Chapter 21

Change Management

Group 2Back to the Beginning

Learnings

I want to preface this by saying this section may only be of interest to people who are taking on private equity (PE) to go public, or to people wanting to learn more about it.

Going into negotiations, I don’t think my local Vancouver lawyers even knew I didn’t need outside money to grow. Their experience had been in big mining deals where substantial outside capital had been required.

I am not sure we even told our lawyers how amazing our cash flow was. They’d probably never been in a situation where the seller wanted advice as the end goal, so they didn’t ask, and we didn’t tell. I think my lawyers assumed that the PE people were in the driver’s seat and the deal was done accordingly.

Hopefully, my learnings will help any entrepreneurs who are thinking of taking on investment from PE and going public. My learnings are as follows:

  • A broker works in his own best interest to close the deal and shies away from hard negotiations for fear of losing the deal and the commission.
  • Select three experienced advisors with no vested interest in the deal other than your own. Lawyers, brokers, and company executives were not enough to provide the high-level, independent advice I needed.
  • Carve out time to talk daily to your advisors. The business will need you; however, good advice will last a lifetime.
  • Keep two PE companies at the negotiating table until the final decision is made. Play the PE people off each other to get the best deal with the single PE firm you know you want.
  • If PE says they will be with you for a period of four to seven years, do not believe them – instead, negotiate as though they will monetize your business sooner than is most advantageous for the business. PE works in their own best interest.
  • Set a due diligence completion date and increase the price if the company’s profit increases during the due diligence time.
  • PE will only be with you for a short time. From their viewpoint, the shorter, the better. You must understand the different scenarios of governance and control that will be in place after PE leaves.
  • PE provides a stamp of approval to the entrepreneur and his or her idea. However, the entrepreneur should not let that feeling of approval affect financial negotiations.

My 51 percent control of the company after selling to PE meant nothing, as I didn’t control voting at the board level. I needed legal confirmation I would control the most board seats after the PE sale and after going public. (When I consider what happened – the way we went public, and what came to pass in the following years – I think of Phil Knight from Nike and Kevin Plank from Under Armour. Both have dual-class shares, which gave them control of their boards. When you control the board, you control the company’s culture and vision. Nike never lost its vision, and that’s what made it the company it is today. This is where I feel I missed the mark – not knowing how to keep board control.)

Create a special director onboarding program. Have them read three to four books critical to the company’s culture and business model. Then, have them work in the store for a day and, in a case like lululemon’s, have the director go through the same development program as the employees. Have them verbally discuss 10 points that indicate their understanding of why the business model works, as well as their grasp of the company’s linguistic abstractions, values, and vision statements. Ask them if they fully understand the hidden, subconscious reasons the business makes money.

The entrepreneur needs to develop his or her own set of directors and not let the PE firms bring in any more of their own directors, other than what has been negotiated at the start for the present and post-IPO.

Never take more money than you absolutely need. When you have more money than is required for your personal life, a new business is required to manage the excess money. This takes your eye off the cash cow of your business in lieu of less attractive, boring investments. Lululemon was a cash cow that provided me with all the negotiating power in the world. I held all the cards but played none.

The Governance Model

With the long-term possibility of going public, we needed a Board of Directors. Its role was to select a CEO, set and oversee a compensation plan for upper management that would reward long-term value, define management succession plans, set our strategic plan, and ensure legal compliance.

I was getting to know our PE directors well. I treated them as my absolute equals and partners, a dynamic I felt was reciprocated. I had built an amazing company, and the directors had the experience to help me continue to put the building blocks in place.

The only thing that stood out for the team at lululemon was that the directors were a group of older men with button-down shirts, pleated khakis, and Blackberries slung on their belts like six shooters. It was the opposite of lululemon apparel.

For any organization to succeed, a combination of different mindsets is critical. Organizational theory would tell you a successful team needs the right balance of conceptual, analytical, structural, and social people. An imbalance heightens risk and mediocrity.

My own abilities were (and are) creative and analytical. I wanted the directors to keep their eyes on the hiring of management and create structural processes into which we could grow.

The Advent people took on our employee development and slipped smoothly into our culture. I loved that they wanted to figure out why we were successful so they could transfer new knowledge to their other investments.

Tom Stemberg, I found, was very keen to offer his advice on how to set up a board. However, Tom did not want to do Landmark, perhaps because he already felt successful in his life. His wife was also against the ideas of transformational development, and I believe this contributed to the roadblock Tom hit with our culture. I wasn’t worried. I thought he would come around once he saw how successful we were because of our development program.

