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Written by

Francesca Bourassa-Corso 40005564


Marco Piccirilli 40001224
Samuel Groulx 40006945
Jérémie Couillard 40069539

For
Professor E. Wong
FINA 402
Short Term Financial Management

Due
Thursday, April 11th, 2019
To:
Mr. Seth Goldman & Mr. Barry Nalebuff
123 Road Street, Bethesda, Maryland
United States
A1B 2C3

From:
Mrs. Corso, Mr. Piccirilli, Mr. Groulx & Mr. Couillard.
Short-Term Financial Management consultants from
John Molson School of Business
1450 Guy St, Montreal
H3H 0A1
Quebec, Canada

Date:
11/04/19

Subject: Financing Proposal for Honest Tea


Greetings Mr. Goldman and Mr. Nalebuff

As previously discussed, my team of consultants and I have agreed to thoroughly analyze


Honest Tea’s operations and finances and craft a strategic plan in line with your vision to support
the company’s rapid growth:

The following concerns (Main Issues) were addressed:

1. What type of investor would best support the company’s mission

2. What structure and amount of financing would be necessary to fund Honest Tea’s rapid growth

Conclusions from the analysis suggest the following recommendations should be adopted
for Honest Tea to fund its growth expansion and sustain market leadership:

The following solutions (Recommendations) are suggested:

Recommendation 1: Raise Equity from Current Existing Angel Investors & Investor’s Circle

Recommendation 2: Raise a Minimum of Two million through common equity issue (1 Million with
existing, 1 Million with IC)

The Recommendations were chosen based on the following decision Criteria:


1. Rapidity of Implementation
2. “Honesty” or Integrity with the Company’s Mission
3. Control
Table of Contents:

QUALITATIVE ANALYSIS
Intro
Company Mission
Company’s Short Term Goal
Current Financial Position
Capital Requirement
Current Investors & Current Structure of Financing
Potential Investors
Potential Structure of Financing

QUANTITATIVE ANALYSIS
Ratio analysis
Cash Flow Statement and Forecast Analysis
Current Valuation of the Company
Investment and Investor Decision Recommendation

ACTION PLAN

QUALITATIVE ANALYSIS
Intro
Honest Tea has been operating for 3 years and it has created a market for slightly sweetened, all-
natural, bottled iced tea. It has demonstrated high growth in all years however, as a fairly new
company, it still operates losses. Management needs to find the ideal investors and the proper
amount of financing that would help the company fund its growth and reach profitability. To do
so, we first need to establish the management’s short term objectives, the necessary amount of
financing required to reach those objectives, determine which investor type would best suit the
company and suggest a sustainable growth strategy.

Honest Tea’s Mission


Honest Tea stands out by adopting a socially responsible framework focussed on offering a
healthy and equitable product that has no hidden ingredients, synthetic chemicals, pesticides or
genetically modified organisms. The company also seeks to have a value chain that is as honorable
as its product by giving back to society through fair trade ingredients and sustainable practices,
forming relationships within unprivileged communities, maintaining direct relationships with its
ingredients and suppliers and leveraging the cultural experience of tea through product packaging.
The methods Honest Tea undertakes to expand operations should reflect the integrity and honesty
it has adopted in its mission.
Original Mission Statement form 1998
“Honest Tea seeks to provide bottled tea that tastes like tea- a world of flavor freshly brewed
and barely sweetened. We seek to provide better-tasting, healthier teas the way nature and their
cultures of origin intended them to be. We strive for relationships with our customers,
employees, suppliers and stakeholders which are as healthy and honest as the tea we brew. We
strive to grow our business with the same honesty and integrity we use to craft our recipes, with
sustainability and great taste for all.”

