Middle Market Growth - November/December 2014 by Association for Corporate Growth

Growth MIDDLE MARKET

// NOVEMBER/DECEMBER 2014

TWO VETERANS OF PRIVATE-FUND COMPLIANCE ON WHAT THE SEC WANTS A QUALIFIED OPINION: KAREN MOON, CO-FOUNDER AND CEO, TRENDALYTICS

CURATED

COMMERCE Julep Bets on Curated Commerce as the New Beauty Model

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M&A DEALMAKERS CORPORATE FINANCE The Paslin Company has been sold to Tower Three Partners

Sur-Flo Plastics & Engineering has been sold to Crowne Group

Schluckebier Oil Co. has been sold to Blue Flame Propane

Gentz Industries has been sold to MB Aerospace

Brown Rehab & Review has been sold to WellComp Managed Care Services

Smith Bros. Tool has been sold to Peninsula Capital Partners

We do not believe that “one size fits all”;

as each transaction is unique.

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EXECUTIVE SUMMARY DOUG TATUM // Chairman, ACG Global Board and Newport Board Group

It’s Time to Make Your Voice Heard

s we prepare to ring in the new year, ACG is ramping up efforts to bring policy issues to the forefront of lawmakers’ agendas with our annual Leadership Week in Washington.

This high-profile event, held Jan. 26-28, will bring together federal

lawmakers, as well as regulatory officials from the SEC and other government agencies. Your attendance ensures that important issues relating to taxation, Dodd-Frank regulations and financing remain top of mind for policymakers. Our efforts in Washington build upon those of the newly formed Congressional Caucus for Middle Market Growth, the bipartisan group ACG Global helped create to bring the middle market’s contributions to the U.S. economy from behind the curtain to center stage. We can’t stop there. We must continue to ensure that lawmakers, thought leaders and the public at large are made aware of the new jobs, infrastructure and other positive economic contributions by midsize companies around the country, as well as those of the capital providers that support them. Consider Julep, a Seattle-based company that has tapped into the hot trend of curated selling by creating highly customized cosmetic offerings for each woman who subscribes to its service. Started by a former Starbucks executive, this company had raised $54 million through early fall and is experiencing fourfold year-on-year revenue growth. The concept of curated selling is clearly gaining backers; in August, Nordstrom said it would buy Trunk Club, another middle-market company that has leveraged this trend in the apparel space—for $350 million. Trunk Club had boosted its staff to 500 employees at the time of its sale. It was featured as the cover story in the April 2014 issue of Middle Market Growth. You’ll also hear from Privcap’s David Snow about the SEC’s scrutiny of private equity and how general partners can ensure they remain compliant with the agency’s regulations. There are a lot of other gems in this issue, including a particularly robust roundup of local events hosted by ACG chapters throughout the country. With this magazine as well as our presence in Washington and ACG networking events, the voice of the middle market is stronger than ever. We look forward to another successful year and hope to see many of you in April for InterGrowth 2015 at Orlando’s Hilton Bonnet Creek and Waldorf Astoria hotel. Thank you for your ongoing support of Middle Market Growth magazine. Happy reading! //

MIDPOINTS RANDY SCHWIMMER // Founder and Publisher, The Lead Left

You’ll Want to Read This Column–Trust Us

rom prehistoric times until 2003, humans cumulatively created five exabytes of data. That’s five billion gigabytes. We now produce that much information every 48 hours. We send out 100 million

emails every minute. Bombarded by this blizzard of bytes, we can’t possibly manage it coherently. What to do? Welcome to the era of curation. Like museum curators, custodians of wisdom and taste guide you to smart decisions about what to read, what to wear and what to buy—all saving you time and money. Just trust our

BIO //

Randy Schwimmer shares his perspectives in MidPoints each issue. A former member of senior management and investment committees for two leading middle-market debt platforms, he is also founder and publisher of The Lead Left, a weekly newsletter about deals and trends in the capital markets. Content sponsored by

judgment, they tell us. For consumers, curation is the Google antidote. Rather than zillions of results generated from a black box algorithm, personal shoppers mail you boxes of customized goodies via monthly subscription services. Here are some samples: • Birchbox – This “discovery commerce platform” ships you fragrances, lotions, body sprays and hair products. • Blissmobox – Offers organic and green products. Like non-toxic office snacks. • BabbaBox – Children’s activity boxes and “super cute” parenting tips. • BarkBox – Yup, for your pets. And those are just the B’s. • ShoeDazzle – Shoes, bags and accessories just for you. From that doyenne of discrimination, Kim Kardashian. • T-Pain Fancy Box – $39 per month gets you “cool gadgets and outrageous gifts” selected by the rapper himself. Sign us up! • Mystery Tackle Box – Our favorite. Reel in lures and bait “trusted by the pros.” Great gift for that special someone who’ll treasure a unique package of worms every month. Continued on next page

MIDPOINTS RANDY SCHWIMMER // Founder and Publisher, The Lead Left TODAY, THE BOX IS THE NEW BLACK. MAKE ME SMART, SEXY AND RICH, AND I’LL HAND OVER MY BUYING POWER.

