August 2008

On March 16, 2007, Menu Foods, an unincorporated open-ended trust established under the laws of the Province of Ontario (TSX:MEW.UN) and a leading North American private-label/contract manufacturer of pet food products sold by supermarket retailers, mass merchandisers, pet specialty retailers and other retail and wholesale outlets set off a chain of events that would go on to expose a fundamental gap in the North American food supply chain. What started a a “precautionary recall” would expand to incorporate 38 brands of cat food and 46 brands of dog food over the next 24 hours. Nearly 1% of all dog food was recalled within a week. Michael Dillion (Dillion Media, LLC), an industry consultant, was quoted in The Economist as estimating pet deaths from the recall would grow into the thousands.

Within 4 days, Menu Foods had lost 45% of its market capitalization (see chart here)

ABC News broke the story on March 23, 2007 that rodenticide (associated chemical name aminopterin), illegal for use in the U.S., was found on imported wheat gluten and used by Menu Foods in approximately 100 brands of dog and cat food. Suddenly, the industry had a sourcing problem, and a big one. The problem was exacerbated on March 29, 2007 when, after a number of complaints related to dry food, melamine, a chemical used in the manufacturing of plastics, was found in the affected wet food, in the kidneys of animals, and in the imported wheat gluten touching off a dry food recall.

After regaining approximately 16% of the value it lost in the stock market between March 16 and March 20, Menu Foods gave back all these gains when it adopted a rights plan to prevent the possibility of an outside party pursuing a hostile take over.

Throughout the balance of March and through April and May, numerous brands were added to the recall list (see full up to date list here). The FDA raided distributors, began sampling all wheat gluten coming from China and even solicited the help of the Chineste government on cracking down on parties responsible for contamination and cross-contamination. U.S. Senator Dick Durbin (D-IL) introduced an amendment that would strengthening human and pet food monitoring, labeling and inspection standards. The Reauthorization Bill, S.1082, which included Mr. Durbin’s amendment passed by a near unanimous vote. In the meantime the recalls go on.

On May 30, 2008, Menu Foods set up a $24 million Settlement Fund to enable parties to recover up to 100% of the economic damages incurred by pet owners, subject to certain limitations. The Settlement Fund, administered by a neutral claims administrator, will be available to persons in the U.S. and Canada who purchased or obtained, or whose pets used or consumed, recalled pet food. The fund amounts to approximately 10% of the company’s revenues for the past 12 months and 120% of the company’s operating income for the past 12 months. Today the company trades at 18.6% of its equity value prior to the recall.

The “demise” of Menu Foods has parallels in other industries. The tort phalanx has biten numerous companies in the pharmacy industry beginning with A.H. Robbins, of Dalkon Shiled fame, Wyeth, of Fen-phen, and more recently Merck & Co., Inc. in civil class action lawsuits associated with Cox-based inhibitor Vioxx. Merck was accused of burying information about risks associated with its blockbuster drug, intimidating scientists and pushing the sales of a drug it knew was dangerous. While the initial break of the Vioxx scandal shaved 40% of Merck’s market capitalization, it had an incredibly strong balance sheet to fund litigation expenses and restructure the company. Two years later the company had recovered all of the lost value.

Another anticipated parallel is Tyson Foods, Inc. Despite being the subject of numerous recalls dating back over 25 years, Tyson’s stock has never lost more than 17% of its value on any one day since January 1, 2000. The dates of the company’s largset losses related to acquisition announcements and indictments related to illegal hiring practices. When the largest beef recall every was announced on February 18, 2008 (some 143 million pounds), Tyson’s stock increased by nearly 10% of its value over a two day period as consumers were expected to increase chicken consumption in light of the news.

If we look for valuation parallels among other publicly traded pet food companies, we don’t find much satisfaction either. Due to their diversified nature, an index of the ten largest public companies with pet food operations tracks, very closely, the S&P 500 during the time of the recall as evidenced by the chart below.

Based on the data above, not much can be derived scientifically. However, my experience has told me the following anecdotal conclusions can be drawn:

1) Since the recall commenced there have been a number of benchmark transactions in the U.S. pet food space, including Mars/Nutro Products (May 2007), Berwind/Eagle Pack Pet Foods (October 2007), Highland Capital/Castor & Pollux (May 2008) and Berwind/Wellness Pet Foods (August 2008). While all the data on these deal (including the date of close for the Castor & Pollux deal) are not in the public domain, it is believed that all of these deals occurred at revenue multiples of between 2.5x – 3.0x. This would be inline with major deals occurring prior to the recall. However, is is our expectation that in order to sustain these multiples going forward sellers will have to have established brand value and be able to demonstrate a requisite amount of control over their input supply chain.

