weekly feature | Sep 27, 2023 |
Scapegoat or savior? Why private equity is a controversial industry topic

Pop quiz. What do the two big furniture industry bankruptcies of the past few months—Mitchell Gold + Bob Williams and Klaussner—have in common? If you said, “They both had private equity owners,” you’re correct. If you said it with a derisive emphasis on the words private equity, you’re in the home industry.

Furniture people have long had a simmering distrust of private equity, seeing outside money as meddling at best, malicious at worst. In certain parts of North Carolina, private equity is so distrusted that Furniture Today ran an article examining PE’s status as a “four-letter word.” But MG+BW’s overnight shutdown caused that ill will to bubble over into the broader interior design world.

The reasons Mitchell Gold + Bob Williams ultimately went under are complicated. But to hear it online, in DMs and at industry cocktail parties, the short explanation is: The private equity firm that owned the business, The Stephens Group, bungled the situation, and as a result, millions of dollars’ worth of orders were stuck in limbo—typical. In the wake of the company’s collapse, posts pinging around social media urged designers to scrutinize their vendors’ financial health, and private equity ownership was sometimes raised as a red flag.

“I’m going through my vendor list looking for [private equity],” one designer said. “Should I be worried?”

A private equity primer
Private equity is a bit like “sustainability”—a subject frequently discussed, but not always interrogated. The term is often used as a catchall for “outsiders with money.” One industry consultant put it succinctly: “When people hear the words ‘private equity,’ they just think of guys with gray hair moving money around.” But private equity is a specific business model, and it’s worth looking at why it has become so common in home.

At base, private equity firms do something very simple: They buy companies, try to make them bigger and better, then sell them at a profit. To get the cash to fuel these acquisitions, they raise money from “limited partners” or “LPs”—people with money—who expect to see a return on their investment, usually within a window of five to seven years.

Private equity companies are similar to their close cousins, venture capital firms, the money managers who have fueled the tech industry’s explosive growth. VC is essentially a genre of private equity—the difference is largely what kind of companies each class of investor is interested in.

Venture capitalists tend to work with early-stage startups. If the company is profitable, it’s almost too late—their goal is to take a napkin sketch and turn it into a billion-dollar enterprise. Big, potentially disruptive ideas tend to attract VCs. Havenly, Modsy, Homepolish and Material Bank are all examples of home world companies that took venture money.

Private equity buyers, by contrast, generally look for stable companies that are already profitable. Their goal is to take a good company and—by cutting costs, streamlining operations or expanding the business—make it a bigger one.

Opportunity knocks
There are lots of private equity firms in America—thousands of them, most with somewhat anonymous, serious-sounding names like Stone Capital or The Rock Group, and each has their own approach. Oddly, industry expertise is not a given when it comes to investment strategy. Private equity firms frequently avoid specializing in a particular area of the economy, instead preferring to spread the money—and risk—around. The Stephens Group, the owners of Mitchell Gold + Bob Williams, has a portfolio consisting of, among other things, a fried chicken restaurant chain, oil and gas companies, and a firm that specializes in “genetic improvement services for the livestock industry.”

Even if many private equity firms prefer to keep a finger in many pots, the home industry has become a common feeding ground. Partially, it’s because the surplus of cheap money over the past decade means that a lot of people are looking for places to put it; almost every sector of the consumer economy has seen a rush of private equity buyers.

But the raw math of the home business has a special appeal for private equity. Home products are typically expensive, and companies will often recoup their cost of acquiring a customer in one purchase. Plus, gross margins are usually decent: You can sell a chandelier for significantly more than what it costs to produce. On paper, it’s a much easier challenge than working in an industry—grocery stores or airlines, for example—where the margins start off razor-thin.

Additionally, the home business has been one of the slowest to wholeheartedly embrace technology. Many furniture and decor brands still have no e-commerce strategy whatsoever. Private equity firms, not without reason, often wager that simply by getting product online, they can multiply revenue.

Lurking amid all that is something slightly more delicate. There is a widespread perception that while home world brands excel at creating beautiful product, they are not always the most buttoned-up operations. Private equity buyers are savvy to this dynamic. If they see that the product is great, but the business is clunky, they assume that they can make a killing if they make the back office more efficient.

“We’re not an industry of financial geniuses; we’re an industry of aesthetics,” says David Sutherland, who, alongside his wife, Ann Sutherland, has sold his namesake furniture brand and the fabric house Perennials to private equity—not once, but twice. “PE brings a lot of financial knowledge to the table.”

Ready buyers

That’s why private equity firms buy. Why do business owners sell? The truth is straightforward: There aren’t a ton of other options.

Some home brand owners pass off the company to their kids, but there isn’t always a next generation waiting in the wings. Then there are “strategic” buys—selling to another company. That’s great when it works, but sticking the landing requires timing and circumstances to line up just right. Unlike tech, ours is not an industry full of cash-rich businesses that can easily absorb competitors—even the most acquisitive home companies tend to only pick up a company or two every year. Google, by contrast, has purchased more than 250 businesses since its founding 25 years ago.

“Private equity companies are in the business, 24/7, of evaluating companies and deciding whether to buy them or not. That is what they do” says Lee Helman, a mergers and acquisitions specialist who focuses on the design industry. “With a strategic acquisition, it’s all about getting them at the right time—one year, they might be very interested in acquisitions, the next, they’re not. Everything has to line up.”

In short, when owners want to sell, private equity is often the best or most convenient offer on the table. This dynamic has triggered a flood of private equity deals in the design industry. A by-no-means-comprehensive list of brands that have either partial or complete private equity ownership: Arteriors, At Home, Flos, Visual Comfort, Thibaut, Lenox, Lumens, TileBar, Sutherland, Perennials, Fendi Casa, Crypton, Chilewich, B&B Italia, Flos, Vaughan, The Shade Store, Studio McGee, Sonneman, Rugs USA—the list goes own.