In the pre-Web world of brick and mortar, retailers had limited curated lifestyle offerings (think Martha and Ralph). Even progressive mail-order houses, like Fruit of the Month Club, were guessing which of 27 varieties of grapefruits and pears you’d savor mid-winter. Today, the box is the new black. Make me smart, sexy and rich, and I’ll hand over my buying power. The great promise of the Internet was eliminating the middlemen; curated consumption restores them, adding good judgment. As Steve Powell, senior adviser with Roark Capital, puts it, “First we wanted ‘Do It Yourself.’ Then we demanded ‘Do It For Me.’ Now curation answers our plea, ‘Do It With Me.’” For middle-market consumer companies, curation highlights trends. For retailers, it allows a clearer path to consumers. Any community of social media and bloggers who “follow” and “like” a brand enhances its credibility. Manufacturers can then measure brand strength. And what a community! The average millennial has 250 friends and spends almost 18 hours a day consuming media. They all want to follow the herd, yet be distinctive. Curated consumption not only tells you what to buy, it tells your friends to tell you what to buy. From cave man to crowdsourcing: the community has become the curator. //

Growth MIDDLE MARKET

// NOVEMBER/DECEMBER 2014

Cover and story photography by Stewart Tilger

FEATURES

Curated Commerce Julep founder Jane Park is blazing her own trail in the beauty market and changing the way women purchase cosmetics. Using the wisdom of the masses, Julep creates unique offerings for individual subscribers who receive its monthly box of products, curated specifically for their personal style. Read more.

“IT’S HARD FOR MANY PEOPLE TO ARTICULATE A DESIRE, SO WE HELP THEM OUT.” // JANE PARK, FOUNDER AND CEO, JULEP

Compliance: What the SEC Wants Two veterans of private-fund compliance give behindthe-scenes details about the commission’s stepped-up scrutiny of private equity. Read more.

TABLE OF CONTENTS

PRESIDENT & CEO Gary LaBranche, FASAE, CAE glabranche@acg.org

VICE PRESIDENT, COMMUNICATIONS & MARKETING Kristin Gomez kgomez@acg.org

EDITOR-IN-CHIEF Deborah L. Cohen dcohen@acg.org

IN EVERY ISSUE Executive Summary MidPoints by Randy Schwimmer Face-to-Face The Ladder It’s the Small Things The Leadership B-Side

DEPARTMENTS THE ROUND • Denver Policy Event Gives Voice to the Middle Market • A Look at ACG’s SEC Task Force Survey Results • Nordstrom Buys Curated Clothier Trunk Club Read more.

A QUALIFIED OPINION Karen Moon, Co-Founder and CEO of Trendalytics, Talks to MMG About the Benefits of Using Data to Track Consumer Trends. Read more.

ACG@WORK • Mid-South Event Full of Southern Charm • ACG Central Texas Awards Regional Companies at Luncheon

ASSOCIATE EDITOR Kathryn Mulligan kmulligan@acg.org

DIRECTOR, CREATIVE AND BRANDING Brian Lubluban blubluban@acg.org

VICE PRESIDENT, CONFERENCES & PARTNERSHIPS Christine Melendes, CAE cmelendes@acg.org FOR ADVERTISING OPPORTUNITIES

DIRECTOR, STRATEGIC DEVELOPMENT Meredith Rollins mrollins@acg.org Custom media services provided by Network Media Partners, Inc.

• ACG Great Lakes Comes to Columbus • ACG LA Event Earns Marquee Billing 2014 Apex Award, New Magazine, Journal & Tabloid 2013 Folio Eddie Honorable Mention, best digital edition 2013 Association TRENDS All-Media, monthly publication

• Surprise Speaker Delights Attendees in Wisconsin Read more.

THE PORTFOLIO The latest middle-market trends and thought leadership written exclusively by a team of expert ACG Partners. Read more.

Association for Corporate Growth 125 South Wacker Drive, Suite 3100 Chicago, IL 60606 ACG Membership: membership@acg.org www.acg.org Copyright 2014 Middle Market Growth®, InterGrowth and the Association for Corporate Growth, Inc. All rights reserved.

FACE-TO-FACE CONNECT TO YOUR NEXT DEAL

Click here to register for the Middle-Market Public Policy Summit.

