Financing luxury companies: the quest of the Holy Grail (not!)

Financing luxury companies

The main characteristic of a luxury company is the importance of its brand’s value. This is by far the most crucial asset of a luxury business. It is due to the extreme concentration of intangibles that such brand embodies.

Since the value of a luxury business is, above all, the financial valuation of its brand, the luxury company’s management needs to implement a strategy that will boost such brand equity. This is the goal of financing luxury companies.

1. What does it take to build a luxury brand with a strong financial valuation?

This implies that the financial strategy will be to maximise, not the net profit, but the luxury brand’s value. Another consequence is that since brands have never been set out on the balance sheet at their true worth, successful luxury companies generally have a very high return on equity, a phenomenon often accentuated by very high profitability.

So, what does it take to implement a strategy that unlocks a luxury brand’s equity?

It takes a lot of time and money to build a lasting luxury brand. Given the importance of the investment to be made in creation, communication and distribution, which are strongly qualitative and only profitable over the long term, a very high gross margin (in the order of 80 per cent) is crucial to the brand’s survival.

To achieve such high gross margins in the long term, some basic rules must be followed from the inception of a luxury brand.

 The first one is to be profitable in the core trade first: the burgeoning luxury brand needs to remain concentrated on the core trade and extend only progressively, and in a controlled manner, to luxury goods beyond its core. A luxury brand is deep in deficit at the beginning, since it cannot waver on the product quality it offers, while its low recognition makes it impossible to sell at high prices. This deficit should be considered as an investment on the brand’s content.

The young luxury company must then set the virtuous spiral in motion by:

  • increasing its sales volume, and thus its production;
  • lowering its costs, enabled by the experience effect, which leads to a rise in margins, since retail prices are maintained at the same level;
  • investing in communication, thanks to the release of the level of finance made, and
  • ultimately, increasing sales prices, made possible by ongoing recognition of the luxury brand.

Diversifying into other products before achieving profitability in the core trade would be a mistake, and could even be fatal to the emerging luxury company.

The second rule is to ensure human stability and coherence of teams. These stable teams will bring creativity of consistent quality, hence fostering brand loyalty in the luxury company’s customer base. When the luxury company launches into products’ diversification, its management team should be mindful of troop morale, since such diversification could be perceived as a rejection of existing lines and their teams. Diversification consuming a great deal of cash, to the detriment of the core trade, management must explain its expansion strategy to its teams, and ensure that money is appropriately spent during the implementation of such diversification.

Meanwhile, it is important for the luxury company to keep on investing strongly in its brand and distribution, in order to maintain a very robust brand and thus be shielded from any risks generated by the diversification. Often, part of the royalties, paid by licensees to the luxury company, as a result of products diversification into perfumes, eyewear or children wear, for example, will be reinvested in the luxury brand and distribution.

Achieving high margins for a luxury company always requires seeking the minimum volume of sales beyond its own borders: internationalisation, and then globalisation, is the law of luxury.  Only the demand side should be expanded abroad, though, certainly not the production side in order to reduce costs, as this would greatly damage the luxury brand.

When a luxury company consistently follows these rules, it usually generates exceptional profitability on turnover, over time. Initially, it must concentrate the bulk of its small capital on the development of its production volume in order to be profitable at the desired sales price. Then, when the luxury company has reached a reasonable cost price, it should swing the majority of its investment into communication, including the development of a quality distribution network.  

2. What types of financing exist, for luxury brands?

Luxury companies, with their high gross margins and net profits rates [1], have become attractive targets for financiers. Private equity funds, in particular, have delved into the luxury world with enthusiasm. From Jimmy Choo [2], to Hugo Boss [3] and La Perla [4], quite a few luxury brands have been acquired, or heavily invested into, by equity financiers.

For young luxury companies, finding a committed, yet not overbearing, equity finance partner is really a way to kick-start their brand to the next level. For example, England-based ready-to-wear and bespoke tweed company, Dashing Tweeds, was initially backed-up by equity investors, allowing the brand to grow and reach national recognition through a major collaboration with high street chain Topshop.

Equity investments may be easier to secure for UK-based luxury businesses, since there are 50,000 business angels in the UK compared to 8,000 in France, and since London is the largest hub for private equity and venture capital funds in Europe. However, the French business angels community, in particular France Angels, is keen to invest in French emerging luxury companies and has inaugurated the ‟Réseau mode Business Angels” in December 2012, to federate business angels around equity investments for fashion and luxury start-ups.

For luxury and fashion start-ups, which do not have ‟proof of concept” yet, and therefore cannot convince business angels and venture capital funds to invest in their companies, a solution may be crowdfunding. In spring 2013, AudaCity of Fashion, a crowdfunding platform dedicated to fashion and luxury startups, will launch in the UK. This way, individuals will network and pool their money to collectively support efforts initiated by fashion and luxury startups.