2) It is my view the companies that provide fulfillment pursuant to a co-pack arrangements will experience lower valuations going forward than those that source, manufacturer and pack themselves. That said, these parties are likely to have lower margin profiles and therefore higher multiples may not translate into substantially higher valuations than if they had a co-pack relationship. It is a function of what the multiple is applied to. However, these companies are likely to avoid large set-asides from transaction consideration to fund potential litigation in the future.

3) I expect to see multiples for boutique brands who can make substantive claims around country of origin labeling, health and wellness and nutritional content to experience premium multiples to the historical trends. Wet and dry raw foods will benefit from pet owners seeking out brands that are free from stigma. That said, these products are expensive and therefore are unlikely to get true mass appeal and the sales associated with broad distribution and national branding. As such, their valuation ceilings are potentially capped. However, I expect a number of brands in this category to create substantial shareholder wealth over the next five years.

More to follow as data becomes available.


I’ve been witnessing a disturbing trend, all in context, over the past 4 months in the consumer capital raise arena. I call it the “steak sauce” round. A stake sauce round occurs when a company tries to raise an interim round between its Series A and Series B. It’s grown up brother is called the “bomber” round, when a company raises an interim round between its Series B and Series C. These are often marketed as A-1 rounds (“steak sauce”) or B-1 rounds (“bombers”). Collectively we refer to them as “tweener rounds”. That said, I have seen more steak sauce offerings than bombers.

So why are we seeing so many interim rounds. Generally speaking, a majority of these offerings come to bare as a result of a company under performing it’s cash flow projections. Often times, in the interest of preserving value for the existing shareholders, a business is marketed under an aggressive set of projections so as to maximize valuation. It’s hard to ask for more money than your projections require, because it essentially invalidates them to a degree. However, projections are often made in a vacuum and fail to take into account the fluctuation’s that invariably occur when you are subject to economic cycles. All consumer businesses will experience some level of performance degradation in a deteriorating consumer environment. Given today’s economic climate it is not surprising that we are seeing so many steak rounds.

The second underlying cause of a steak round is that first time entrepreneurs underestimate the cost associated with market penetration. Invariably, in a start-up capital deployment is not fully efficient. Additionally, many consumer categories are either highly competitive or require work to educate the market on the value proposition. This takes more dollars than anyone ever anticipates.

Steak rounds are no fun for anyone. No surprise there. Existing management has to market the progress of the company in order to recruit more capital and existing investors must show support (hopefully with deep pockets) in order to incent new money to come into the equation if possible. Often times management must put on a brave face in light of performance that has not met. Further, this is a distraction for management at a critical time as tweener rounds can be protracted exercises, and the company is likely operating in challenging environment, hence the need for the additional capital ahead of plan.

So if you are faced with seeking fries for your steak round, how do you come up perfectly cooked (note I did not say well done)? A few ideas:

1) My first suggestion is to take mitigating action well in advance of tacking institutional capital. That is to focus your strategy on either profitability or defined market penetration. It is more marketable to show traction in one market that it is to show limited traction, but a broad distribution foot print. This is counter intuitive to many, but an ounce of prevention is worth a pound of cure. Of course this might not always be a viable strategy.

2) If you take anything away from my blog, ever, it is that you should not re-open your prior round. Not only is this a weak market signal, but it complicates things later down the road. It’s like getting a tattoo when you are 18; there is a high likelihood that you might regret that very demarcation later in life. Instead go for a convert. Convertible debt at a discount to the next rounds valuation offers the best opportunity to bring in new money due to the protections that it provides.

3) Be realistic, your convert should be at a discount to the next round and offer warrant coverage. Go heavy on the warrant coverage as opposed to the discount. Warrants will dilute everyone when exercised, discounts only dilute those who have invested to date when realized. I often hear from people who take my advice on a convert but do not offer a discount. More often than not those people end up less than enthused with the results of their tweener. Discounts of 10% – 33% are appropriate and warrants of 10% – 20% of the investment are within the acceptable parameters.

