CHAPTER 18

The Initial Public Offering of Donna Karan International

Opening a discourse on what I would have done differently is an interesting launching pad. More cases than not, managers tend to laud themselves and allow pride to overtake memory. However, a number of interesting lessons emerged in my time as a manager of two large fashion companies in the United States that have applications beyond such geopolitical boundaries. Of course, different cultures react and respond differently, and this may be why multinational corporations like Toyota prefer to hire local managers in the United States to handle operations rather than import them from Japan. Having a leg up on cultural nuances ranging from working conditions to employee expectations is a big advantage.

The scope of the book has been historical. However, as my narrative comes to a close, I would like to reflect a bit on what has been discussed while providing further insight. To do so, I would like to delve a little deeper into Donna Karan New York and the departure of Takihyo Inc. (Takihyo) from that entity. Over the course of 10 years, Donna Karan blossomed into the household name that it is today. Although there have been more positive than negative points, the negative ones in the story demand attention to supplement future endeavors for readers and as a means by which I can learn. In other words, I would like to return to the Donna Karan story to learn from my mistakes and develop solutions to combat them rather than terminating the discussion on a purely historical note leaving readers to speculate.

The Donna Karan Company underwent three primary stages. The first stage was the startup. Other than the aforementioned work with Peter Arnell, the branding genius, there was a lot of legwork on both sides of the partnership. When I fired Donna to start the new company, she had to learn some of the necessary elements to running the company. Donna didn’t have any previous management experience; she only knew how to run the design team. Though this skill is important when it comes deciding what garments to make and how to thread seasons together to create a uniform and appealing look for consumers, the managerial decision making was a bit lacking. There was some overlap. Donna could make design decisions that I couldn’t, but I would suggest certain color palates or styles to Donna so she could create a new line that was cohesive with the brand.

There were disputes among top management that at times could not be settled by one person. Instead, multiple opinions appeared on various issues, and no one had the upper hand. I try not to regret any of the decisions I have made before, but I prefer to learn from my mistakes. Donna Karan New York was a 50/50 partnership. With any new venture, I have tried to stray away from an equity split down the middle especially when I have such a vested interest.

Before organizing the company, Donna and I were discussing how the company should be managed. Takihyo, being Frank and myself, would have total control over all financial and managerial elements of the business, and Donna would have total control of the design room. This was our verbal contract, but we never put it into writing. When Steve came into the mix, the dynamic changed dramatically. The operating agreement should have spelled out the split in managerial and financial decisions. Instead, Donna could have Steve make decisions for her and would use her equity position to leverage the execution of whatever plan Takihyo did not condone. As a result, even if Takihyo held half of the company, we could not control the direction of the business without engaging legal counsel, and at that point, such a new company could unravel over lowered morale resulting from indecisiveness among management. There is nothing worse than having hundreds of people relying on you and you can’t give them a straight answer. By the second phase of Donna Karan New York, we were building up a new brand of diffusion line: DKNY.

If I were to do it all over again, I would have reconsidered the terms of the operating agreement. If the partnership were an investor and a manager, a split down the middle was no problem. Provided that the investor did not meddle with the manager, there would be no cause for concern. However, this 50/50 partnership dichotomized members from varied experience levels and areas of expertise. From the beginning of any new startup in which I am manager and financier, I ensure the equity position is levered in my favor even if marginally. A 2 percent difference could have made a world of difference at Donna Karan New York. If a point over partnership distribution is debated, this could be easily mitigated by issuing phantom shares to the minority partner. The equity split 51/49 would only be in place for tougher decisions.

I mention this because Donna Karan was growing at a tremendous pace. Whenever a company prospers, wealth begets greed and selfishness. It may be a part of human nature. If I can make a dress and sell it for double the price to consumers, capitalism applauds regardless of state and creed. The majority of my narrative on the Donna Karan Company focused on the downsides of the business. I was so concerned with losing money that I forgot about what would happen if I made money. Everyone and everything was against me on the managerial end, so I did my best to make the company a success. In so doing, I misplaced some of my energies. Everyone was against starting a new company with Donna because Anne Klein had been going so well. So I spent most of my time defending my arguments and making arrangements to protect the new venture from all of the problems that could arise.