ACG’s Middle-Market Policy Summit to Address Leading Issues If you want your voice heard in Washington, sometimes you’ve got to show up. On Jan. 27, ACG leaders and middle-market dealmakers will come together for ACG’s fourth annual Middle-Market Public Policy Summit during ACG Leadership Week in Washington. The message is clear: The middle market is an essential driver of growth for the recovering U.S. economy and warrants favorable national policies to support it. Last year, 40 ACG chapters and more than 100 members attended the event. Federal legislators, regulators and leadership from ACG Global will kick off half a day of presentations that address leading issues including taxation, access to capital, DoddFrank, the Volcker Rule and other policy concerns affecting the middle market. In the afternoon, ACG volunteers will canvass Capitol Hill to meet at the congressional offices of their states’ delegations. The event will include a tutorial on congressional office visits led by Amber Landis, ACG’s senior director of public policy. Make your voice heard and don’t miss this important event. //

FACE-TO-FACE CONNECT TO YOUR NEXT DEAL

CHAPTER EVENTS Get involved! This winter, ACG chapters across the globe will host hundreds of local events. Check out what’s happening at your local chapter, register and join in on valuable educational and networking opportunities.

2014 Annual ACG South Florida Awards Dinner in Fort Lauderdale Left: Philip Cassel of Cassel Salpeter & Co. (left), John Majer of McGladrey and president of ACG South Florida, and Stuart Miller of Lennar Corporation, winner of the chapter’s Outstanding Corporate Growth Award. Right: Representatives from ABB Optical Group, winner of the Deal of the Year Award.

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Had a newsworthy chapter event? Send a 150to 200-word summary and high-resolution photos to Associate Editor Kathryn Mulligan.

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THE ROUND NEWS THAT MATTERS CONGRESSMAN JARED POLIS // Giving the middle market more attention.

Denver Event Gives Voice to the Middle Market The contribution of the middle market to the health of the U.S. economy was lauded by a diverse slate of speakers at the Voice of the Middle Market event held in Denver in September. ACG Global, ACG Denver and the National Center for the Middle Market brought together academics and business leaders to discuss issues facing the middle market at the University of Colorado Denver Business School’s Jake Jabs Center for Entrepreneurship. Kicking off the discussion was Denver-area U.S. Representative Jared Polis, D-Colo., co-chair of the new House Congressional Caucus for Middle Market Growth. Polis’ background includes public and private sector experience and the successful launch of several companies, including Blue Mountain Arts and ProFlowers.com. Other speakers included Gary A. LaBranche, president & CEO of ACG Global, Tom Stewart, executive director of the National Center for the Middle Market, Jim Kaufman, managing member of Mogul Advisors and Ward Cerny, president of ACG Denver and vice president of Bernstein Global Wealth Management. According to the National Center, Denver’s middle-market sector comprises over 1,400 firms that generate $76 billion in revenue and employ nearly 600,000 workers, including restaurant chain Noodles & Company and footwear manufacturer Crocs. The Congressional Caucus for Middle Market Growth will serve as a spotlight to highlight the contribution of this sector to the national economy. //

THE ROUND NEWS THAT MATTERS ACG STUDY

Midsize PEGs Wrestle with Regulatory Woes Increased regulatory scrutiny in the wake of Dodd-Frank is creating challenges for financial professionals at midsize private equity firms. That is among the key findings of a new study by ACG’s SEC Task Force. The group polled compliance, finance and operations officials at private equity firms about regulatory issues ranging from uncertain financial disclosure requirements to SEC examinations and their firms’ use of general solicitation. Responses from more than 200 financial professionals confirm a strong need for continued dialogue with the Securities and Exchange Commission to ensure that the agency’s compliance requirements are fair, understandable and not overly burdensome for firms. “No one is feeling the pressure from the current regulatory environment more than CFOs,” said Blinn Cirella, CFO of Saw Mill Capital, who spoke on an ACG-hosted webinar on Oct. 2 to disclose the study’s findings. “Not only are we worried about meeting a multitude of deadlines, keeping our LPs happy and keeping our auditors happy,” she said, “but we also have to understand increasingly complicated deal structures and keep up with confusing compliance regulations.” Continued on next page

WHICH REGULATORY ISSUES ARE YOU CONCERNED WITH? SEC Examinations IAA Compliance Valuations General Solicitations Legislation Fees & Expenses Broker-Dealer Registration Cybersecurity 0%

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For more information about the ACG SEC Task Force, contact ACG Public Policy Senior Director Amber Landis.

THE ROUND NEWS THAT MATTERS

See the full results of the survey here.