Of course, the way out of this mess is to be realistic about your capital plan in the first place. Easier said that done. However, the price of imperfection later is much greater than the value created by creating the price of perfection now. I know there I go again, robbing you of value on behalf of investors.


Depending on your choice of estimates, the pet industry (products, services, medical) is a $40+ billion industry. Even if you do not own a dog or cat, the proliferation of the pet industry over the past 24 months would be hard to miss. Pet products and services are cropping up in traditional retail and service environments, including department stores, hotels, chain mass and drug stores. The reason for this proliferation, in my opinion, is that given the size of the market and the forward projected growth, these channels what their slice of the, er, kibble. The truth is that pets are become surrogates for children in double income families and among empty nesters.

With increasing affluence being amassed by certain segments of the pet owner population, there appears to be an unending willingness to spend of pet health and wellness and creature comforts. This phenomenon is often reffered to as “the humanization of pets”. Consider that Neiman Marcus has incorporated a pet section into, nearly every Ritz Carlton is now pet friendly, The Loews hotel chain offers a “Loews Loves Pets” program, and many major retail brands including Coach, Harley Davdison and Channel are offering branded pet products. More will certainly follow as success stories emerge.

Despite it’s size and potential for growth in the industry, it is often under represented in discussion of the consumer landscape and certainly under appreciated by the investment banking world. That is to say, historically transactional finance advisory has serviced the vertical through adjacent markets, primarily food industry bankers. As such. the equity research associated with the pet market is, well, quite sparse. More often than not, due to the structure of the industry, pet related market information is buried as a footnote inside the annual reports and associated coverage of conglomerates who control the pet food space — Nestle Purina, Del Monte Foods, etc. Consider that two of the largest pet industry pureplays — Petsmart and VCA Antech have no buldge bracket industry bank coverage. This has, in my opinion ,created some information asymmetry between the investment community and the operators. However, we expect this will soon change as capital inflows into emerging brands in the industry begins to accelerate. In the interim, I’d like to think I am here to help. Below is an overview of the major pet industry trends as I see them (copyrighted, all rights reserved, not kosher to represent as your own, etc., etc.).

If you are an operating or investor in this space, and you are interesting in seeing my full industry module, I can be reached at


It was the summer of 2002 and I was working as an investment banker in midtown Manhattan at Gordian Group, LLC, best known for representing Ben & Jerry’s in their sale to Unilever PLC, when I came up with my fool proof can’t miss get rich quick scheme. Despite the fact that I was very much enjoying being a freshly minted MBA and working in a prestigious boutique bank, I was young enough to dream big and stupid enough to believe that anything was possible. Late one night with my green banker light reflecting off the pane glass window, I penned a historic, to me, letter to Mr. Jack M. Greenberg, CEO of McDonalds. A letter that could have altered life as I knew it. The fact that I am telling you about it here, should make you cognizant of the fact that things did not turn out as planned.

At the time of my letter, all was not well in the land of the golden arches. Eric Schlosser had just penned Fast Food Nation and the stock was trading at $30/share on it’s way to $15/share. I, however, was prepared to extend Mr. Greenberg an olive branch, a way to monetize value for shareholders — sell Chipotle Mexican Grill to me, or, if that was not palatable, sell me the rights to open and operate Chipotle in New York City. In the summer of 1999 while interning at a private equity shop in Denver I had discovered Baja Fresh, a Wendy’s property, and due to a previous stint in New York City, I knew the city was ripe for a burrito revolution and that there was not a local property that could service the demand when the wave crested. My real goal was to get the franchise rights for the local territory, but I figured taking the audacious approach would enable me to offer the franchise rights as a compromise assuming we would come to an impasse on valuation.

I had tried this stunt before, in 1998, involving Fresh Samantha, a producer and marketer of fresh juice beverages, out of Saco, Maine. Unfortunately, I lost out on the property to Bain Capital, LLC, but I would like to believe my letter catalyzed the process that allowed Bain to buy Fresh Samantha. Neither party ever sent me a thank you note. At the time I was woefully under prepared having no access to capital and no sense on valuation, so it was no surprise that my previous effort failed based on execution, as opposed to ambition.

