CHAPTER 9
DANCING WITH ELEPHANTS
RECESSION-ERA CAPITAL
As fall 2008 was coming to a close, Zico had strong momentum. Not only did we have $4 million in sales projected, but also Zico had become Big Geyser’s fastest-growing brand. We had built a strong team in New York, and a two-person team to cover natural food stores like Whole Foods and work with our new broker, Presence Marketing. We were in the process of building a sales and marketing team in Los Angeles and we had signed Haralambos, the top craft beer and nonalcoholic beverage distributor on the West Coast, even though they were already distributing Vita Coco.
The coconut water category was starting to get the attention of the investment world as well. In 2007 Vita Coco had added to their war chest with a $2 million investment from a leading venture capital firm, Verlinvest, with a follow-on investment the next year rumored to be over $10 million. A strong third competitor had also emerged, ONE coconut water, with mainly West Coast distribution. We undoubtedly needed some serious capital to stay in the game. We were able to raise a few million more from our existing investors to fund 2008, but I knew we needed more. We had to raise at least $10 million, and ideally $15 million. That wouldn’t happen just passing the hat to friends and family (again), beverage industry executives who could spare $50,000, and a few individual angel investors I knew who had pockets that deep. Now was the time to talk to the professionals. In normal times, given our growth and that of the category, we should not have had a problem convincing a venture capital firm that Zico was a sound investment with a potentially huge upside. We were, at the time, competing to be the number one or number two brand in a new beverage category that was doubling, sometimes tripling, in volume year over year. That sort of scenario doesn’t come along very often.
But the financial markets of 2008 were no normal time.
By September 2008, average U.S. home prices had fallen by over 20 percent versus their peak in 2006. Fifteen percent of homes were worth less than the mortgages on them, a number that would climb to 23 percent over the coming years. Although this was certainly only the tip of the iceberg in terms of the underlying financial crisis, when consumers realized they had less wealth in their homes, they stopped spending money on stuff (including investing in stocks), and the U.S. equity markets took a tumble. The Dow Jones Industrial Average, which had peaked at a record high of 14,000 in October 2007, would fall to below 8,000 by December 2008. Economists believed the crisis, which was now global, would cost the U.S. economy alone $22 trillion according to a U.S. Government Accountability Office study.
I was trying to raise $15 million during the worst financial crisis since the Great Depression. So I talked through our options with my adviser Jim Tonkin. He agreed we needed to raise a large amount of capital and I asked him what he thought our chances were of doing so anytime soon. “Look, the long-term outlook for Zico is great,” he said. “People are not going to stop drinking beverages. If anything they become a relatively affordable luxury in tight times. There’s plenty of money sitting in these venture firms. They’re going to be more cautious and perhaps tougher with their terms but they need to invest somewhere.”
I asked him where we should start. “Are you ready to make a pitch next week?” Sure, I said, where? “Let me see if I can get you into NCN. The presenting company list is set, but I’ll bet I can get them to squeeze you in.”
PITCH PERFECT
So in November of 2008, I flew to San Francisco to speak to a select group of investors at a one-day conference called the Nutrition Capital Network (NCN). That Jim could get me on the bill on such short notice is a testament to the respect he had in the industry. Hundreds of food and beverage companies in the general health, wellness, and nutrition categories apply to present but only a couple of dozen get the nod.
All of the selected companies would present to about thirty-five leading venture capital, private equity, and strategic (meaning corporate) investors. The strategics included Nestlé, Campbell Soup, Kraft, General Mills, and Mars. Lots of other important people were there, including Coke and Pepsi and a who’s who of natural food investors.
Generally these investors were looking for companies that had some unique innovation and a chance to break out from the competition and go on to generate at least $100 million in revenue in a reasonable number of years. They all, of course, hoped to spot and invest in the next billion-dollar brand. This wasn’t where entrepreneurs came to pitch pie-in-the-sky ideas. With rare exceptions, the companies that presented were already generating between $1 million and $10 million in annual revenue. What they all had in common was that the experienced team at NCN felt there was something special enough about each company that their members/investors would find interesting.
Each company had ten minutes to make their pitch onstage in front of the room of maybe 150 people. In the afternoon was a sort of speed dating process where companies would sit at their designated table while every ten minutes a bell rang and investors would move from one table to the next.
I was scheduled to present late in the morning, and Jim and I met to strategize at breakfast that morning about what would make Zico stand out from the crowd. “What if,” I asked Jim, “I went up and told them that I didn’t need any money?”
“You’re going to tell a group of investors that you don’t want their investment?”
“Right,” I said. “Everyone is too desperate in this economic climate. I’m going to play hard to get.”
“All right,” he said. “At least it should get their attention.”
I took the stage at my designated time and started off saying that I hoped the organizers wouldn’t give me the hook for saying this, but we don’t need any capital right now. We just completed another angel financing round, I went on, that would allow us to double our revenues over the next year. Once we’ve done that, and refined our strategy, we’ll know we are truly onto something, then we will need more money to fully capitalize on the opportunity. “So I’d like to introduce you to Zico if you’re not familiar with it, explain what we’re doing to build the next billion-dollar beverage brand and the positive impact we can make on the world while doing so. I look forward to meeting with some of you afterward if you want to learn more.”