WHICH BEST DESCRIBES YOUR FIRM’S TOTAL ASSETS UNDER MANAGEMENT? < $250 million $250 million to $500 million $500 million to $1 billion $1 billion to $5 billion > $5 billion Not Applicable 0%

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More than two-thirds of the registered investment advisers among the survey’s respondent group were from PE firms with less than $1 billion under management; ACG believes its survey is the largest to date of middle-market private equity firms and thus representative of that group’s particular concerns. Among those worries, the topic of SEC examinations garnered the most responses, followed by compliance with the Investment Advisers Act, valuation issues, general solicitation rules, legislative issues such as carried interest and taxes, and allocation of fees and expenses. In addition, the issue of cybersecurity—underscored by the disclosure in October that JP Morgan Chase suffered a breach affecting 76 million households in its customer network—is emerging as an additional concern, respondents said. More than 40 percent of respondents said the ACG SEC Task Force should undertake a host of initiatives on their behalf, including best practice sharing, information gathering, webinars, comment letters to the SEC and discussion forums. The group’s advocacy appears to be paying off already. According to ACG President and CEO Gary LaBranche, “Hundreds of ACG members have actively engaged in policy efforts, and we can point to a number of successes, in particular with the SEC. We’ve found (the SEC) to be very open to input from ACG. The commission has modified some regulatory rulings as a direct result of the feedback and the opportunity to meet with PE professionals, compliance officers and other ACG members.” //

THE ROUND NEWS THAT MATTERS

Photo by Trunk Club

Menswear Concept Trunk Club A Treasure for Nordstrom Want something delivered at no cost? No worries. Unhappy with the way your merchandise has worn? Nordstrom lets you return it for a full refund long after the purchase date. So it’s no surprise the Seattle-based company would be among the first traditional retailers to recognize the potential of a service-oriented startup such as Trunk Club. Trunk Club, whose army of stylists hand selects complete outfits for their shoppingaverse male customers, fetched a $350 million valuation when Nordstrom purchased it in an all-stock deal in July. The primarily online retailer was hatched in Chicago by serial entrepreneur Brian Spaly, founder of custom pants maker Bonobos and a former private equity analyst. Trunk Club grew quickly, in large part due to outside funding from Greycroft Partners, U.S. Venture Partners, Anthos Capital and Apex Venture Partners. MMG recognized the promise of this distinct concept as well, featuring Trunk Club as the cover story in its April 2014 issue. At the time, Greycroft partner Dana Settle told the magazine rather presciently that Trunk Club’s model “was the next logical step a retailer would take,” adding: “That’s where the opportunity is.” Right she was. //

THE ROUND NEWS THAT MATTERS

Download the full report here.

Latest Report from National Center Targets Operations Middle-market executives are good at making operational improvements at their companies. That’s the finding of a new study from the National Center for the Middle Market entitled “The Operations Playbook” released in late September. “On the whole, middle-market executives rate themselves highly on operational effectiveness, but they place the bar even higher and see a strong need to improve their performance,” according to the report, which polled 250 C-suite executives from midsize firms and 150 executives from larger companies. What middle-market executives find difficult, the study reports, is sustaining the improvements they make. “Our experience shows us, and the data confirm, that companies do a much better job of sustaining gains when they approach their operations as systems, with parts or subsystems that can be fine-tuned both individually and in concert,” the report says. Key takeaways from the study include the following directives: • Manage your operations as a four-part system that includes problem-solving, daily management, strategic alignment and people development; • Keep top managers close to the work, whether in a plant, distribution center or office; • Find an operations philosophy that works for your company; • Ensure that everyone in operations knows the larger strategy. //

THE ROUND NEWS THAT MATTERS

CohnReznick Study Finds Middle-Market Execs Confident Middle-market executives are positive about their firmsâ&#x20AC;&#x2122; growth prospects and access to capital, despite having little knowledge about new federal legislation designed to benefit small and midsize companies, a new study finds. The Middle Market Pulse study by the accounting firm CohnReznick surveyed U.S. executives from a wide range of industries. Overall, their outlook was positive on the prospect of future growth; however, few were well-informed about the Jumpstart Our Business Startups Act, a 2012 Obama administration initiative to make public equity more accessible to small and midsize firms. An overwhelming majority of respondents (89 percent) said their firmsâ&#x20AC;&#x2122; financial situation was the same or better than a year ago, according to the study, which polled 300 C-Suite executives at middle-market firms and was released in September. Similarly, 57 percent expected their profit to improve in the second half of 2014 compared to a year earlier, while 31 percent forecast it would remain the same. Continued on next page

THE ROUND NEWS THAT MATTERS CohnReznickâ&#x20AC;&#x2122;s National Liquidity and Capital Formation Advisory Group, which produced the survey, asked executives about the challenges their businesses face. The top three issues identified were general economic conditions, maintaining and increasing sales, and attracting and attaining qualified employees. To drive business outcomes, the most common strategy among respondents was to increase products and service offerings (47 percent); expanding geographic locations was a distant second (31 percent). On the topic of raising capital, the leading motivator for executives to embark on a liquidity event or capital raise was a desire to transform or expand their business (38 percent), while the least common trigger was distressed selling or to protect assets (9 percent). Nearly half of respondents had concerns about employeesâ&#x20AC;&#x2122; acceptance of change while 47 percent had reservations about finding the right investor or strategic partner. Allowing respondents to select multiple sources of capital, the survey found that over two-thirds of middle-market executives were most likely to look to commercial banks for funding, compared with less than half who would seek private equity financing and only 15 percent who said they would pursue an IPO. Only one-third of those surveyed were familiar with the JOBS Act and less than half were comfortable with the idea of crowdfunding to raise capital. Regardless of their minimal interest in public markets, the vast majority of respondents felt they could raise capital over the next six months and planned to use the funds in a variety of ways, including to develop new products and services, launch new sales and marketing programs, and update and expand their firmsâ&#x20AC;&#x2122; technology resources. //