This time around, for my dance with Mr. Greenberg, I was much more prepared. I still had no money but I was armed with numbers. On the capital front, I had left a few messages for folks so I could say, “it’s in process, but I don’t expect a financing contingency in my proposal”. Truth be told my plan was to team up with the founder who still owned a big slug of equity, despite the fact that McDonalds now owned a controlling stake, and he was shurly backable and would not want to see his baby sit in idle while McDonalds focused on fine tuning its strategy oversees (note: I did manage to have a conversation with Steve Ells, the founder, as part of the process and at the time said he had no interest in buying Chipotle back, funny how things would come full circle). What I brought to the table was blind ambition and capital markets relationships.

In my effort to prepare for going mono e mono with Mr. Greenberg. I tried to learn how to value franchises. The logical place to start, I assumed, was to look at McDonald’s valuation and understand where the deal would become accretive to them. The problem was, at the time, that Chipotle was accounting for a large percentage of McDonalds’ quarterly earnings. I knew the deal would not be easy on that basis alone. However, McDonalds was trading at 20.0x LTM EPS vs. a historical average of 25.0x. I dug into the numbers and growth rates that we available, looked at public company comp list, circled up a number and fired off my letter to Mr. Greenberg and began to wait. Summer became fall and McDonalds’ stock went in the tank (I was an owner, and still am). I was hopeful for a letter from Mr. Greenberg. I went back to waiting.

My magical letter arrived in December 2002, “Mr. Jaffe – If we wanted to sell Chipotle Mexican Grill or partner on an expansion, we would know who to call. You would not be on that list. Sincerely, Mr. JackGreenberg.” Mr. Greenberg lost his job two weeks later. I’m not sure the events are correlated. Chipotle entered the New York City market in 2003, lines were around the block. While I loved the food, I was melancholy about my lost opportunity. On the plus side, I learned a little something about valuing franchise businesses. Below is a summary of points you should consider if faced with the same task.

1) All revenue is not created equal. Spilt the revenue stream into restaurant sales and franchise royalty fees. If you are valuing a large operating business you will focus on profitability, but in a growth equity context looking at revenues is useful. Value the revenues based on their prevailing multiple. Consider that McDonalds is valued at 3.0x, prevailing market comps are trading at a median multiple of 10.7x, with hot properties like Panera bread trading at nearly 24.0x.

2) You need to dig into the franchise contracts to understand the value of the non-controlled entities. Length for contract, contracted value flowing to the parent, supply relationship, and buyback and control provisions all impact where on a valuation range an operation should fall. Longer contracts with more recurring revenue streams is better than less. Discounted buyback provisions are favorable. You should also assess where a franchise is in its useful life if the contract has a rebuild or upgrade provision. This value inures the franchisor, since the franchisee bears the cost but only captures a majority of the benefit, but not all.

3) Analyze location and location density. See Boston Market as what not to do. Did Sydney need 9 locations and Toronto 3? A company that is expanding more rapidly and into markets outside it’s core competency (Krispy Kreme anyone?) should be viewed as riskier investments and the risk should be reflected in the discount rate applied to any cash flow analysis. More highly valued real estate also brings lease pricing risk. If they franchisor owns the land and leases it to the franchisee that has intrinsic value, which translates to a higher multiple.

4) Look at comps. Same store sales. Sequentially. Year over year. Profitability as well. Average sales per store open 12+ months. Are there more winners than losers? Are there outstanding stores and laggards? Are margins compressing, if so why? What are the cap-ex costs relative to its closest peers. Comp restaurant sales growth of 10% is a base line in a favorable economy, high single digits in a more turbulent environment. Higher growth should translate into a better multiple. Average sales per store should be continually improving to command a higher multiple. Restaurant level margins of at least 20% is favorable. Expanding operating income margin, in double digits is good.

5) Estimate ROI as average sales per store * restaurant level operating margin (total revenue less operating cost divided by total revenue) = restaurant level cash flow. Investment cost per store divided by restaurant level cash flow = ROI. As a baseline 30%+ in favorable economic climates.

Net net, Mr. Greenberg put me back in my place. However, unlike my pursuit of Fresh Samantha, I had the valuation nailed. Applying my analysis to Chipotle’s go public numbers got me within $0.25 of the offering price. Now that I have learned a little something, third time is a charm?