Coming back to private equity investments, these may be a way for the founders of a mature luxury company to ‟cash in” and get financially rewarded for all their prior hard work. However, problems arise if the laws of luxury management are not scrupulously complied with. Indeed, if these laws, which are the opposite of traditional marketing laws, are not respected, further to the equity investments, the high profitability of the luxury brand becomes volatile as a result. These laws of luxury management are often unfamiliar to non-specialists and are highly subjective and qualitative, therefore far from the quantitative measures dear to financiers. One of the easy traps to fall into, is to force a reduction in structural expenditure on maintaining the luxury brand, particularly if that brand is undergoing short-term pressure from shareholders because of temporary falling profitability. While these cuts in ‟useless” expenditure may seem to have an immediate positive impact on the operating results of the luxury company, the cuts damage the brand and image in a way which is invisible, at first, but which, a couple of years down the line, may be irreparable.

In addition, the exact valuation of the luxury company may become an issue, during the negotiations between the luxury company’s owners and the private equity financiers, as the valuation of the brand is based on an extreme concentration of intangibles, difficult to measure in factual terms.

Another external strategy to find funding for a luxury company is to get access to debt financing. While this would be a relatively easy move for an established luxury business, because it already has several sets of annual returns and statements to prove its financial stability, an emerging luxury company may struggle.

Mature luxury houses, which can provide evidence of solid sales revenues, have access to global debt markets, tapping into investment grade facilities, bridge loans, or, even more sophisticated loan products such as structured trade finance. For example, a fur brand like Hockley may approach its usual bank to finance the purchase, at auctions, of extremely high quality and expensive furs. Such short-term financing would be secured against these furs. Hockley would then make some luxury coats or accessories out of these furs and pay back the capital and interest deriving from the structured trade financing, by way of regular instalments, using the cash flow generated by the sale of these luxury products over time.  

As debt finance is difficult for them to access, emerging luxury companies may look at factoring as a viable alternative for the management of their cash flows. Factoring seems relatively difficult for SMEs to obtain in the UK, while it is a standard and often-used financial tool in France and the US. Factoring companies such as GE Capital or Hilldun Corporation in the US, Eurofactor, BNP Paribas Factor or Natixis Factor in France, agree to advance 80 to 90 percent of the total amount of an invoice, to the luxury company, after such luxury company has delivered its merchandise to its distributors. The remainder of the invoice, minus the costs for the factoring service, is paid back to the luxury company when the distributor pays the factor. Costs for the factoring service vary between 0.6 to 3 percent of the amount of the invoice. Such costs are based on the luxury company’s annual turnover, number of invoices issued and number of clients.  

National trade associations, keen to nurture creativity and innovation, have provided several financing tools for emerging luxury and fashion companies.

One of the most innovative tools is the ‟Banque de la Mode” (i.e. fashion bank), launched in March 2012 in Paris. Chanel, Balenciaga and Louis Vuitton Malletier, among others, have pooled their efforts with the Fédération Française du Prêt-à-Porter Féminin, to create a ‟guarantee fund”, which provides financial guarantees to young designers who are asking banks for loans, as well as a ‟refundable advance fund”, which provides short-term financing up to 100,000 Euros per designer.

In England, the launch in March 2013 of Creative Industry Finance, an Arts Council England initiative offering business development support and access to finance for creative industry enterprises, may prove a useful tool to accelerate the growth of English emerging luxury companies in the future.

Finally, NEWGEN, set up by the British Fashion Council (‟BFC”), offers catwalk designers financial support towards their show costs and the opportunity to use the BFC Catwalk Show Space. NEWGEN has successfully supported designers such as Christopher Kane, Mary Katrantzou and Meadham Kirchhoff. Fashion Fringe, founded in 2003 by Colin McDowell and IMG Fashion, also nurtures talents such as Erdem and Fyodor Golan.  

Unlocking the brand equity potential of a luxury company is a delicate balance between forefront, as well as cutting-edge innovation and creativity, and rigorous financing and human resources management skills. Finding the right finance partner and financing solutions should be a priority for any luxury company, especially if such enterprise is still quite vulnerable, at the early stages of its development.  

[1] Highly concentrated brands on niche products, such as Louis Vuitton Malletier and Rolex, have consistently obtained net profit rates above 35 per cent on sales for more than 20 years.
[2] Jimmy Choo was sold in 2011 by private equity firm TowerBrook Capital Partners LLP to Labelux, the privately held group that owns Bally, for more than GBP500 million.
[3] It is said that private equity fund Permira bought Valentino Fashion Group for 2.6 billion Euros in 2007, in order to acquire Hugo Boss, in which Valentino had a 51 percent stake.

[4] Since 2007, La Perla is owned by JH Partners, a consumer-focused private equity firm.


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