I explained what coconut water is and why it was becoming popular. I talked through our New York strategy, our results with Big Geyser, and how we would replicate it in other markets, following the yogis. I finished by saying, “Not only are we building what we believe will be a great new beverage brand, we’re building a whole new category. And the wonderful thing about a coconut water category is first, it’s about simple, healthy, natural replenishment. That’s something consumers want and the beverage industry should deliver. But additionally, we can help create massive and sustainable economic impact in the tropical world. There are no losers in this scenario. That’s what gets me excited and if it does you, too, I look forward to discussing more about it with you this afternoon.”
I came down off the stage and the audience broke up for the scheduled coffee break. Jim came up and said, “Nailed it. I took a look at your dance card for the afternoon meetings and it’s already full.”
When it was time for the speed dating section, I felt like a prince holding court with Jim as my gatekeeper. Nestlé had the first slot and were so excited they blew past their ten minutes and Jim had to interrupt them and say, “Gentlemen, sorry to say your time is up. I’ll be back in touch to schedule something in person if you’re serious.” We met with all the major firms and they all seemed interested.
Over dinner and a nice bottle of wine that night, Jim said, “It’s time for a roadshow. The fish are nibbling; let’s see if any will bite. But look, nothing’s going to happen between now and the New Year so spend some time with Maura and the girls and rest up; 2009 is going to be a wild year.”
Jim set up meetings after the New Year to follow up with some of th
e potential investors we met at NCN. For a few weeks of 2009, we were constantly on the road. One week it was Boston. The next Los Angeles and then up to San Francisco. Late in January we even trekked to Switzerland to meet Nestlé’s team.
As long as I was on the road, I figured I’d take the time to learn about other markets. I saw potential for Zico everywhere. In Boston I talked with managers at Whole Foods and met with two potential distributors and visited a few yoga studios. I did the same in San Francisco and spent some time with our early customers at the four Funky Door Yoga studios.
As excited as I was about expanding to these other markets, I knew many a company had failed in the process of expanding from one region of the U.S. to the others. Dunkin’ Donuts, an institution in New England since the 1950s, struggled to expand west and had two failed attempts to enter California in the 1990s and again in the early 2000s and only recently figured out the right strategy. You can’t necessarily cut and paste what made you successful in one place and assume it will work in the next. I spoke with Steve Fellingham, previous CEO of Carvel ice cream, in the early days of Zico. At its peak Carvel had $300 million in sales per year and had real momentum in the northeast but couldn’t find footing in the rest of the country. Steve said, “Be careful. National rollouts are much more expensive and complicated than most people realize.”
Those couple of weeks had been a whirlwind, but now I was home in New Jersey spending some time with Maura and the girls and back to running the business while we waited for the term sheets I hoped would start rolling in.
The responses did start coming in but the first few were not encouraging. One firm said they loved the concept and me but the business was just too small. Another said the opportunity was “too binomial: it might work big but might flop completely.” Welcome to the beverage business, I muttered under my breath. Another said they were interested, but they were waiting for the financial markets to calm down before they started to invest again. What happened to all the excitement we generated at NCN, I thought.
A week later, Jim called to say that he had spoken to one of the firms and they would be sending a term sheet later that day. “Don’t get too excited,” he said. “I know these guys and I’m not expecting to be wowed.”
I refreshed my e-mail every fifteen minutes or so for the rest of the day and finally saw it come through. The term sheet was attached as a PDF and it was just two pages describing the broad outline of what they were proposing. It seemed simple and straightforward. But as I read the details I was in disbelief. I called Jim. “Do I have this right?” I asked. “They’re offering $5 million to own 51 percent of Zico, and if I don’t make their target sales figures they’ll suddenly own 90 percent?” That meant that my latest investors would effectively lose half of their value since they invested at a valuation of close to $10 million. And that was the best-case scenario. If we didn’t achieve the goals they set, effectively every investor would lose 90 percent or more, and Zico would have to become huge to recover that. This is called a “cram down” in the finance world. Basically the new investor squeezes down everyone else’s ownership to own more for themselves.
“That’s what they seem to be offering,” Jim told me. “Look. It’s a first offer. Don’t freak out, just sleep on it and if it’s not right call them and tell them so and let’s see how they react. The good news is that having one term sheet on the table makes it easier to get others.”
I talked the offer over with Maura as I helped Ciara get ready for bed that night. Ciara was eight at the time and I could see her listening intently. She had lived with the talk of Zico in the background most of her life and had handed out her share of samples at demos and events. We talked about Zico in the family like he was a rambunctious but gifted little brother. Before Maura could jump in with her opinion about the offer, Ciara piped up. “Wait a minute, Daddy,” she said in her high-pitched voice that shrouded a mind insightful beyond her years. “You’re telling me they will give Zico some money but you don’t get to keep any of it yourself and they own half of the company and if you do something wrong they own it all? Why would you do that, Daddy?”