THE ROUND NEWS THAT MATTERS

VERTICAL VIEW // CURATED CONSUMPTION TAXI ! “Curated consumption” describes the growing trend of products and services customized for the individual consumer, often through subscriptions or mobile apps.

Uber, the smartphone app connecting riders and drivers, received $1.2 billion of VC funding in 2014, the largest capital infusion in the curated consumption space.

774 MILLION

Nordstrom’s recent purchase of men’s curated clothier Trunk Club is among the largest strategic acquisitions in the curated consumption segment, with a $350 million valuation.

In 2013, $774 million was invested in the curated consumption category across 93 deals, a sharp increase from the $407 million invested in 68 deals in 2012. The 2011 LBO of Eismann, a German frozen food delivery service, was one of the largest curated consumption private equity investments, garnering $380 million from Glide Buy Out Partners and Indigo Capital. Curated consumption deals were most common in the consumer non-durable sector in 2013, followed by retail and media.

“There is a huge coexistence between these curated concepts and mobile apps—users can sit on their couch and have things delivered to them.” — Andy White, data analyst, PitchBook

All stats are from PitchBook for the middle market (deal values between $25 million and $1 billion).

CURATED

COMMERCE

Julep Bets on Curated Commerce as the New Beauty Model BY JUDITH NEMES

Photo Courtesy of Julep

Photos by Stewart Tilger

JULEP // Business: Custom online nail polish and beauty products Headquarters: Seattle, Washington Founder: Former Starbucks Executive Jane Park Outside Capital: $56 million from Andreessen Horowitz, Altimeter Capital, Azure Capital, Madrona Venture Group, Maveron Point of differentiation: To disrupt the traditional beauty counter sales model Website: www.julep.com

Jane Park is on a mission. The trailblazing CEO and founder of Julep Beauty Inc. is attempting to style her company into the next big beauty brand by ripping up the old playbook of selling cosmetics through glamorous celebrities and glitzy department stores. Instead, she’s creating a unique customer experience for each and every woman who interacts with her brand. That use of curated commerce, or curated retailing as it’s often called, is among the most important of several strategies Julep is deploying to disrupt the traditional beauty counter model and build a loyal following of women for its proprietary brand of nail polish, makeup, skin care and accessories, Park says. Moving quickly to design and deliver popular products is another essential ingredient for success. Click here to read more about Julep’s strategy.

ASK THE AUDIENCE // Julep seeks feedback directly from its customers.

The cosmetic market is big: Nearly $500 billion is spent globally on beauty and personal care products. Purchases are expected to surpass that mark by 2016, according to Euromonitor International, a market research firm. Analysts say companies in the beauty sector, along with other types of consumer goods, are especially poised to take advantage of the benefits of curated retailing. Unlike Birchbox, the popular monthly subscription service that selects only brand-name samples of beauty and lifestyle products, Julep develops some 300 of its own products in-house each year based in part on feedback from a select group of customers. Julep’s team chooses the combination to assemble for monthly delivery by combing through survey data from subscribers about their style and color preferences so packages match their profiles. Members can further customize by swapping out products when they get a sneak peek at their selection online before it’s mailed. Subscriptions run from $19.99 to $39.99 per month, depending on terms. “It’s hard for many people to articulate a desire, so we help them out,” explains Park, 43. “We’re trying to be the college boyfriend you never had, the person who anticipates what a woman wants before she knew she wanted it.”

WISDOM OF THE CROWD

“WE’VE LEARNED HOW TO CONNECT WITH PEOPLE AT THE KEY MOMENT WHEN THEY CAN HAVE DECISIONMAKING POWER AND THEY LOVE US BECAUSE THEY CAN SEE THE IMPACT OF THEIR INPUT.” Jane Park Founder and CEO, Julep