It should come as no surprise to many that the debt capital markets are in disarray. I hesitate to use the common phrase “crisis” because deals are still getting done, which means there is capital available for quality deals with appropriate levels of leverage. What is clear is that the leveraged transaction markets peaked in May 2007, when it was announced that CDW would be taken private by Madison Dearborn Partners, LLC for approximately $7.3 billion utilizing 8.5x leverage. In the ensuing struggle to place the CDW debt, the market made some realizations — this was not good business, the risk reward profile was no longer aligned. In the months that followed, the perceived risk of a slowing within the U.S. economy, and therefore a potential rise in the associated default rates for highly levered deals, many with light covenant packages, became so fever pitched that the debt markets all but locked up. Banks took to lending only into their best existing credits, if at all, and, if so, on very cautious terms.

Debt is very important to the private equity buyout landscape, as purchase price multiples and leverage are highly correlated, as buyout firms seek to invest as little equity as possible in levered transactions. As the chart below illustrates, deal leverage and, as such, transaction multiples peaked in 2007. As the second chart illustates, the impact of this compression has been material in deals sizes sub-$100 million.

In my recent conversations with a handful of PE firms, I am hearing an increasing willingness to over capitalize companies on the equity side (50/50% debt to equity vs. 60%/40% or 70%/30%), with the assumption that they will lever and dividend out excess capital to investors at a later date, when appropriate. This assumption shows a belief, maybe lacking current foundation, that a thawing will occur. The new found predilection for over equitizing doesn’t seem to be moving the needle however, as buyouts are down this year, with $26 billion of domestic deals announced in 2Q08, down 93% from the same period in 2007 (Thomson Reuters). Further, the credit quality of LBOs has also declined, with 93% of 2008’s first quarter deals rated in the ‘B’ category, well below investment grade, up from 78% last year (Standard & Poors). While the bond markets are effectively closed to new LBOs, banks have still provided financing, says S&P, with “ample liquidity available from local lenders to fund private-equity transactions.” I’m not sure I would go that far out on a limb.

This leads me to the crux of this post, how are deals getting down in light of the fact that seller expectations have not fallen at the pace they have been undermined by available credit? The answer is buyers and sellers are bridging the gap with mezzanine debt or seller subordinated financing where mezzanine is not available. Seller subordinated financing is essentially deeply subordinated debt or preferred equity wherin the seller is the underwriter or part, or potentially all of the transaction. Popular back in the roll-up days of the go-go 90s, seller debt vanished from the scene due to a glut of available debt capital from third parties at attractive prices and structures. However, as lenders have retrenched, the idea has re-emerged. Take for example, the sale of Unilever’s North American laundry detergent business to Vestar Capital Partners for $1.08 billion. As part of the deal, Unilever will retain “preferred shares in The Sun Products Corp. [the NewCo formed when Vestar Capital Partners merged its business entity, Huish Detergents, with the newly acquired brands] with a face value of $375 million” per the company’s press release. If it wasn’t already clear, this was not a roll-up but a deal between a global enterprise and a firm with a $3.7 billion private equity fund.

While there is substantial mezzanine debt locked up in institutional funds, they remain frugal investors and focus on companies that have established and sustainable profits. A large portion of the lower end of the middle market is not an attractive mezzanine candidate, due to size and profit history, and service firms tend to get the cold shoulder relative to product firms from these sources. The benefits of seller subordinate financing are the note can be simplistic, flexible and easy to implement. The pitfalls are many however, namely that the seller is generally showing weakness if they express a willingness to be a financier of last resort.

Seller financing can be a useful tool, sometimes the difference between a deal that gets done and one that meets its demise. With any type of debt financing, the use of seller paper has long term implications, which can impose burdens on the issuer and the company. At the outset of engaging in a private equity backed transaction search, a discussion as to whether this form of financing is a realistic alternative and the structure that would minimize the associate risk should be undertaken. However, the more substantive reality is that sellers will need to come to grips with the fact that valuations have in fact contracted. Their choices are to consider lower prices, more structured deals, including earnouts or seller financing, or wait around for another cycle. This isn’t a lesson I enjoy teaching but it is a fact based reality.

Let’s just hope death spiral preferreds are not the next to make a comeback.


In my previous post I alluded to the importance of keeping your valuation grounded. Let me be very clear, I am not advocating underselling yourself. When I say grounded, what I mean is connected to some rational equation, as opposed to some arbitrary heuristic. Easier said than done, I know, especially for companies that are early in their growth cycle and are experiencing accelerating market traction. Further, young consumer companies often lack known comparables to base a valuation off of.

