifestyle brand, and lifestyle brands were a mega-trend at that time. I didn’t want to package it in anything fake. So, we ran a process, and we had a couple of really good partners to choose from.”
We ended up with offers from all eight groups of investors who came to Vancouver. Their proposals ranged between $225 and $270 million, but in the end, it came down to personality match.
Tom Stemberg
Midway through the beauty contest, I got a call from a man named Tom Stemberg. Tom was the founder of Staples. He’d served as CEO of the company for sixteen years and as chairman of the board for another, taking Staples from a start-up operation to a leader in the office superstore market. Tom was also a partner at an equity firm called Highland Capital.
Tom first heard of us when both Staples and lululemon were up for a retail award. When we won, he decided to go and see one of our stores for himself. Tom’s wife was from Toronto, so he visited the Briar Hill location. He walked into the store and was shocked by the crowds inside. He noticed the enthusiasm of our customers and the quality of the products. His wife, who’d purchased several items, loved our designs and technical features.
“People were practically fighting over garments in the store,” Tom said. “I went outside and saw that there wasn’t even a name on the front, just the logo. I went to another store, and it was the same thing. I had to know what was going on.”
Tom and I met face-to-face in Vancouver. At the end of our conversation, he told me he wanted to invest if we ever took lululemon public. He would offer $20 million in return for a board seat. His investment meant lululemon would get the benefit of everything he knew about real estate locations in the US.
Tom also said we would need a board of directors to conduct lululemon’s governance. My only experience with a board was the advisors at Westbeach. The Westbeach advisors had been very helpful, so I was enamoured by the board concept. It seemed I had an ally in Tom.
Advent
Advent International out of Boston had moved to the top of our list. Advent was founded in 1984, and since then, had specialized in the growth and restructuring of companies around the world, representing tens of billions of dollars in capital.
Advent valued lululemon at USD $225 million. It wasn’t the biggest offer we’d received, but I still didn’t feel I needed the cash nearly as much as I needed the right partners. I had a good feeling that Advent would fit the bill. We must have been incredibly appealing to a PE firm. We had trademarked our name and logo worldwide, we were set up to be global, and we had the best apparel metrics in the world. We were a cash cow with a product the world wanted, and we were the only company that knew how to manage a highly volatile technical knit fabric.
David Mussafer, the managing partner of Advent, seemed to take a long-term view of what lululemon could achieve. Besides that, David and some of the other Advent people had a super hike on the Grouse Grind,
which spoke well about their fit with our culture.
David and his partner, Steve Collins, completed our full development program and set out their goals. I was impressed with their due diligence and their desire to understand lululemon. They seemed like they would be perfect for us.
While we were in Boston meeting with Advent, we also saw Tom Stemberg again. Tom was still very interested in getting involved with lululemon—so interested, in fact, that he told me Highland Capital would come in for 25 percent of the portion I would sell.
Advent had reservations about Tom Stemberg, but it would take me a long time to learn their reasons. In any case, everyone agreed to the arrangement. All that was left was the due diligence that both Highland and Advent had to do on lululemon, plus the final negotiations. I had been clear with Sean that negotiations were not my area of expertise. I trusted him to be great.
Months went by doing due diligence. A lot more time than I wanted. It was late September 2005 before we were closing in on a final deal, which coincided with the arrival of my twins. In retrospect, this put undue subconscious pressure on me to complete the deal.
I think Advent and Highland dragged on due diligence on purpose. They had their price set, and they realized we had a very junior negotiator. Each month the demand for our product increased in double-digit numbers, and the value of the company increased correspondingly. Advent and Highland were happy to let the deal drag on to confirm that our sales and profitability numbers would continue without their having to increase the price they would pay.
Shannon went into the hospital in late September. Our sons, Tor and Tag Wilson, were born minutes apart just before midnight. There wasn’t much time for me to celebrate or relax. Advent and Highland had called for a meeting in early October.
I went into that meeting assuming an agreement had been made. I was confident that the due diligence had gone well and that the meeting was mostly a formality to sort out the details.
I was wrong.
Steve Collins went through a list of dimensions they’d used to evaluate lululemon. He said they were concerned that lululemon’s current sales compared to last year’s showed that sales were falling. Right away, he tried to bring the price down from USD $225 million to USD $200 million. I was stunned. I later found out we were just oversold and waiting for inventory.
Lululemon had been exceeding all its sales expectations, performing even better than was indicated in the previous year’s numbers we’d shared with Advent in the summer. I didn’t understand how we could over-perform and see our value take a hit. Another new development from Advent was that they wanted to take 50 to 51 percent of the company.
Looking back on it, I realize it was all negotiation and posturing. We didn’t need to negotiate at all.
When I replay the scenario in my head, I wish I had stood up, told them that the price had just gone up to $350 million, and walked out of the meeting. The power was all lululemon’s—I was in over my head.
In retrospect, the incentive for a business broker was no different than that of a real estate broker. Their number one goal is to do the deal. It is very risky for a broker to drive for the best price for their client and lose a deal. When the deal is lost, a broker gets zero. In final negotiations, the broker stops working in the best interest of the client and instead works to get the deal done. In retrospect, I paid for a negotiator, but I didn’t get what I expected.