But, now that Tom was inside lululemon, he seemed sure our future value depended on “professionalizing” our company. Culture took a back seat, since, in Tom’s view, professionalization had little to do with culture.

Bob Meers

As the Board took shape, Advent had a recommendation for an operating partner. An operating partner is someone a private equity firm puts inside the company, who is paid for by the company but works to the benefit of the private equity firm and acts as their eyes and ears.

Advent put forward former Reebok executive, Bob Meers. Bob had been with Reebok when it was the number one athletic company in the world, easily dominating the top position of the women’s fitness market with step classes.

Where Reebok had failed, I thought, was in their decision to shift away from women’s fitness, a business they knew well and at which they were best in the world. They’d chosen to shift focus to men’s fitness and big sponsorship marketing and were quickly swallowed up by their massive competitors in the men’s market – primarily by companies like Adidas and Nike.

What I liked about Bob were the lessons he’d learned. He’d seen the mistakes and had gained experience through them. He also understood women’s fitness, which was valuable to lululemon. Finally, he came highly recommended by Advent. Most importantly, Reebok had been built on the foundation of Landmark, and Bob told me he had been through most of the courses.

After meeting Bob, I realized he might be a good fit as CEO, as well as a member of the Board. I was a father to three toddlers, and I was tired of travelling. Where else could I find a Landmark-trained athlete who understood the future of the women’s market? How else was I going to be the father I wanted to be?

On our way to dinner in Boston, I asked Bob if he was interested in the position of CEO. He immediately lit up.

We announced both the private equity deal and Bob Meers’ appointment to the CEO position in a press release on December 8, 2005. In January 2006, Bob arrived in Vancouver to begin work. Bob and I shared an office for six months. Having a new CEO onboard didn’t alter the number of hours I spent at work, but it relieved me of almost all business travel. I could come home at night and spend time being a husband and father.

Bob’s arrival brought a mix of excitement and wariness. He was a new, older, experienced, East Coast executive coming in to run an unorthodox, highly personal, female-dominated, West Coast company that operated like a family. This time, I’d expected the wariness, and I knew it would take a while to foster trust in the people working for me. This was why Bob and I worked in the same office for six months – I wanted to ensure he understood who we were at every level. Bob’s compensation package was not negotiated until after he had ingratiated himself into the company for a few months. With the CEO offer on the table, Bob leveraged this in negotiating his compensation. It was a very big mistake on my part to engage Bob before compensation has been discussed. Advent was so keen on having a Boston managing partner as CEO that they too fell into Bob’s trap.

Foreign Markets

Before Bob joined us, I’d looked at some expansion plans beyond North America. I was reluctant to open stores in Europe because human resources complications were akin to those we’d discovered in the state of California. I felt that rules around hiring, firing, lunch breaks, vacation, cost of benefits, and the threat of legal ramifications created weak business processes which, in turn, developed employees to be good but not great. In my opinion, that’s why few great retail managers come from Europe or California – it’s all due to the overregulation in those markets.

Fortunately, there were other locations to explore. Back when I was with Westbeach, a man named Kano Yamanaka was my Japanese distributor. In the years since, we’d maintained contact and become friends. As lululemon was picking up momentum, Kano and I decided that he would open a lululemon franchise in Japan with a view to opening a series of stores. Westbeach had had a lot of success in Japan, and I wanted to build on that with lululemon.

Kano’s first store had opened a year earlier. Since then, it had performed moderately well even though it wasn’t in a prime location, it wasn’t big enough, it was spread over two stories, and so on.

Playing it safe was not what we needed, as we already had a proven concept. I needed a prime location to ensure that if lululemon wasn’t great in Japan, it wouldn’t be because of the same challenges we’d experienced in Santa Monica. Like a science experiment, I had to remove all external variables to validate our business philosophy.

It became apparent that Kano’s financial resources were not as deep as they once were at the apex of the snowboarding business. Perhaps he had stayed in the market too long. While Kano was doing his best with what he had, I wanted someone committed to prime locations, who could afford to build out the brand.

We got an offer from Descente, a large Japanese company with a very modern CEO who wanted to westernize his staff and teach them what North American retailing was all about. He even wanted them to speak English. Lululemon bought Kano out of his franchise and made an agreement with Descente, who, under Bob’s approval, opened three more lululemon stores in Japan.

If I had not stopped travelling, I would have seen that the well-educated but incompetent new executives Bob hired were reluctant to work in our stores. Consequently, the top of the organization started to lose an understanding as to why our stores performed so well.