Valuing a profitable and established operating business, is a more straight forward exercise, as one can rely on precedent transactions analysis, comparable public company analysis, discounted cash flow analysis and inputted IRR calculations. Performing a DCF for an emerging growth business where the terminal value comprises the majority of the valuation is not good fundamental finance. Alternatively, applying transaction or trading multiples to a small base of operating results is not much better. While there is no formula for overcoming these challenges, some heuristics can be helpful in guiding one through the thought process.

Before we get into the point of heuristics, let’s go the opposite direction and talk about some of the most eye popping pre-money valuations that have been reported recently:

– October 24, 2007: Facebook raises $240 million on a $15 billion pre-money valuation;

– January 18, 2008: Slide raises $50 million on a $500 million pre-money valuation;

– March 19, 2008: Federated Media raises $30 million on a $200 million pre-money valuation; and

– April 21, 2008: Ning raises $60 million on a $400 million pre-money valuation.

– May 5, 2008: Meebo raises $25 million on a $200 million pre-money valuation

So what are the common strings. First, several of these companies own dominate or near dominate market positions in the fast growing on-line world where growth rates dwarf those of traditional businesses. Second, a number of these companies were founded by and are run by folks who have created substantial investor wealth in the past. Ning was co-founded by Marc Andreessen of Netscape fame. Slide was founded by Max Levchin, of the PayPal lineage. Third, the Facebook deal was strategically motivated. Some say Microsoft was valuation agnostic, a fact I don’t believe. Finally, most of these companies did not need the money and therefore they could dictate the terms of the investment. The point I am trying to make is that even these absurd valuations could be rationalized given the market positions, growth rate or strategic importance of the transactions. While deals like the above, grab headlines they are far from the norm, but rather the exception.

With that out of the way, we turn to how to derive your own valuation. A good place to start is to understand how others will look at your business. Experience has told me that you can break up a company’s drivers into tangibles and intangibles. Tangibles are things are observable or can be estimated with some degree of accuracy like actual financial performance, addressable market, distribution footprint and profitability levels. For the most part, these factors are observed traits or have corollaries that can be observed based on historical experience. Intangibles relate to observations that are open to more interpretation — quality of management, first mover advantage and brand value. The value ascribed to these factors will vary between potential investors based on their perceptions; tangibles less so. I have summarized my own view of this hierarchy below.

Now that you know what investor will be looking for, you can sketch out a realistic expectation of your pre-money valuation. For a consumer business idea that is raising money on a business plan, I’ve generally seen valuation ranges of up to $5 million for first time CEOs, and up to $20 million for proven management teams on their second go around (think Clairisonic, which was founded by Sonicare (Optiva Corp.) vets David Giuliani and Jack Gallagher – ed note: I have no idea what their pre-money was on any financing) Where a company’s falls in the range between $0 – $5 million or $0 – $20 million should be based on an honest assessment of intangible factors.

For an operating business, one should add a tangible valuation component. Generally, I base this a multiple of historical revenues and forward 12 month revenues. In a capital raise you can sell based on forward run rates. The multiple I rely on is based on precedent transaction and trading multiples where the point in the range I select is based on the tangible business factors that do not show up in the financial results. For example, Sambazon, a producer and marketer of Acai, a so called “super fruit”, based beverages controls the supply of Acai from the Amazon rainforest. This is in marked contrast to its competitors and quality control in the Acai beverage market is very important. Bad Acai is commonplace and leads to a poor customer experience. Based on this thought process, much of which can be observed and verified, I would value Sambazon, if I was doing so, at the higher end of the range. I would tick down similar rationales for all the tangible valuation factors.

Once, you have completed your analysis sum of the parts gets you a good sense of where you should be aiming. All of the above notwithstanding, I encourage company owners to focus on finding the right partner first and valuation second. Communicating a sense of openness on valuation is important even if a healthy debt as to what if fair ensues thereafter.

Happy hunting.


Over the past 18 months, I’ve been exposed to a number of emerging consumer brands. There are very interesting companies reinventing traditional consumer services, those putting a new twist on an established space and those that are pioneering new niches. For companies that have a product orientation, we are seeing a new paradigm emerge. Gone are the days where a product could lead and demand would follow. Today it takes real marketing and advertising spend to drive sell through and institutional capital wants hard data that the risk they are taking is distribution risk, not product risk.

