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Selling Out Trendy Kiehl's was the ultimate family firm. So why the heck cash out?
By Heather Chaplin

(FORTUNE Small Business) – The hardest part was telling her daughter. There were disappointed customers, weeping employees, and her own sense of loss. But when Jami Morse Heidegger decided to sell Kiehl's, the company she'd inherited from her father and grandfather, it was 9-year-old Nicoletta's reaction she feared the most.

Kiehl's began 149 years ago as a humble pharmacy on Third Avenue and 13th Street in Manhattan's Lower East Side. But under Jami's tutelage, it had become wildly popular with fashionistas and skin-care connoisseurs worldwide--and was such a growth machine that it was no longer manageable. So on April 14 of this year, after years of declaring she would never sell, Jami took an estimated $100 million offer from L'Oreal, the world's largest cosmetics company, and let go of the family business. When she told her daughter the night before inking the deal, Nicoletta crawled under her covers and refused to speak. Even at such a young age, Nicoletta had a sense of destiny: to be just like Mom and run the family business.

Jami had never pictured it coming to this. As recently as last January, she told FSB in interviews that she wanted to scale back Kiehl's rather than sell it to a corporate parent. Courted for years by cosmetics titans such as Estee Lauder and L'Oreal, she had clung stubbornly to independence and to her own bottom line, which was not always financial. (What other company president would create a line of horse shampoos simply because her little girl wanted one?)

Competitors of all sizes have marveled at Kiehl's ability to create exceptional customer demand without even revamping its plain-Jane, turn-of-the-century packaging. Now they're wondering why Jami succumbed, how L'Oreal wrested away the prize, and if the Kiehl's mystique can escape the corporate taint. Jami is wondering the same things--as well as how it will feel to be an employee rather than an owner. "All my life I knew there was a place for me in the world," she says. "No matter what happened, there was always Kiehl's. It was a great sense of security and excitement." And she had passed those feelings on to Nicoletta--who likes to mix nail polish concoctions in her bedroom. "To deny that to my daughter," says Jami, "was very, very difficult."

Her dilemma isn't new, or unique. Small, independent businesses have a cachet big companies can't match. But it's hard to maintain. Even those icons of quirky independent business, Ben & Jerry's, sold out to Goliath food corporation Unilever this spring. Says cosmetics industry analyst Allan Mottus, who has followed Kiehl's since the days of Jami's father's reign: "It's the nature of the beast. You either grow or die. There's no in-between." But the Morses had hoped they could defy that dictum.

Their story began in 1921, when Russian-Jewish immigrant Irving Morse, Jami's grandfather, bought the original pharmacy. His son Aaron expanded the brand, taking it into a small, odd mix of locations: Neiman Marcus in Beverly Hills and a handful of local health-food stores. Aaron is remembered in the blocks around the Manhattan store for his flamboyant ways. He would pull people in off the street and insist they try his new antipimple medication or his shampoo.

He was also known for the fights he had with his daughter in the store's back offices. They yelled so loudly about Jami's plans to expand that customers and employees would gawk when the two emerged. "My father wanted [to keep it] small and manageable," says Jami. But when she took over in 1988, she saw a wider horizon.

Jami did maintain her father's practice of giving out wildly generous samples, and she kept the products' simple packaging. She held on to the Lower East Side storefront, which--with its low-hanging chandeliers, family photographs, and old apothecary bottles--has become a pilgrim's destination for Kiehl's lovers. But Jami took the line into more Neiman Marcus stores, as well as Barneys, Bergdorf Goodman, and Saks Fifth Avenue, plus Harvey Nichols in England. She built a new factory in New Jersey and computerized the mail-order system. On her watch, Kiehl's grew 20% a year to hit sales of $40 million in 1999, all the while maintaining a profit margin estimated to be 85%.

Kiehl's was her life. Even after settling in Los Angeles and having three children, she commuted to the East Coast for years. With her 18-hour days, refusal to discuss financial matters, and willingness to spend time with customers, she developed a reputation for eccentric leadership almost as great as her father's. Jami was exacting, liked to follow an idea rather than do market research, and was generous to a fault.

Her company was hot; her family was living the good life. Her husband and business partner, former Austrian ski champ Klaus Heidegger, gave her a diamond that dwarfed the knuckle on her ring finger. The early-1990s New York City social scene wanted her for one of its own. Nicoletta got equestrian lessons and her own pony. Klaus got to indulge his taste for an airplane and Hummers, which he drove around the family's backyard. "I loved the success," Jami says, "seeing my photograph in the papers, being recognized. I wasn't at all inclined to listen to my father." (Aaron Morse died in 1995.)

It was only last Christmas that Jami began to wonder if perhaps she should have listened. Several magazines published glowing articles about Kiehl's, and the extra press pushed the little company past cult status and into the limelight. Demand, already overwhelming, grew to a level the owners couldn't handle. The mail-order division became clogged with hundreds of calls that never got returned. Shipments were delivered to the wrong addresses with note cards for the wrong people. Department store orders--normally filled in two weeks--took six. New products weren't even making it onto the factory's production schedule. "It was like a snowball rolling downhill and just getting bigger and bigger," recalls Klaus. Adds Jami: "I came full circle. I see that my father was right. I created something I couldn't control."