We agreed to USD $200 million. The next issue was the 51 percent ownership. Steve Collins argued that with Highland and Tom Stemberg in on the deal, they needed 51 percent of lululemon to share between them. I said no, but once again, I was just trying to hold my ground. Instead of the 30 percent I had originally proposed, I told them I would sell 48 percent so I would still have a majority interest. Advent agreed to this, and the deal was finalized. It was all a great learning for me.
When we were at $110 million in sales, even more people told me I would not be able to run a company from $200 million to $1 billion, and that I should get help. Of course, I’d also been told I didn’t know how to run a company from $15 million to $100 million, despite how perfectly everything had gone. I think I had reinvented retail and people development models, and in retrospect, these new models would have gotten me a lot further than bringing in outside expertise with conflicting priorities.
Still, I was satisfied with the outcome. The people from Advent and Highland had proven themselves to be savvy businesspeople and skilled negotiators. It seemed that having Tom Stemberg, David Mussafer, and Steve Collins on my side in future negotiations would only benefit me and lululemon. Since I had not operated a company of $110 million in sales, I trusted this group to provide the guidance I asked for and hold my hand into the future.
I have made many life decisions that were strictly survival-driven, but never wealth-driven. In selling to private equity, I was motivated by a desire to develop an idea, a concept, a philosophy that was solid in its foundation into a global phenomenon to elevate the world.
To go from essentially owning nothing to having $100 million in my pocket gave me one thing above all else: an easier night’s sleep. I could breathe easy knowing my kids would be taken care of. But after years of basic poverty, Shannon and I still had a 1930s Great Depression mentality. We thought that at any moment it could all be taken away, or that it was all a dream, so we did our best to make sure our lifestyle didn’t change.
Chapter 21:
Change Management
Learnings
I want to preface this by saying this section may only be of interest to people who are taking on private equity (PE) to go public. Going into negotiations, I don’t think my local Vancouver lawyers even knew I didn’t need outside money to grow. Their experience was in big mining deals where substantial outside capital was required.
I am not sure we even told our lawyers how amazing our cash flow was. They’d probably never been in a situation where the seller wanted advice as the goal, so they didn’t ask, and we didn’t tell. I think my lawyers assumed that the PE people were in the driver’s seat and the deal was done accordingly.
Hopefully, my learnings will help any entrepreneurs who are thinking of taking on investment from PE and going public! My learnings are as follows:
1. A broker works in his own best interest to close the deal. A broker shies away from hard negotiations for fear of losing the deal and the commission.
2. Select three experienced advisors with no vested interest in the deal other than your own. Lawyers, brokers, and company executives were not enough to provide the high-level, independent advice I needed.
3. Set out time to talk daily to your advisors. The business will need you, but good advice will last a lifetime.
4. Keep two PE companies at the negotiating table until the final decision is made. Play the PE people off each other to get the best deal with the single PE firm you know you want.
5. If PE says they will be with you for a period of four to seven years and that they’ll probably take you public in the first four years, be cautious, as they must work in their own best interest.
6. Set a due diligence completion date and increase the price if the company’s profit increases during the due diligence time.
7. PE will only be with you a short time. From their viewpoint, the shorter, the better. You must understand the different scenarios of governance and control that will be in place after PE leaves.
8. PE provides a stamp of approval to the entrepreneur and his or her idea. However, the entrepreneur should not let that feeling of approval affect financial negotiations.
9. My 51 percent control of the company after selling to PE meant nothing as I didn’t control the voting at the board level. I needed legal confirmation I would control the most board seats after the PE sale and after going public. (When I consider what happened—the way we went public, and what came to pass in the following years—I think of Phil Knight from Nike and Kevin Plank from Under Armour. Both have dual-class shares,
which gave them control of their boards. When you control the board, you control the company’s culture and vision. Nike never lost its vision, and that’s what made it the company it is today. This is where I feel I missed the mark—not knowing how to keep board control.)
10. Create a special director onboarding program. Have them read three to four books critical to the company’s culture and business model. Then, have them work in the store for a day—and, in a case like lululemon’s, have the director go through the same development program as the employees. Have them verbally discuss ten points that would indicate their understanding of why the business model works, as well as their grasp of the company’s linguistic abstractions, values, and vision statements. Ask them if they fully understand the hidden, subconscious reasons the business makes money.
Lululemon was a cash cow that provided me with all the negotiating power in the world. I held all the cards but played none.
The Governance Model
With the long-term possibility of going public, we needed a Board of Directors. They were to elect a CEO, set and oversee a compensation plan for upper management that would reward long-term value, define management succession plans, set our strategic plan, and ensure legal compliance.
I was getting to know our Directors well. I treated them as my absolute equals and partners, a dynamic I felt was reciprocated. I had built an amazing company, and the Directors had the experience to help me continue to put the building blocks in place.
The only thing that was weird to lululemon people was that the Directors were a group of older men with button-down shirts, pleated khakis, and Blackberries slung on their belts like six-shooters. It was the opposite of lululemon apparel.
For any organization to succeed, a combination of different mindsets is critical. Organizational theory would tell you a successful team needs the right balance of conceptual, analytical, structural, and social people. An imbalance heightens risk and mediocrity.