From the employees’ perspective, we didn’t necessarily want Bob’s new hires working in the stores because they were not athletic and not the brand. We didn’t have an executive onboarding program (that was my fault), and we eventually came to see new executives as inauthentic salesmen instead of authentic Educators.

We were beginning to understand the difference between “experienced” new management and lululemon’s “self-developed” people. I had turned to experts to expand our business but discovered there were no experts for our new technical retail model. The self-developed people of lululemon lived to sup- port others in being great and were “leaders creating leaders.” This was part of the reason lululemon had grown so fast without losing control.

Australia

Lululemon’s first Australian store was a brand-starter on Melbourne’s Chapel Street. I was expecting a three-to-four-year brand build. There were many reasons I thought lululemon would be a natural fit in Australia. A love of the outdoors and a healthy, active lifestyle is a deeply ingrained part of Australian culture, just as it is on the Pacific Coast of North America. It’s casual and laid back – a place where women would find functional athletic clothing a natural extension of themselves.

But I’d also looked at Australia to solve a problem. A big issue with North American apparel is that excess inventory is sold at a discount at the end of a season. I realized that if I could get stores open in Australia, I could move the end-of-season winter goods to Australia at the beginning of their fall season and vice versa. This would eliminate discounting in North America. It was a brilliant idea in my mind.

By moving inventory back and forth with Australia, I could give each hemisphere something brand new, in the right season, at full price. Even if the product we transferred only “broke even” after the transfer, it was better than discounting.

A central part of our retail store rollout consisted of opening an out of the way, inexpensive showroom with open doors only a few days a week. We would educate, hold design meetings and network with a local community before opening a store. We had the cash flow to play the word-of-mouth strategy in Australia and wait for the tipping point. We also had to learn about their labour laws, and customs and duties before going all in.

US Rollout

An April 2006 analysis on Canadianbusiness.com described Bob’s plans in the following way: “Meers . . . seems determined to relive Reebok glory by building lululemon into a ubiquitous global brand . . . Meers quickly ticks off his plans: additional outlets in Los Angeles, San Francisco and Seattle. A new store in Chicago. Multiple shop openings in New York City and Boston in Q3 or Q4.”1

To assist with his plan, Bob hired a top retail executive named Celeste Keely who had run the Western US for Abercrombie & Fitch. It became obvious that our director, Tom Stemberg, knew nothing of cool small-box retail real estate and as a director was becoming a liability. Consequently, someone of Celeste’s background in vertical apparel store locations was essential. I thought Celeste was a good hire – I was adamant to not hire anyone from apparel wholesale, as I didn’t want them bringing their old processes to a new business.

Lululemon’s primary strategy was real estate expansion in the US, which Bob had made a cornerstone of his tenure as CEO. The vision was to build the US in the same mould as Canada.

The expansion looked good, but the new stores were in expensive, high-profile shopping malls, and I didn’t know to what extent we’d first seeded cities with a cool, urban street location, or if we’d been pro- active in creating excitement or building networks in the local yoga and athletic communities. We wanted to ensure the locations were correct for Super Girl customers. I was overwhelmed at the salary Celeste commanded, but I trusted Bob in his choice. In retrospect, Celeste was a “yes” person who couldn’t stand up to Bob about the choice of new stores. Bob just wanted the quantity of stores to push the stock price up, quality be damned. Bob already had a short-term game plan for himself, and Celeste did not prove to be the guard at the gate for the company.

After a series of poor performing locations, we had an epiphany: We came to understand the power of our showrooms, pop-ups, and community marketing. We had not yet realized the strength of what we had invented.

We were ready for expansion. New stores would add substantially to lululemon’s valuation, as analysts would model out our profit a year in advance and then recommend a higher price for the lululemon stock if we were to go public. The idea of an IPO was still highly conceptual to me, but it seemed Advent and Highland talked about it constantly.

I thought I had made the right moves to succeed in the US. I had hired an experienced CEO, I had Tom Stemberg who seemed well-versed in US real estate, and I had Advent who were private equity retail experts. I believed the PE partners when they said lululemon needed another four to five years to mature.

New York City

We’d recently signed the lease for our first store in New York City. Lori Jane Budd – a former track athlete, Calgary lululemon Ambassador, and most recently, manager of the highly successful Oakville, Ontario lululemon store – was on her way to Manhattan to run the new location.

As Lori recalls, “I told Chip that if he ever opened a store in NYC, I was the person to do it. Without hesitation, he responded with ‘Great! I will pay you $80,000 a year to manage it.’ I was beyond ecstatic at his apparent confidence in me . . . yet slightly overwhelmed, but that night I sat down with my husband and put my one, five, and ten-year goals down on paper for the first time.