Even if private equity ownership was truly a bright red flag for designers looking to scrutinize their vendors (more on that later), it would be difficult to avoid. Rare are the residential projects that don’t involve specifying any products that touch PE money.

Ripe for conflict
Just because it’s common doesn’t mean that people like it, and you do not have to dig too deep to find complaints about private equity. Some of them are right there in the business model, which can entail “finding efficiencies and cutting costs”—often code words for laying off employees, a surefire way to engender bad vibes and ill will.

Even if jobs aren’t on the chopping block, PE firms and their acquired companies often end up at loggerheads due to misaligned incentives. Private equity firms make money by selling a company, not by running it long-term. The result can be cut corners and clumsy tinkering—even if things go “well” by private equity standards, owners and employees can feel burned by the experience.

“You can cut a business down to the bone, sell it and make a profit, but you’re not setting it up for long-term success,” says Satya Tiwari, the president of Georgia-based furnishings brand Surya. “I always say: Okay, you’ve maximized your return and skinned this down, but now someone else has to buy it and run it—there’s a receiving end too.”

And when private equity goes poorly, it can go very poorly. One of the lesser-understood aspects of the business model is how PE firms finance their purchases in the first place. Sometimes they buy a target company outright using cash. But just as frequently, there’s financial engineering involved. Private equity firms often take out loans to finance a purchase, then saddle the company with the debt. In other cases, they’ll push a company to sell its real estate to generate cash, then rent the property back from the new landlords—a so-called “sale-leaseback.”

Such arrangements can saddle a company with bank debt and expensive leases, hamstringing its ability to navigate the ups and downs of the business cycle. If things go really bad, private equity can lead to the kind of abrupt shutdown we saw with MG+BW. Deeply in debt, the brand’s owners, lenders and landlords couldn’t agree on a plan to finance operations going forward, forcing it to close without warning. There was a lot that went wrong at MG+BW, but private equity ownership absolutely contributed to its sudden downfall.

Even the psychological aspects of third-party ownership can play a big role. “If my name is on a company, I’m doing everything in my power to save it from going under,” says Tiwari. “With private equity, they’ve already put money into it, they have no emotional connection—it’s numbers on a spreadsheet.”

Tiwari is part of a vocal, not-so-small group of insiders who have questioned whether the business model simply doesn’t work for significant parts of the home industry. He made headlines recently after acquiring Global Views and RST Brands, saying that he was taking a Warren Buffett–inspired approach and looking to hold the companies indefinitely, not pass them along at a profit.

Alongside boilerplate complaints about third-party ownership are more specific critiques. For one, the time horizon of private equity firms—often five to seven years—simply doesn’t line up with the slow-moving pace of the home business. “Newness I’m releasing this year is going to help me out three or four years down the road, but a private equity firm halfway through its investment doesn’t care about that. They just want to fatten the pig, cut out unnecessary costs and sell,” says Tiwari. “‘Long term’ can’t mean three to five years, it’s more like seven to ten years. Private equity will never do anything they have to wait ten years for.”

For another, say critics, private equity companies often assume that home companies can move between distribution channels—from residential designers to consumers to commercial designers to retail buyers—quickly, and with minimal friction. Anyone who has tried to do that knows that the pitfalls are many. A brand that seeks to pivot quickly from designers to consumers is in danger of losing both.

Winners and losers

Although the PE business model has challenges, and dramatic collapses like those of Klaussner and Mitchell Gold + Bob Williams are real, many private equity arrangements work more or less how they’re supposed to.

Sutherland and Perennials are a case in point. Lacking a son or daughter who wanted to take over the business, David Sutherland had long assumed that he would be “carried out on a stretcher” from his namesake brand. But after conferring with the company’s CFO about a succession plan, he met with an Austin-based private equity firm, which expressed interest in acquiring a stake in his company.

“It worked perfectly because they were already clients of ours, and many of their friends were clients of ours,” says Sutherland. “They understood what we were all about on day one, and we were aligned from the beginning. … and they brought some much-needed financial expertise to the business.” A few years later, the Austin firm sold its stake to another PE business, Bertram Capital. Everyone made money on the deal, and Sutherland has similarly rosy feelings about his new partners.

A lot of PE deals are like that: relatively low key. Some pan out better than others, but explosive collapses are infrequent. Partially because of their rarity, and because the industry is already primed to distrust outside meddling, big PE failures tend to dominate news coverage. “Everyone knows someone who knows someone who has had a bad experience,” says Seth Kaplowitz, a lawyer who specializes in representing design firms. “It becomes this convenient explanation for why something went wrong.”

In that respect, private equity firms serve an accidental secondary role in the industry. In addition to providing a handy exit strategy for the right business owners, they’re a useful scapegoat. It’s socially awkward to place the blame for a company’s collapse on well-known industry players who may show up at the next High Point Market cocktail party. Easier to pass the buck on to anonymous penny-pushers who generally don’t mix in design social circles.

Clearly, private equity ownership alone doesn’t dictate a company’s success or failure: Just weeks after the Mitchell Gold + Bob Williams shutdown, another company, Noble House Home Furnishings, abruptly filed for bankruptcy, citing rising inflation costs and sagging demand. This time, however, the business was family-owned. “Everything is a case-by-case situation,” says Helman. “Everything has its own unique set of circumstances and nuances around it. Some wounds are self-inflicted; some wounds are inflicted by exogenous factors. Some are just bad luck.”

Homepage image: Adobe Firefly

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