The Seattle-based company relies on early input from some customers about products currently in development, inviting about 6,000 women from its database to participate in its Idea Lab. They’re asked to share opinions on products via email, Google video chats and Facebook. That deft use of crowdsourcing with social media boosts the management team’s confidence about whether a product can be tailored to a subset of subscribers who will feel it’s been made just for them. Once new products are shipped, the company pays close attention to users’ reviews on Twitter, Facebook, Pinterest and the like. Park has a strong sense for what works in the marketplace. The daughter of Korean immigrants, she graduated from Princeton University and Yale Law School. After working at The Boston Consulting Group, she made a name for herself heading up Starbucks’ new ventures group. Park launched Julep in 2007 with her own funds and backing from angel investors. “We use our point of view as the starting point of a product,” Park says. “We’ve learned how to connect with people at the key moment when they can have decisionmaking power and they love us because they can see the impact of their input.” Park formulated Julep by inviting everyday women to gather at proprietary nail salons in Seattle and bond over their love of beauty products. The goal was to glean input about the kinds of beauty items and colors they found appealing. Initial feedback was loud and clear: They wanted constant updates on exciting new nail polish colors and beauty and skin care products made from wholesome, non-toxic ingredients, recalls Park. By 2011, Julep translated that brick-and-mortar model to an online format for national reach. “We took what we were doing in our parlors and put (those products) in a box and began offering them online as a subscription box with particular types of women in mind for each type of package,” she says.

New subscribers, or Julep Mavens, complete a survey about their color, clothing and lifestyle preferences to determine which of five general categories might be right for them: Classic with a Twist, It Girl, Boho Glam, Modern Beauty or Bombshell. If the completed survey concludes you’re Boho Glam, you favor a mix of earthy tones and playful, vibrant colors in your nail polish preferences. Members can always change profiles and pick different packages during the online sneak preview. They can also swap out individual items, further customizing what they want to show up at their doorstep. Julep is among a growing set of companies emerging to offer a customized experience to help customers cull through the dizzying array of products available on the Internet and in stores. Sellers edit down choices to a manageable selection based on data analytics, online surveys and other measures, tactics that give them a greater chance of offering something relevant and desirable to the potential buyer. Retail analysts expect more startups and small businesses to hit this niche of the e-commerce market, but success is not a foregone conclusion. Investors say they’re placing bets on only the best of these companies— the ones that pick the right product categories, figure out how to appeal to the particular preferences of their customers and build loyalty so they keep coming back for more. Specialty retail brands and discretionary products sold online—cosmetics, clothing, home accessories— are particularly well-suited to curated retailing because merchants track who’s coming to their site and can tailor an experience that matches customers’ preferences based on a variety of data collection sources, explains Jason Stoffer, a partner at Maveron, a venture capital firm. With offices in Seattle and San Francisco, Maveron specializes in consumer startups and was one of Julep’s first investors. Its co-founder is Starbucks CEO Howard Schultz.

“WE’RE TRYING TO BE THE COLLEGE BOYFRIEND YOU NEVER HAD, THE PERSON WHO ANTICIPATES WHAT A WOMAN WANTS BEFORE SHE KNEW SHE WANTED IT.” Jane Park Founder and CEO, Julep

SUBSCRIPTION MODEL // Julep’s subscribers receive a monthly box with products designed in-house.

“The next generation of brands is going to curate merchandise in a way that feels relevant to each and every consumer,” Stoffer says. Like Julep, “companies will need to have a two-way dialogue between the brand and consumers...Jane (Park) is creating an emotional connection between the brand and the consumer and building a loyal community that’s buying those products.”

HEAVY HITTERS As of early fall (2014), Julep had raised $56 million in capital, primarily from venture capital firms that include Andreessen Horowitz, Altimeter Capital, Azure Capital, Madrona Venture Group and Maveron. Celebrity backers are getting in on the action too, most notably Will and Jada Pinkett Smith, and Jay-Z. Crowdfunding has also made its way into the company’s financing repertoire. When Julep improved the applicator top of its nail polish bottle with help from the design firm IDEO, the company used crowdfunding from subscribers to pay for the first limited production run of the new Plié wand. Indications so far point to Julep’s continued growth. The company declined to reveal how many monthly Maven subscribers it has, but says revenue grew 400 percent in 2013 compared to 2012. It expects similar growth in 2014.

“THE NEXT GENERATION OF BRANDS IS GOING TO CURATE MERCHANDISE IN A WAY THAT FEELS RELEVANT TO EACH AND EVERY CONSUMER.” Jason Stoffer Partner, Maveron

“The subscription model can appeal to investors as long as the company can keep the products they offer fresh, build customer growth, scale up when it grows, and do it in a profitable way,” observes Mara Devitt, a partner at McMillan/Doolittle, a Chicago-based consulting firm. The firm’s research shows consumers are challenged about what to buy when faced with a sea of information. Items well-suited to ongoing subscription services tend to be lower-priced, non-essential goods, such as beauty products, jewelry and accessories, and products for babies, children and pets, says Devitt. “Curated retailing is a great service,” she observes. “In essence, it’s like finding a source that you’re trusting to cull through the vast assortment of products and services available today.” Just ask Kelsey Sander, a nail polish fanatic who signed up for Julep’s subscription boxes more than a year ago. She gets a steady stream of two new nail colors every month without the mind-boggling task of searching through the endless supply of new shades that inundate brick-and-mortar stores and online retailers. Two new colors (plus an additional beauty product) are selected each month for each of the five categories, but Mavens like Sander can swap polish colors from other profiles if they don’t like what’s offered in theirs. “I would never go online to shop for beauty products,” says Sander, a 24-year old teacher in New York that Julep deems “Classic with a Twist.” “I wouldn’t know where to start.” Sander tried Birchbox before switching to Julep, but she canceled after two months, realizing she was accumulating samples she wasn’t going to use. Ultimately, curated retailing works best with products that delight people—like nail polish—and helps them sort through the madness so they can express themselves in their own unique way, asserts Devitt. “Otherwise, why would we need it to be curated?” she asks with a laugh. //