Once the DKNY line was launched, consumers only wanted more. We could only raise prices so much without squelching the demand, so we needed to capitalize future growth. However, our current assets shrank considerably on a cyclical basis. Every new season was difficult for us because we had to come up with the cash to pay for the next one, which was significantly bigger than the last. After taxes, the company’s income could only afford so much further growth. At this point, Donna Karan New York had its first major upside problem, which I had previously neglected.

I could do little on this front and had few options. I could bring in another partner, but the amount of equity needing to be sold would not be in the favor of Donna or Takihyo. We would end up having to sell a business that we started, and we would be left with only a small portion of earnings from a company growing at an exponential rate. Though venture capitalists may think of this as a successful exit strategy, I saw more potential in the company and it was so new that I couldn’t abandon it so soon. I didn’t want to lose money because we were making so much.

First, while we were successful initially, we feared not being able to keep up with demand. Since we were designing and manufacturing seasons ahead, we needed capital for various material commitments ranging from a host of new fabrics and accouterments to inspire the design team to money to pay our invoices and working capital requirements. Our problem before starting Anne Klein II had been capital restraints. Our growth had been so fast that our capital demands outpaced our earnings. To fuel this momentum, we only had a few options. Our growth was tremendous and we were running out of money to fuel the forward momentum. This was a good problem that we could not have foreseen.

At DKNY, we ran into the same problem a little down the road. Neither Donna nor I wanted to add new partners with money. We did not want to issue new debt because the company was graded BBB. If we were to issue debt, we would be required to pay about 10 to 12 percent on the bond. This would not have hurt the company, but it seemed to be a steep price to pay for operating capital. So Donna and Takihyo were left with one other option: go public.

Entering the public market is a great financial tactic if done properly. Outside money pours into the company to furnish funding for future endeavors. Because there are many different investors instead of one or two other partners, power within the company is diluted. Donna and Takihyo would still hold a significant control of the company. Additionally, with a public company comes more attention and brand recognition. We would be able to raise further funds in the future through equity issuance as well as provide shareholders with dividends or share buybacks once the company reached a kind of stasis in the marketplace of developed nations. From this perspective, we had a lot to gain and little to lose.

However, the initial public offering (IPO) was a harried endeavor. We started working with Bear Stearns and Merrill Lynch for the launch in 1997. They were pushing us to go public because they were concerned about their bottom lines as publicly traded companies. For the investment banks, mergers and acquisitions (M&As) as well as IPOs offer a significant amount of their bread and butter. It is in their best interest to get companies to go public. Once done, they take their fees and move on. So, every day, people from Merrill Lynch and Bear Stearns were at the office pushing everyone to get everything from a prospectus drafted to coming up with numbers for a starting bid price for the stock. Once the stock launched, and we were public, we took a step back and let the market decide what would happen next.

Going public could continue our business. In this sense, the IPO was a success. The stock was launched and shot up about 10 percent in the first weeks. However, shortly after, the equity tanked. There were a number of reasons for this, some of which arose out of not having enough time to prepare our prospectus as well as to iron out details between Donna, Steve, and Takihyo. Steve and Donna used this to their advantage and we did not have time to argue with them before the IPO. The investment banks, with Bear Stearns as the lead underwriter, wanted to hurry the offering.

Taking note of the shareholders’ interest is important, and regardless of how little their votes may count, they tend to add up, especially when market consensus shifts from bullish to bearish. My narrative places the Anne Klein story before the Donna Karan New York story for good reason. One started much before the other; however, some overlap occurred but for the sake of simplicity were illustrated one after the other. Before we sold Anne Klein to Arthur Levine at Kaspar was about the same time that we were considering going public.