Beverage comps are a great example of this. Companies like Tazo Tea, Sobe and Oregon Chai raised minimal institutional capital. Odwall was the exception back in the early days raising $8 million from Catterton Partners. Contrast that to Izze, which raise more than $11 million from the likes of Sherbrooke Capital and Greenmont Capital, FRS, which raised $25 million from Oak Investment Partners and Radar Partners, and Honest Tea, which raised $12 million from Inventages, the investment arm of Nestle S.A. The reason this came to be, is that the money necessary to differentiate yourself from the competition has accelerated exponentially. For example, FRS utilizes Lance Armstrong as a spokesperson. I suspect that’s not cheap.

The problem, as previously alluded to, is that institutional investment funds that focus on consumer products, have been loathe to take product risk. If you ask them their ideal company metrics for a private placement and many of the traditional players will tell you $10 million in capital requirement and $10 million in revenue run rate, if not trailing. Notably, this investment class has been buyout in terms of its orientation. However, few companies can achieve the required growth sans institutional capital given the competitive environment. We call this the Consumer Capital Conundrum.

While well heeled investors in this space are morphing to fill the capital void, Catterton, historically a buyout fund, closed a $300 million growth equity fund in March of 2008. Swander Pace has countered with its “brands of tomorrow” (or future?) program. A number of permutations have ensued, VMG Partners, Encore Consumer Capital, etc. Health and wellness funds have filled this void for appropriately situated companies, as their interest tends to be piqued at between $3 million and $5 million in trailing revenues. That all notwithstanding, if you are a consumer brand whose revenue base is beholden to a national Whole Foods contract, you’re facing an uphill battle on the capital front. On a regular basis my partners and I meet interesting consumer brands with $2 million in trailing revenues who are seeking an agent for their $10 million Series B financing. So how do these companies survive until they are ready for institutional capital?

If my partner Tom Newell were here he would tell you that a sound capital development program starts with a focus on profitability. Let’s assume that you don’t have the luxury of the slow growth plan that Tom would advocate. Survival begins with an emancipated view of capital recruitment. Yes, it would be wonderful to find a handful of deep pocketed angels to see you through, and some do, but in the consumer arena this is a rarity, especially in markets dominated by technology investment. My advice to companies is two fold — a) don’t be above using organized angle groups to recruit capital and b) do not let you valuation get ahead of itself.

When I talk about organized angel groups to entrepreneurs, often times they make a face that one might make if they had opened a skunked bottle of Chateau Margueax. In reality, organized angel groups are providing an effective funding avenue to consumer oriented companies. As an example, Adina World Beat Beverages raised $5 million through the Keiretsu Forum. That’s not pocket change. Consider that angel investors placed $26 billion into companies in 2007 vs. institutional investments of $30 billion. Some say that angels account for another $10 – $20 billion in angel investments outside the organized reporting environment. For example, my wife and I have invested in her business outside of any regulatory reporting environment other than the IRS. Net net there is no shame capitalize your company $50,000 at a time. Keiretsu Forum, Alliance of Angels and others are delivering real value for companies by connecting them to angel investors without forcing them into an endless string of one-on-ones.

The second piece of advice to consumer companies I can convey is keep your valuation reasonable. Let me be clear, I am not saying bend to the whim of investors or agents. What I am saying is keep your valuations grounded in tangible business results. A large pre-money valuation on a de minimis revenue base only constrains capital recruitment. It might make your early money feel good about your progress to have an every increasing valuation on their incremental capital contributions, but it is only going to create a headache later when valuation is leveled by an institutional investor. A rule of thumb is don’t let you valuation exceed 3.0x revenue plus intangible value (brand value). I haven’t seen a situation where intangible value had exceed $10 million prior to $5 million in revenues, that’s not to say it can’t happen (see FRS). Net net, I ask that you simply bring realism into the equation.