“I managed the Oakville store for over a year,” Lori continues, “and it became one of the top performing stores in the company and produced many managers that moved to other stores and regions. In early 2006, a lease was finally signed in Manhattan, and I was offered the position of Store Manager. I promoted my assistant manager to take over the Oakville store and planned my move to NYC.

“Bringing this company to NYC exceeded every expectation I ever had. We attended unlimited yoga and fitness classes around the city, meeting instructors, and talking about the brand. There was no middle ground – people either hadn’t heard of us yet, or they were already obsessed.”

To borrow from Frank Sinatra, if you can make it there, you’ll make it anywhere. His lyrics were top of my mind as we decided on lululemon’s next big expansion. New York City has always been a world leader in retail and apparel – in some ways, taking lululemon to NYC was something we had to do.

Expanding into New York was nerve-wracking, partly because of the high rents. It was a surprise to set up in Lincoln Square and see how little space we could get. Sometimes a company might open in New York, taking a high rent, and not make any money on the location. They would just use it as a marketing ploy to build the brand since New York has major international appeal. Despite the size of our store, we managed.

If world-class logistics managers knew how the staff at our smallest stores (located in Lincoln Square and West Edmonton Mall) problem-solved, they’d hire them at a salary of half-a-million dollars a year. Our employees were amazing.

Michelle Armstrong

Meanwhile, the question of going public was looming larger by the day. In 2006, just after we’d made the private equity deal with Advent and Highland, Pricewaterhouse Coopers was brought in to assist with auditing lululemon.

A young woman named Michelle Armstrong was the manager of the audit. She came out to lululemon in March of 2006. We were so impressed with Michelle that we offered her a job as director of finance, to augment Brian Bacon, our CFO. Up to this point, I hadn’t put a lot of effort into hiring finance personnel. Working in the stores, I had developed an acute sense of the business and could tell within a few percentage points the exact profit and cash flow of the company. My new partners did not have this same insight, and at $110 million in sales, we could no longer only operate based on my innate sense of numbers.

Much to the surprise of Michelle (and everyone), the prospect of the IPO came up within a few months of her joining lululemon.

As Michelle puts it, “When I got hired they told me it would be a two-to four-year time horizon for us going public, but then in August [2006], Bob brought me into his office and said, ‘Actually, we’re going to start the process now.’”

This wasn’t just a surprise to Michelle – most of lululemon was surprised. I wish that I had the type of relationship with Michelle at that time where she would have felt comfortable letting me know the IPO was coming sooner than expected. The world in early 2006 was awash in capital, and there were a lot of parties eager to invest in IPOs. Under Armour had just gone public, as had Crocs, both at high valuations. David Mussafer, Steve Collins, and Tom Stemberg all advised me that lululemon needed to make the move sooner rather than later.

I didn’t know that Advent and Highland were already thinking of their exit. I expected Bob Meers would preside over a five-year period of growth, after which we’d presumably open the books and assess our options. I didn’t know how closely his profit motive was tied to that of private equity.

Conflicts of Interest

I had been transparent that I was not averse to going public. I thought the IPO and public experience would allow me to be a valuable mentor to my children if they ever, one day, took their companies public. (Now in 2021, my son JJ has taken a functional mushroom company called Optimi Health public, and he has asked me to be an advisor – very cool.)

At a Board meeting just before going public, Tom said I had to clean up my personal connections to rid myself of conflicts of interest as a future director of a public board. To clean up, I had to change three things. The first was to let go of my sister-in-law, Susanne Conrad, as a Board advisor since she would be a conflicted director as my relative. Susanne was the spiritual leader of our culture and a critical part of what made lululemon profits rise above all competitors.

“Because I was a family member,” Susanne recalls, “there was a fear about optics. I was asked to step down just before the company went public. I would have liked to stay on the Board. I think I sustained the company culture at the board level.”

Even though we’d lost Susanne from the Board, it was still very important to have her as part of the team. I wanted her to coach and develop our top 100 people every quarter, as her background was executive-level coaching. Working with Delaney Schweitzer’s Training and Culture team, Susanne would become one of lululemon’s most beloved speakers. The curriculum Susanne developed, ‘igolu’ (now known as “Lightyear Leadership”), is a comprehensive self-leadership methodology that she delivered to thou- sands of lululemon employees and Ambassadors from 2007 until January of 2017.

As Susanne remembers: “Delaney [SVP retail] and I worked to make lululemon a place where people could come and be with like-minded people, workout, sweat, and make work a place where we could transform some of the most difficult things in life with humour and love.”

