Hold the Mayo

mayoHampton Creek, a prominent start-up that is trying to bring tech industry panache to the world of mayonnaise, ranch dressing and other food products, has come under scrutiny by regulators for its business practices.

The Securities and Exchange Commission has opened a preliminary inquiry into Hampton Creek, according to a person briefed on the situation who asked not to be named because it had not been announced publicly. The S.E.C. inquiry is a response to a recent report that described an organized effort by Hampton Creek to buy large quantities of its Just Mayo product — a mayonnaise that uses a plant-based ingredient instead of eggs — by sending undercover contractors into stores. Kevin J. Callahan, a spokesman for the S.E.C., declined to comment. Hampton Creek’s chief executive, Joshua Tetrick, said he had heard from the S.E.C. about the informal inquiry but declined to give further details. Reports said the product buyback effort, which took place in 2014, made Just Mayo seem more popular than it was, not long before Hampton Creek raised $90 million from venture capitalists and other private investors. The basic details of the program were confirmed by a former Hampton Creek employee, who asked for anonymity because of confidentiality restrictions with his onetime employer. After the report, Mr. Tetrick wrote in a blog post that the mayonnaise shopping spree was part of a quality control program that had minimal impact on overall sales. The inquiry puts a cloud over Hampton Creek, which has described itself as the fastest-growing food company in the world. It has promised to tackle the food industry with the gusto of a technology start-up, using some of the same big data tools to do so. One of its goals is to identify healthy, plant-based ingredients that can substitute for common foods like eggs, with less of a negative impact on the environment.

Hampton Creek, based in San Francisco, has been praised by the likes of Bill Gates; received financial backing from prominent Silicon Valley entrepreneurs and investors like Marc Benioff and Vinod Khosla; and succeeded in getting its products widely distributed at Walmart, Costco, Whole Foods and other retailers.

The inquiry may be only the start of tougher questions facing Hampton Creek. The company is believed to be losing significant amounts of money. It is raising up to $220 million from investors, according to a Delaware filing provided by Equidate, which tracks private company shares. It’s not uncommon, of course, for start-ups to bleed red ink in their early days. But Hampton Creek, founded in 2011, faces some basic challenges with the manufacturing costs for its products. According to one former employee, in 2014 the company had negative gross margins of about 20 percent on Just Mayo, meaning that the raw cost to the company for every $1 it got in sales was about $1.20. The issue arises from Hampton Creek’s use of premium ingredients in its products without charging shoppers the often eye-popping prices attached to such food products. The vegetable oil used in Just Mayo, for example, does not come from genetically modified organism sources, which adds significant cost, according to the former employee. But on Walmart.com on Friday, a 30-ounce jar of Just Mayo was selling for $3.66 — 32 cents less than a jar of Hellmann’s mayonnaise of the same size. In an interview, Mr. Tetrick said the company planned to break even by the end of next year. “We are fortunate to be well capitalized,” he said, declining to disclose how much the company had in the bank. He added that some of Hampton Creek’s dressings, mayonnaise and food service cookie products were gross-margin-positive, meaning they generated more revenue than they cost to make. “We’re not trying to optimize at every turn, thinking, ‘What’s the margin?’” he said. “It’s about solving the bigger food problem. You know what we do about it? We attack it.”

The company’s program to buy its own mayonnaise has raised eyebrows among retail analysts. Food makers typically do quality checks through every step of production until the product lands on grocery shelves. Kurt Jetta, chief executive of TABS Analytics, a research firm, said that while he had heard of companies buying their own products off retail shelves, in most of those cases, “it’s to jack up the sales numbers, not for quality assurance.” He also said paying retail prices to buy products for quality assurance made “zero financial sense.” When food companies want to move a product off a grocery shelf to replace it with a reformulated or newly packaged version or because it has passed its expiration date, they issue a credit to the store manager — and then only to cover the price the retailer paid, not the consumer price. Some food industry consultants, though, said it was not unheard-of for companies to buy their food products off shelves.  Stericycle is a company that helps manufacturers with “audits” of their products for quality assurance purposes. “Manufacturers and retailers may need help with on-site resolution, including handling consumer complaints, product quality evaluation and much more, but they may not have the internal staff to handle those things quickly and efficiently,” said Kevin Pollack, vice president and general manager at Stericycle. Word of the program was mentioned briefly in a lawsuit against Hampton Creek filed this year on behalf of two former contractors for the company who were seeking unpaid wages. The contractors worked in stores in 2014 and 2015, representing Hampton Creek and handing out samples of Just Mayo to spread word of the product. But according to the lawsuit, Hampton Creek required the contractors to also “buy out shelves of Defendant’s products.” The SEC is trying to determine whether Josh Tetrick’s Hampton Creek Inc. improperly recognized revenue from purchases made with company money, said the people, who asked not to be named because the matter isn’t public. The opening of an SEC inquiry into the buybacks is a preliminary step and doesn’t mean the company will face an enforcement action. It was reported this month that Hampton Creek undertook an operation to purchase its own mayonnaise starting as early as 2014.

The SEC has jurisdiction over the closely held company because it has raised money from outside investors. “It doesn’t matter if the security is a private or public one; the SEC can bring an action against both,” said Jay Gould, a former SEC attorney and now partner at Winston & Strawn. Gould was speaking generally and is not involved in the Hampton Creek matter. Hampton Creek has raised more than $220 million and Tetrick, the firm’s founder and chief executive officer, told employees last week that he expects to raise another round of financing by early next month that will value the company at $1.1 billion, said a person who attended the meeting.

In late 2014, Hampton Creek raised $90 million from venture capital heavyweights Founders Fund, Horizon’s Ventures and Khosla Ventures as well as Salesforce.com Inc. co-founder Marc Benioff and Facebook co-founder Eduardo Saverin. Also that year, Hampton Creek instructed workers to buy back its own products from supermarkets. Hampton Creek said at the time that the self-purchases were primarily for a quality-assurance program designed to understand the product from a customer’s perspective.

Tetrick a spreadsheet of quality assurance purchases. The survey data — containing almost 3,900 entries in 15 states from March 2014 to January 2015 — didn’t account for hundreds of Just Mayo purchases by Hampton Creek contractors during that period. Five former contractors and two ex-senior staff members say the buyback assignments were separate from quality checks at stores. Tetrick said in a statement that the self-purchases accounted for less than 0.12 percent of sales. Since launching Hampton Creek in 2011, Tetrick has set out to revolutionize the food industry. The self-proclaimed food-technology company claims to make cheaper and healthier alternatives to everyday grocery items by replacing eggs with ingredients generated from plants.

Tetrick, 36, went around Silicon Valley vowing to take down competitors like Hellmann’s and won over leading venture-capital firms. Despite criticism from other investors who say the company is less an innovator than a deftly run marketing machine, Hampton Creek has turned Just Mayo into a cherished brand among sustainability-minded consumers.