The Anne Klein Company was in trouble because Donna was gone, but the brand and operating company still had room to grow and a relatively healthy balance sheet for such an old-fashioned house. So, we had kept Anne Klein on the wayside as an entity, which Frank and I owned. However, once talks of bringing Donna Karan public were initiated, Frank and I had to exit most executive meetings because of what the SEC would consider a conflict of interests. Although Anne Klein and Donna Karan were two entirely separate identities in the public eye and in the design room, the SEC still considered them competition. Indeed, some overlap occurred, but most of it was negligible. Nonetheless, because one company was privately owned and the other was about to go public, a host of new restrictions were put in place against Takihyo’s best interest. From a legal view, Anne Klein was a competitor to Donna Karan New York so any information regarding Donna Karan New York could not be leaked into the Anne Klein Company. Since we held significant interests in both companies, all Frank and I could do was sit around and hope for the best. These regulations against our involvement in the company significantly hurt our chances of a successful public launch.

In short, Frank and I could do little to change Donna and Steve’s minds regarding the guidelines listed in the initial prospectus. The blinding speed at which the investment banks were pushing us to go public didn’t help either because neither Steve nor Donna saw any imminent problems with what they were suggesting. As I mentioned, the banks didn’t care about the company going public; they cared about their fees. The fees only came once the company went public, and after that, there was no more support despite the contracts because we paid the invoices. In a way, Donna Karan International’s failure as public equity best illustrated that when it comes to money and people outside of the business, managers need to be careful, especially because all people are only interested when it comes to their own financial well-being rather than that of others.

The saddest part of this whole debacle was that Donna Karan International, as we renamed the company, was still making money. The balance sheets and cash flow statements were strong, perhaps a lot stronger than many other companies that were publicly traded at the time. The value of the brand wasn’t going anywhere as long as the managers didn’t make major changes to the business model and the design teams continued to innovate and grow. Even though shareholders lost a lot of money in those few months, at the end of the day, ownership in the company was still worth a lot more than where the stock ended up. Though efficient market theory is still discussed today, from a manager’s perspective, it remains only a theory with little basis in reality.

Making matters more complicated was the differentiation between the brand and the company. In most cases, when a company is acquired, the name is bought separately from the operating company, or only one or the other is purchased. Frank and I gave Donna the right to keep her name: This made sense to me because I would never imagine that Donna would sell it. However, for legal purposes, the name Donna Karan was kept in a separate entity to avoid other complications. Donna put the name in an entity she named after her daughter. So, Takihyo did not own the name, and we held the operating company although we were responsible for the company’s branding, marketing, and publicity from scratch. This point is important because the final sale of Donna Karan International included the sale of Donna’s name, but Takihyo did not and could not benefit from it.

To me, Donna did the unthinkable. Along with the company we started from scratch, she sold her name after the company went public, tanked, and was resold. The investment banks suggested Donna take the royalties from the operating company and deposit them into Gabrielle Studio, the company that owned the Donna Karan New York brand name. We had created Gabrielle Studio because if anything happened to the operating company (bankruptcy, litigation, etc.), the Donna Karan name would remain unaffected. Since Gabrielle Studio owned the brand name, the company existed separately from the operating company. However, because of the initial structure, the input from lawyers, CPAs, and company executives bringing all the risks to the fore, the brand name would need to be saved even in the worst-case scenarios. Takihyo could not own the name because it would be considered an asset to Takihyo and could be lost in litigation. However, if Donna owned a company in which the name had been housed, the brand name could not be taken away because the name was her own. I never thought Donna and Steve would be the only ones to benefit from the brand name, as the purpose was to shield us all.

Louis Vuitton purchased Donna Karan International after the stock entered bankruptcy territory trading for a tenth of the IPO price. The massive French luxury conglomerate paid nearly twice as much for the brand as they did for the company. Louis Vuitton got the operating company for a real bargain considering the cash flows, partly due to John Idol’s role as the company’s president before the sale as a fantastic accounting and managerial mind, future growth prospects, and good timing. Looking back, perhaps I should have kept the name within the company.

When all was said and done, I was still in the black on the balance sheet, but I wound up losing a lot of money when the company was grossly devalued in the markets in addition to losing on the sale of the brand that Takihyo had created with Peter Arnell. Other than altering the equity split, I should have spent more time concentrating on both scenarios: if we became tremendously profitable and if we failed. I only focused on the failure of this company because of the negativity surrounding me. This led me to make cautious decisions, but they lacked the broad strokes necessary to take the reins with such a successful company. Even though the Donna Karan New York brand is still alive and well today, great entrepreneurial success does not always equate with a perfect execution.