NIMBLE STRATEGIES FOR PRODUCT INNOVATION // The traditional beauty brand model of stocking department store shelves with products that took years of development and marketing to women without their direct input is the antithesis of what Jane Park, Julep’s founder and CEO, is all about. A common underpinning of her strategy is to move quickly—and intelligently—during product development and follow-through to get the final package into consumers’ hands. Julep employs technology development concepts such as randomized testing and iterative processes to keep refining a product before it’s considered ready for prime time. Responding swiftly to suggestions from women participating in its Idea Lab during product formation also helps designers pivot and make necessary changes before it’s too late. The company gets its goods to market quickly because it manufactures products domestically through agreements with existing factories. An in-house team brings ingredients to the plant and takes over the entire production process, explains Park. Julep distributes its nail polishes and beauty supplies to national chains, including Nordstrom and Sephora. Domestic production guarantees Julep can get its latest colors to them in a speedy fashion. In addition, much of what it sends retailers for mass-market sale is based on the most popular re-orders from its monthly Maven subscribers, says Park. “We hope all 300 of our new products each year will be a huge success, but it’s up to our Maven community to repurchase and tell us which products they can’t live without,” she says. She figures others won’t be able to live without those products either. //

Photo Courtesy of Julep

Two veterans of private-fund compliance give behind-the-scenes details about the commissionâ&#x20AC;&#x2122;s stepped-up scrutiny of private equity

COMPLIANCE What the SEC Wants BY DAVID SNOW

ost private equity general partners did not grow up thinking, “Someday, I’d really like to be a Registered Investment Adviser.” And yet, today that is just what many of them have become, with certificates from the Securities and Exchange Commission

to prove it. The unwelcome transition from boutique firm to regulated investment adviser continues to be a culture shock for many firms, especially those that are smaller and under-resourced, say two compliance experts. Scott Gluck, counsel at law firm Venable LLP, and Matt Reynolds, director of financial services at McGladrey—who both have observed firsthand the increasing interactions between SEC staff and private funds—say too many GPs are unaware of the agency’s goals and motivations. “We spoke to a number of our private equity clients and got an idea of (their) biggest frustrations,” says McGladrey’s Reynolds. “What I kept hearing over and over was, ‘I just want to do it right, but the SEC won’t tell me what’s right.’ Well, that’s not their job. Their job is to look at what you do and make sure that it’s in the best interest of the clients.”

COMPLIANCE // Many GPs are unaware of the SEC’s goals.

“I THINK THE WAY THAT FUNDS CAN REALLY GET IN TROUBLE WITH THE SEC IS IF THEY APPEAR TO HAVE KNOWINGLY AND INTENTIONALLY VIOLATED THE PROVISIONS OF THEIR LP AGREEMENT, OR MISLED INVESTORS.” Scott Gluck Counsel, Venable LLP

Indeed, while GPs shouldn’t expect a how-to guide from the SEC, they should be aware of five main areas in which the commission is looking for all manner of weaknesses and vagaries that risk misalignments with clients. OPERATING PARTNER ECONOMICS There is no one right way to compensate the operating talent brought in to add value to private equity-backed portfolio companies. But the SEC is interested in ensuring that these economic arrangements are in accordance with fund documents, and also made clear to investors. “I think the way that funds can really get in trouble with the SEC is if they appear to have knowingly and intentionally violated the provisions of their LP agreement, or misled investors,” says Venable’s Gluck, who adds that too many limited partnership agreements are “silent with respect to operating partners,” leading the SEC to criticize GPs for being “horribly vague” about how they pay for the advice and resources put to work in the portfolio.

An extensive video interview with Gluck and Reynolds can be found on Privcap’s website.