Long short the consumer capital continuum looks as follows:

> Product Risk > Sub $3 million in revenues > Angels and angel groups

> Early Distribution Risk > Sub $5 million in revenues > Local VCs/small consumer capital/local VCs

> Distribution risk > $10 million revenue run rate > Mainstream consumer capital


If you don’t have a pet, you likely know someone who does. While the economy may be experiencing a contraction, spending on pet related products and services is accelerating. The $41 billion industry is expected to grow by 12.5% annually for the next 2 years. The “humanization of pets” movement, as it is called, is big business and private capital has been part of the beneficiary food chain. Increasingly, we are hearing from investors an accelerating interest in investing in the pet space.

Pet food has been the historical proving ground for private equity in the pet space. Swander Pace Capital had previously experienced a favorable exit in selling Eagle Pack Pet Foods, Inc. in October 2007 to Berwind Corporation, owners of the Elmers franchise. Other notable deals include Teachers’ Private Capital (the direct private equity arm of the Ontario Teachers’ Pension Plan)/Doane Pet Care Enterprises Inc., which sold to Mars, Inc. for $840 million and Cypress Capita/Meow Mix Holdings, Inc., which sold to Del Monte Foods Co. for $705 million (~ 2.7 Revnue). Most recently Catterton Partners sold Wellness Pet Foods, Inc., a provider of natural pet food products whose brands include All Wellness and Old Mother Hubbard, to Berwind for ~ $400 million (~ 2.7x Revenue — theme anyone?). Catterton only bought Wellness in January 2004 for $45 million. That’s a handsome return in a short period of time.

The above is what I call Pet Food M&A v 1.0. The reality is that pet food is morphing in light of both input trends, food trends and consumer behavior. Organic pet food from Castor & Pollux and Newman’s Own, wet raw food from any number of purveyors, and dry raw from likes of Natura Pet Foods (my dogs are EVO consumers), The Honest Kitchen and Nature’s Variety and others, are new and interesting twists on the pet food equation. Given that raw is a $169 million sub-vertical and is expected to grow to $453 million 2012 (a 28% CAGR), I expect interest both from investors and consolidators to focus on organics and the raw niches. This will set the stage for Pet Food M&A v 2.0.

The first salvo in v2.0, was Highland Capital’s transaction with Castor & Pollux Pet Works of Portland Oregon. Not much is known about the deal or public. While Castor & Pollux appears in Highland Capitals portfolio list, there was no press release announcing the deal. If you were a CFO searching for a Portland position you might come across the salient details that Castor & Pollux “recently received a significant infusion of capital from Highland Capital Partners” in their on-line job posting ad. No matter. Given that Founding Partner Tom Stemberg is on the board of PETsMART, Inc. and Castor & Pollux is currently carried only in competing chain PetCo Animal Supplies, Inc. (where my dogs shop), there is some salient value Highland can likely add.

I suspect we are only in the first inning of v2.0. I also expect velocity for investment will pick up as the niches mature and investors become more aware of the trends in organic and raw food and that purchase multiples will exceed the long term trend of 2.7x due to the lower revenue base vs. franchise value of brands in this category. However, buyers will attempt to leverage their distribution frameworks to justify keeping multiples in check.

If you are a purveyor in this space with $5+ million in revenues, please call me. 🙂


I’m a banker, no not that kind of banker. An investment banker. I help others raise money to grow their businesses. I help business owners monetize their investment. Along the way, I’ve learned some things that might help you…without having to pay me.

I’m also a husband, dog dad (Greta (my angel) & Tyr (my devil)), a triathlete, Walla Walla wine collector, locavour, bike commuter and wanna be gardener. However, that’s not why we are here.

In my 10 years of investment banking experience I have had the opportunity to work with companies across the size and industry continuum. I have sold all or portions of Fortune 500 companies and raised Series A capital for start-ups. I have worked on Wall Street and in a boutique investment banking environment. Along the way, successes have been enjoyed and some mistakes made. Through it all some patterns have emerged that I can now share. Hopefully, these can be of benefit to anyone who reads this blog.

On “i’m not that kind of banker”, I will be blogging about my insights as an investment banker in the market. My focus will be on the consumer, food, specialty retail and business services arenas where I am passionate. At times I will blog about market conditions, finance theory, investment banking products and process. Other times I expect this blog will be about cool products, health and wellness, recruiting advice and, honestly, about my dogs. I intend this to be modular — take what you like, leave what you don’t, but enjoy it either way.

/bryan jaffe

All opinions expressed herein are my own.  They do not necessarily reflect the views of my employer, and shall have no recourse thereto.