Kiehl's was not in financial trouble. But Jami and her husband made the unusual decision to scale back. There were the usual suitors--lots of them--but Jami wanted to preserve the essence of the business and pass it on to her daughter. She soon learned some hard facts, though. Contracts with department stores can't just be cut, her lawyers told her. Customer demand doesn't slow down just because you want it to. Desperate, she tried stopgap approaches to keep up with her booming business--leasing space to start a distribution facility, moving a factory bathroom to make an office. Nothing helped. "When you need new equipment for your factory, you don't just go and buy it at Home Depot," Jami says. "There were issues that needed to be addressed, and I just didn't have the resources to address them."

In February, she called Philip Shearer. He is the dapper and aggressive president of luxury products for L'Oreal's U.S. subsidiary, Cosmair Inc. Shearer had been wooing Jami and her husband for two and a half years when he got the call. "He seemed to be genuinely interested in Kiehl's," Jami says. "He knew what we were doing; he'd read my newsletters; he knew the ingredients in particular products. I thought he understood who I was and what I was trying to do with Kiehl's."

While companies such as Estee Lauder have been snapping up niche players like Bobbi Brown and Stila left and right in recent years, L'Oreal has been busy building mass-appeal brands such as Maybelline into international powerhouses. When L'Oreal did decide to compete in the burgeoning specialty market, Shearer and his boss, Cosmair chief executive Guy Peyrelongue, set their sights on only one company, Kiehl's. They liked its image and respected its roots, Peyrelongue says. Although L'Oreal has no track record with boutique lines, it is known in the industry for its methodical and masterful building of upscale brands such as Lancome and Redken. And Jami liked knowing her "baby" wouldn't be one in a stable of niche brands fighting for attention, money, or space.

Finally, Jami was impressed by the fact that L'Oreal spends more than any other cosmetics company on research and development--about 11% of annual sales last year, compared with Estee Lauder's 4%.

All sound reasoning, to be sure. But standing outside of Kiehl's on one recent afternoon, hip young women with Kate Spade bags and skimpy mules expressed something close to horror at the news that Kiehl's now belonged to L'Oreal. The attitude: It just won't be the same.

Peyrelongue shrugs this off. As far as he's concerned, such loyalty is part of what L'Oreal is paying for. "People are so in love with Kiehl's, their concern is we will change something," he says in his thick French accent. "But people will see it's going to be the same products and the same essential program. Kiehl's is still going to be Kiehl's." He and Shearer lurch back in mock horror, hands to hearts, at a joke about introducing Kiehl's in Wal-Mart. (Remember Halston's misguided romance with J.C. Penney?) They have no intention of destroying the brand for a few quick bucks, they maintain. "We want to keep the line very exclusive," Peyrelongue says.

As long as they do, Kiehl's should be fine, says Linda Wells, editor of Allure. "I know Karl Lagerfeld isn't sitting there with a thread and needle making my Chanel suit," Wells says, "but the appeal is there. The feeling of exclusivity is still there." Knowing L'Oreal's reputation for brand building, Wells sees little if any risk to Kiehl's from the acquisition. "The company will benefit from having the power and muscle of L'Oreal behind it," she says. Besides, most customers aren't reading merger news in The Wall Street Journal, and they don't pay attention to who owns whom.

At L'Oreal, company execs say that Kiehl's trademark sampling will continue, its reverse-chic packaging will remain the same, and the brand will be as hard to find as ever. Changes for the U.S. involve small things--adding more phone lines, increasing factory size, maybe developing a Website. Even Nicoletta's line of horse shampoos is slated to remain where it is in the front window on Third Avenue.

Knowing that Jami's personality has been key to Kiehl's success in recent years, L'Oreal is signing her to a three-year contract as president of the new acquisition, with an option to renew. Whether the parent company will need her forever, though, is another story. After all, L'Oreal's real plan for Kiehl's lies on Asian and European soil, where it hopes to launch major expansions, and Jami is hardly known for international dealmaking skills. During the transition, however, both parties are eager to stick together--Jami to see her baby grow up, and L'Oreal to maintain the status quo.

In a conference room high in the Manhattan skyline just a few days after inking the deal, Shearer's arms are folded tightly across his chest, but his eyes gleam. "I think we played this game pretty well," he says. He is fairly twinkling behind the confines of his blue suit. And understandably. In acquiring Kiehl's, Shearer has pulled off a major coup, something no other beauty exec was able to do. Mottus, the analyst, gives Jami credit for helping him do it. "They sold before they could screw up," Mottus says. "A less aware manager would have taken it down the tubes."

Jami agrees. Kind of. "I am totally confident this was the right choice for Kiehl's," she says. "But I see it as a sacrifice. I'm not convinced it was the right choice for me personally. Ask me in a few years."