Maura smiled and gave me a nod that said, “I’m going with Ciara on this one.”
I called the managing director of that firm the next morning. “Thank you for the term sheet. I talked it over with my eight-year-old daughter and she thought it was a bad deal,” I joked, “so I’m going to have to decline.
“Frankly,” I went on, “I can’t imagine ever being in a situation where I would accept these terms.”
“Mark, you do understand that we would figure out a way to make this attractive to you as CEO as you continue to grow the company?”
The underlying message was evident: they would issue more shares to me, as CEO, and perhaps I could earn as much or even more money in the end than if I held on to the ownership I currently had. Unspoken was the likelihood that my earlier investors would take a bath. If properly structured and managed, there is nothing illegal about this and sadly it’s not uncommon. If a company is about to go out of business or had been overvalued in an early round, some negative impact to investors may be inevitable. Fortunately, we were not in that situation and I wasn’t going to leave my early loyal investors in the dust.
A few weeks later I received a very attractive offer from a VC firm in New York. But it came with a major catch and a strange warning. The firm would put up the entire $15 million investment but only if I somehow managed to get one of the big beverage companies like Coke or Pepsi to sign on as partner. Because of Zico’s relatively small size, that would be no small feat. At a meeting where we hammered out the details, one of the partners also called me aside and asked me if I knew a guy named Jesse Itzler. What a strange question, I thought. I told him that I did know Jesse. Well, I knew of him. He was one of the guys who had founded Marquis Jet and had become a sort of center of gravity for the celebrity and sports world in New York.
“And you are asking about Jesse because?” I prompted.
“I hear through the grapevine that he’s thinking about starting a coconut water brand,” he said. “If he does, watch out because he’s a monster. Jesse knows everyone. You don’t want to go up against him.”
Walking away my first reaction was, “Screw this Jesse guy.” I was already dealing with some heavy competition. The idea that I should be wary of someone just because he knew some athletes and celebrities was something that I wasn’t going to spend my time worrying about.
“Well,” Jim said after the meeting, “now all we need is a strategic to throw in a few bucks. Let’s start at the top. You take Coke and I’ll take Pepsi?”
BRAIN DRAIN
Jim went straight to the top and managed to set up a meeting with PepsiCo’s head of mergers and acquisitions. We traveled to their stately headquarters in the rolling hills of Purchase, New York, and drove our cheap rental car past the sculpture garden that included works from Rodin, Calder, Moore, and Giacometti. I couldn’t help but think that any one of these pieces of art was probably worth more than Zico at that time. We met the executive alone in a large conference room. He was not a social guy and we had awkward and cold introductions. At the end of my brief presentation I said, “So we have an investor ready to put up all the capital we need, and we’d like to figure out a way for Pepsi to become a minority partner. We don’t even want access to your distribution network right away. We think it’s too risky for a small brand.” The only time he spoke during the whole presentation was to say, “Well, that’s surprising, we’re very confident in our distribution network’s ability to manage and grow small brands.” At the end he said, “Thank you for coming. It’s all very interesting and we’ll get back in touch if we’d like to have any further conversations.”
That was it. Walking away, I had the feeling of being drained of information. I also believed he was wrong about the distribution. Putting a young coconut water brand in a funky Tet
ra Pak package into either Coke’s or Pepsi’s distribution network right away might be disastrous. I had heard through my Brazilian contacts that PepsiCo was looking into potentially partnering or buying our supplier Amacoco outright, so their standoffishness was understandable. They were potentially looking into cutting off our supply. He didn’t see us as future partners—we were future competitors, and he wanted all the details he could gather to win the fight. I was pretty confident that we’d never hear back from PepsiCo again, but I knew sooner or later they would get into the coconut water business.
Everyone in the beverage industry could see that the big players, with Coke being the prime example, were vulnerable with sales of carbonated soft drinks either flat or declining. Speaking in Atlanta in late 2009 to a room full of analysts, investors, and reporters, Muhtar Kent, the CEO of Coca-Cola, admitted that the company had been caught flat-footed by the changing environment.
According to Kent, the company had “not focused enough on the changes taking place with our consumers and customers. In essence, we were too busy looking at the dashboard and were not sufficiently paying attention to the world outside of our windshield.” It was an admission that, in not being responsive to cultural currents, they were in danger of running that big red truck off the road and into a ditch.
Carbonated soft drinks, the core of Coke’s business, had been in decline on a per capita basis in the U.S. since 1997. In terms of total revenue since 2005, Coke had done a great job fighting for a shrinking pie but that was only going to work for so long. “They missed a lot of trends,” was how Bill Pecoriello, CEO of Consumer Edge Research, put it in a 2009 Ad Age interview. “There was a shift away from certain beverages and needs being filled by alternative beverages.”
High-Hanging Fruit Page 18