Susanne had the energy and advocacy I wanted on the Board. I was sorry to lose her, but the company was lucky to have her in the years that followed. I asked Rhoda Pitcher, a change-management consultant, to replace Susanne on the Board. I was counting on Rhoda to help us protect the company’s culture through the coming changes.

The second thing I had to do before going public was sell my 50 percent stake in our manufacturing partner. I was okay with this if lululemon bought my share. The ownership of factories was essential to ownership of the vertical model, but Tom and Michael Casey, then Lead Director, deemed factory owner- ship too risky. They didn’t want to be in the manufacturing business. They didn’t see it as an integral part of the business model, but rather as a distraction.

The third change we had to make was to replace my lawyer, confidante, and our company secretary, Jon McCullough. Tom said we needed an American law firm who understood US public law.

Each of these steps seemed so incremental that there was never one specific moment where I thought to say stop. I now understand it was a highly manipulative move by Advent and Highland to gain control and power before I even knew what they were doing. From this point forward, I had been swindled, but I just didn’t know yet exactly to what extent.

The E-commerce Mediation

Another thing lululemon needed to clean up before our IPO was our e-commerce. I had waited to properly invest in e-commerce while our company was in rapid growth. We couldn’t manufacture quickly enough to fill our own stores, so we didn’t need an e-commerce store just yet. I understood that e-commerce had come to stay, and I appreciated its power in completing a top-to-bottom vertical model with absolutely no middleman to skim profits.

In 2006, I felt that e-commerce was good for a commodity product – something a customer already understood – while lululemon was primarily touch and feel. At that time, there was no video to educate e-commerce customers on our product. Our value was not in the look of the garment but in its tactile feel and technical features. A photo worked for fashion but not for lululemon. Today, you can ship three or four garments to somebody so they can try them on and return them if they so choose. There was nothing near that level of sophistication in 2006.

Lululemon had its own selection of commodity products, including yoga mats and yoga straps. We also had a few items to sell at a discount. So, in the early days, I made an agreement with a digital company to sell commodity and discount products online. It was a small agreement with no buyout clause.

If I wanted to regain complete control of lululemon’s online products, it looked like we would have to buy them out.

It was clear lululemon was a raging success, so the company asked for $2 million as a buyout. I wasn’t convinced this was anywhere near an appropriate price and I refused. We went to mediation, and their ask jumped to $7 million.

Mediation, in my experience, usually splits something down the middle, so by then, it looked as if I would get hit for $3.5 million. I countered at negative $6 million to get the price down to $1 million. Mediation collapsed, and I let it go. My private equity partners pushed Bob to settle at any price because they knew what I didn’t; an IPO was imminent, and they wanted a clean slate. The company paid out $9 million.

This wasn’t just a lesson in e-commerce, or in being specific in contracts. I needed to grow up and make more solid legal agreements.

Needing More Directors

At the last Board meeting before our IPO, Tom told me we needed more Board members to fill committees as a public board. Tom, who had been on many public boards, had a deep Rolodex of quality people who were more than happy to come to lululemon. I had none, and I had no advance advice that I should be looking for directors who would support me and my vision for the athletic apparel business.

Tom told me it would be a good idea for me to sell more stock as we went public because then there would be more floating shares and institutions would be more apt to buy and hold. If the institutions bought and held, then fewer stocks would trade and demand would increase. As demand increased, so would the stock price. This is a great strategy for a PE firm that wants to monetize their investment and get out. I found it to be terrible advice to a founder like myself who already had more cash than I knew what to do with. Especially as I couldn’t imagine a better place to invest my money than in the company I had built.

It was important for me to go public because I believed this would provide control over my inherent weaknesses of global financial control and auditing. I am one of the few people who has likely ever thought that imposing financial reporting parameters on public companies would be a good thing. But for me, having this area controlled allowed my mind to focus on brand, innovation, culture and product. I knew lululemon would get the best out of me if I didn’t become a businessman, but worked on the business. Releasing myself of the burden of financial control allowed me to continually work myself out of a job and be lululemon’s futurist. However, as I would learn, the inherent risk of being a futurist is there is only room for one futurist in a company. Throughout this process, I learned that a public company is driven by quarterly public reporting, and that inexperienced CEOs with poor compensation are only able to perform over a three year horizon.



1. Laura Bogomolny. “Toned and Ready: Lululemon Transitions,” Canadian Business, April 24, 2006, www.canadianbusiness.com/business- strategy/toned-and-ready-lululemon-transitions/.