As one retailer after another seems to fall in the private equity buyout wave that has swept through the industry the past three years, one former big box executive has lined up $300 million in venture capital funds to foster the growth of a slew of new chains.
Staples founder Thomas Stemberg came forward in July with plans to invest between $15 million and $20 million at a time with small retailers to help nurture and grow new concepts through the Highland Consumer Fund, a venture for which Stemberg is the co-managing general partner. Its other co-managing general partner is Ted Philip, who founded Lycos Inc., an Internet portal. The fund will particularly target upscale chains with small footprints, niche products, healthy inventories and an emphasis on customer service.
“We think we've found an underserved need in the market,” says John Burns, partner, HCF. “There's been a shortage of funds available to help them grow.” The firm plans to place the funds over the next four to five years raising money from institutional investors, endowments and pension funds.
Howard Davidowitz, chairman of Davidowitz & Associates, a New York City retail consultancy and investment firm, agrees that this segment of the market has been long ignored.
“What's needed are some new concepts that excite the consumer,” says Davidowitz. “What Stemberg is looking for are unique concepts to nourish.” In a sense, Stemberg is looking to provide for other firms what venture capital did for Staples when he was running the company. In its infancy, Staples received an infusion of funds from Bain Capital (which has gone on to be a major player in the private equity buyout parade). Those funds helped Stemberg grow the Framingham, Mass.-office supply chain into a $14 billion category killer in the office supply market before he stepped down as CEO in 2002. He served as chairman of the board until 2005.
But times have changed. Since the mid-1990s early-stage financing for retail has all but dried up noted Davidowitz, as venture capitalists have instead directed resources to startups in other more high-profile industries — most prominently technology. With HCF, Stemberg is attempting to fill that void.
HCF is an outgrowth of the Lexington, Mass.-based venture capital firm Highland Capital Partners, which in recent years has funded fledgling specialty retailers such as Lululemon, a Vancouver, B.C.-based chain with 53 stores worldwide, including 11 in the United States, that produces and sells yoga sportwear; RecRoom Furniture & Games, a Chicago-based marketer of bar stools, pool tables and arcade games for the home and New York City-based gift and entertaining retailer Blue Tulip with 14 stores.
Highland Capital Partners was formed in the late 1980s. Its funds were earmarked for ventures in technology, health-care and communications. In 2005, Burns says, he and Stemberg joined the firm to generate funds targeted to retail and consumer verticals. For now, Burns says, they are evaluating all retail categories but prefer lifestyle retailers similar to ones Highland Capital has financed in the past.
What HCF wants to see included in retailers' requests for funds is “proof of concept.” By that, Burns means, it wants evidence that the concept works and consumers are buying the product. They are focused on local retailers whose operation is economically viable and with a cash infusion of up to $30 million can demonstrate exponential growth from one or two stores into a regional or national chain.
Retailers who receive financing from HCF can use the funds for anything, ranging from securing leases to expenses for build-out and marketing to re-capitalization of the business.
However, analysts warn investing in these undeveloped companies is not without risks.
“I wouldn't put my money in these businesses,” says Davidowitz. He contends when you deal with companies without critical mass you stand to lose your entire investment whereas if the companies have substantial real estate holdings you stand to get a percentage of it back.