VALUATION POLICIES As with the compensation of operating partners, the SEC is not advocating any one right way to arrive at fair value in investor reports. And GPs who think the commission will recommend any one policy are missing the point that the rule book needs to be written by the GP. “Valuations in general tend to drive management fees,” notes Reynolds. “The SEC looks very closely at whether you are valuing everything consistently and fairly. Whatever way you’re going to value your assets, do it consistently. Make sure it’s written down. Make sure that you can track back to that. Do it in a way that’s fair to the clients when you’re basing your fees off of the valuations of those assets.” The backdrop to this need for clarity and consistency is the suspicion that some fund managers strategically mark up or mark down assets based on their fundraising timeline. But even cynics can be disarmed with full and timely disclosure. Adds Gluck: “When we met with the SEC, they told a story that there was a fund that had changed its valuation methodology three times over the span of two or three years, yet each change was disclosed to the investors. They told (investors) what they were doing, explained how this changed the valuation methodology, and, at the end of the day, the SEC didn’t find a deficiency because the change in methodology was disclosed.”

POTENTIAL CONFLICTS OF INTEREST This covers a large area, of course, but Reynolds and Gluck say the SEC is interested in myriad potential conflicts that are specific and endemic to private fund managers. One area of focus has to do with the allocation of deals and expenses among multiple funds. Again, the SEC can’t tell you what a proper policy looks like in this regard, but it does know a “loosey-goosey” approach when it sees one. Says Gluck: “The SEC has expressed great concern that fund managers are passing fees and expenses off to their limited partners or off to portfolio companies. (SEC Director of the Office of Compliance Inspections and Examinations) Andrew Bowden said that 50 percent of the private equity funds that they’ve examined have had material problems with controls or fees and expenses.” One type of expense that doesn’t necessarily involve the most dollars, but seems to inspire great exasperation, is luxury travel. The SEC will ask, “Did your investors benefit from your Gulfstream G450 trip from Houston to Chicago, or just you?” Reynolds tells a story: “We had a client who was doing work in Alberta and they had to hit six different locations. They loaded up about six guys on a private jet and went to each one of those. The SEC came in and said, ‘That was improper. I can’t believe that you did this.’” The client then showed the SEC that commercial travel to the multiple locations would have been more expensive, and the commission dropped the objection.

COMPLIANCE PROGRAMS Your firm may have crafted a compliance program, but you may be shocked to learn that it isn’t good enough in the eyes of the SEC. Gluck and Reynolds explain that too many GPs fall short for an understandable reason: failure to adequately structure cultures of compliance around functions that are not, in fact, core to the business of private investing. As Reynolds puts it, much of the rigor required by the Investment Advisers Act “doesn’t feel like it makes sense,” because of rules touching on, for example, personal stock trading records in a market dominated by investments in private companies. But arguing that certain rules are too obscure for private equity won’t get you very far. Gluck argues that a GP group should be “complying with all of the record keeping and reporting requirements, because the SEC is not going to be very sympathetic if you aren’t complying simply because you say, ‘Well, we weren’t aware of that.’ It’s the responsibility of the adviser to be aware of the rules and regulations that the fund is subject to.”

INVESTMENT ADVISERS ACT RIGOR Like it or not, many private equity firms are now Registered Investment Advisers and must behave according to the Investment Advisers Act, brought into law in 1940. An adequate compliance program will incorporate all of the sometimes less-relevant rules of this act. In fact, says Reynolds, the SEC often uses certain rules within the act as “threshold items” for determining to what extent a firm has an adequate compliance program in place. One such item is compliance with the custody rule—viewed (unadvisedly) by some GPs as irrelevant to their business. “Complying with the custody rule is very important for a private equity fund because when (the SEC does) come in for an exam, it’s one of the first areas they’re going to look at,” says Reynolds. “If a fund isn’t complying with the custody rule, even if it is expensive, (the SEC views) that it could be indicative of a greater likelihood that there is other wrongdoing going on, or other failures to comply, as well.” The SEC’s Office of Compliance Inspections and Examinations has asked for a staff increase of some 75 percent, with the added people primarily focused on the private funds market. This means that all registered GPs should expect inspectors to come calling. When they do, Gluck and Reynolds recommend extreme self-awareness and documentation. This doesn’t always come naturally to private equity professionals. “The SEC is coming,” says Gluck. “The most important thing a fund manager can do right now is to know their LP agreement, go through their expenses, do an internal review, and see if they have an issue, because if they do have an issue, it’s infinitely better if they figure it out now rather than have the SEC figure it out.” // David Snow is co-founder and CEO of Privcap, a digital media channel for the private equity community.

“COMPLYING WITH THE CUSTODY RULE IS VERY IMPORTANT FOR A PRIVATE EQUITY FUND BECAUSE WHEN (THE SEC DOES) COME IN FOR AN EXAM, IT’S ONE OF THE FIRST AREAS THEY’RE GOING TO LOOK AT.” Matt Reynolds Director of Financial Services, McGladrey

MID D L E-M A R K E T P UB L I C P O LICY S U M M IT P R I V A T E C A P I T A L , P U B L I C G O O D .SM

J A N U A RY 2 7 , 2 0 1 5 7 : 3 0 A . M . â&#x20AC;&#x201C; 1 : 3 0 P. M . PA R K H YAT T WA S H I N G T O N , D . C .

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