When Do Designers Reach the Next Level?

Twenty-five million dollars seems to be the magic number for young designers to hit for their businesses to reach real scale.

NEW YORK — Joseph Altuzarra, Prabal Gurung and Thakoon Panichgul sent their fall collections down the runway over the weekend, and beyond the trends and how their new styles would be received, one other thought no doubt preoccupied all of them: When would their companies be ready for the next level? Well, here’s a hint: The magic number is $25 million.

This story first appeared in the February 13, 2012 issue of WWD.  Subscribe Today.

That is the sales volume that indicates a brand is on its way to going corporate. Even then, of course, that’s no guarantee of success — the road is ragged. Many brands lose money and very few designer businesses ever get to anything close to $25 million in sales. The revenues flow from the clarity of the brand, and many designers are simply unable to sharpen their aesthetic enough to grow substantially. Design is fine, but it’s focus that propels a designer from the merely interesting and inventive to a commercial success.

“They have a creative idea, and they just put it in the line whether or not it’s realistic. They just go for it,” said Jack Hendler, president of Net Worth Solutions Inc. “They think that every season they need to reinvent themselves in their entirety. They need to have consumer sensibility. They need to create the core business.”

Debt can pile up quickly as companies lose money in their early years, when financial backers of all sorts are often relied upon to help fund operations. Even Ralph Lauren revealed last fall that he had been close to going out of business several times. “Its white knights and family and friends and people just get tired,” Hendler said of the funding crunch fledgling designers face.

And while $25 million may be the magic number to emerge from the minors into the majors, with a certain thriftiness, plenty of designers get by with smaller businesses.

“We finance hundreds of companies that are not doing $10 million that are making money,” said Gary Wassner, president of Hilldun Factors. “They’re doing just fine. Some of them are just not capable of ever being a Tory Burch. The public is never going to accept them in that way.”

Smaller brands make money by hustling and being creative — getting sponsors for their fashion shows, getting by with as few samples as possible.

“What I generally hear from people is that if they produce 100 samples for a season, they’re going to sell 50 to 60 percent,” Wassner said. “Better editing could save them a tremendous amount of money.” Samples can cost $1,000 each, or up to $4,000 for furs and coats.

Buzz and editorial exposure can also help defray a host of expenses. Wassner said a brand that’s on everybody’s lips can make do with one salesperson to book orders, while a lower-profile company might need three salespeople who are paid a total of $200,000 to $300,000 to generate the needed volume.

Experts agree that designers have to control such selling, general and administrative expenses to make their businesses work.

Gross margins — or the difference between the sales dollars brought in and the cost to produce and distribute goods — are generally good in the designer realm. Initial margins could be 70 percent and then fall to 50 percent, factoring in stores’ chargebacks for shipping quirks and markdowns for slow-moving goods.

Yet the higher the margin the brand takes, the smaller its distribution.

Victor Wahba, partner at accounting and consulting firm WeiserMazars, said a designer business with $25 million in sales could have margins of 40 percent, leaving it with $10 million after the goods are made and shipped. Of that, $6.25 million might go to SG&A expenses, and $3 million to hold two glitzy fashion shows, leaving the company a $750,000 profit.

Not shabby, but usually it’s not quite that cut and dry.

Before most companies get to that level, they also have money coming in from other sources, be it a design fee for a capsule collection for a mass merchant chain or another retailer; their own retail store, or, more lucratively, a licensing deal.

“The most common place to start is a fragrance license,” Wahba said. “The accessories have also started to pick up a great deal of attention over the last two decades as well.”

To get a licensing deal, a brand has to be known, and therefore has to have decent distribution — and, again, that’s where the magic $25 million number comes in, since that level indicates an awareness among consumers.

“A $10 million brand doesn’t license itself,” said John Howard, chief executive officer of Irving Place Capital and an investor in Proenza Schouler. “There’s a little bit of a chicken-or-the-egg thing there.”

Once a brand is large enough to expand into other categories, there are many possible paths forward — from jeans to shoes to bags.

“In the end, it’s all about accessories,” Howard said. “There are very few couture businesses or luxury businesses that make money in the higher end. People have stars in their eyes. It’s really hard to make money in ready-to-wear only. We’re always dazzled by these LVMH [Moët Hennessy Louis Vuitton] numbers, but in real life, and particularly in American business, there’s not that many companies that are designer-driven businesses that do those kinds of numbers.”

What about those designers who have hit the $25 million level and are now trying to get to the next step up — what is the magic number for them? The answer: $60 million.

“A lot of private equity firms will target companies of $60 million and above” for investing, said Douglas Hand, attorney and founding member of Hand, Baldachin & Amburgey, which works with designers. “[At that level] you have hit a repeat-customer shelf, you have a core customer who comes back season after season. Once you hit those shelves, it’s very hard to get nudged off them. Not only do your customers buy [but] retailers know that.”

Then the sky is perhaps the limit. If companies keep growing beyond $60 million to $100 million, then $200 million and up, they can start to eye the public markets. Take last year alone, which saw initial public offerings from Prada, Ferragamo and Michael Kors.

Brunello Cucinelli plans to go public this spring, while speculation is that Tory Burch might do so one day. Not only does that give the companies access to capital to expand further, there is another allure: Kors personally made $117 million in his firm’s IPO.