Management’s Short Term Objectives


Honest Tea’s management has established the third round of financing would be used for the
following purposes:
1) To provide additional working capital as the money provided by the first and second sound
of financing is insufficient.
2) To help expand production and distribution channels.
3) To hire a skilled sales force. With Sobe’s acquisition by Pepsi, there is now a labor supply
of highly industry-knowledgeable workers.
4) To purchase marketing and merchandising materials such as coolers and other sales
incentives
5) To allow the Three Rivers Bottling production unit to reach profitability as it is currently
operating at a third of its production potential.
6) To fulfill large purchase orders by new channels such as Safeway which requires many
units to be delivered.
Current Financial Position
The current position of Honest Tea can be described to be in a medium financial health
situation. Even though the company has medium liquidity and minimal leverage, they are lacking
in their efficiency and profitability. Nonetheless, the forecast of the income statement is indicating
an improvement in their profitability ratios for the upcoming years. Since the beginning of their
activities, the operating and net margins each year have been negative since EBIT and net income
have both been negative. However, they are expected to improve and reach profitability in 2002.
Considering that the firm opened in 1998, it is typical that they operate at a loss for the first few
years and hopefully will eventually start making a profit.

Projected Financial Position


The projected financial position of Honest Tea shows a healthy financial situation. As for
the liquidity ratios, the decrease in the cash, current and quick ratios can be explained by the
increase in liabilities to support Honest Tea’s operations. Nevertheless, these ratios are still
positive and indicate that the company is still in a sustainable liquidity position. Moreover, for the
efficiency ratios, Honest Tea is expected to have a significant improvement in its cash conversion
cycle. Although the DSO increases in the number of days held, the decrease in the DIH and
increase in DPO counterbalances the change in the overall period. Hence, Honest Tea expects a
decrease in its cash conversion cycle, which represents an improvement in its efficiency of cash
management. We will dive deeper into the projected financial position later in this report by
projecting the balance sheet and cash flow statements.

Capital Requirement
According to our cash flow analysis projections for 2001 and 2002, and taking into account all
management’s short term objectives reflected in the income statement projections, we have
computed a minimum capital requirement of 2.04 Million, which we have rounded off to 2 Million.
This capital would be used to cover for a predicted net loss of $861,500 in 2001 that includes a
total operating cash outflow for the period of 2.04 Million. The operating cash outflow reflects the
following expenditures:
1. Increased Marketing and Promotional Expenses
2. Increased wages and salaries
3. Coolers Bought
4. Increased R&D
5. Slotting fees paid to new retailers
In 2002, it is expected that Honest Tea will be cash flow positive as well as Net Income Positive
(1,105,100 $). It should be a pivoting year for the company as operating cash flows will be positive
(around $40,000) which means Honest Tea will be able to sustain its operations without additional
paid-in capital.

Current Investors & Current Structure of Financing


The company’s current investors are the following:
1. The founders have made a start-up investment of $ 300,000.
2. First Round of Financing Family and friends have invested $217,500
3. Second Round of Financing: Satisfied customers and angel investors invested 1.2 Million
$ (4m Valuation)
4. Third Round of Financing part one: Existing investors committed an additional 1 Million
(8.5m Valuation), but managers believe it is insufficient for what they must accomplish.
This is why additional investors are required in this round.

Potential Investors
In order to assess the issue of finding the ideal investors that would support Honest Tea’s business
strategy, mission, and round of funding of about $2 million, here is a list of the different type of
investor the organization should look for:

Angels (Investor’s Circle)


Pros:
1. The IC was founded in 1992 and has experience with over 120 companies, including
socially responsible startups like Honest Tea.
2. Mr. Goldman has already worked with the IC group previously.
3. Their investments can range from $10 000 to $6.5 million.
4. Most investors align and respect Honest Tea basic convictions.

Cons:
1. Funding will mostly be topped at $500 000 but it could be possible to convince them to
invest more if shares are increased.
2. Dealing with the IC group can be complex as per past experience in the case where several
investors require various terms according to each investor’s needs. However, management
has experience in dealing with large groups of investors.

Venture Capitalists
Pros:
1. Significant investment amount ($5 million)
2. Great financial advising to bring on the board of directors of the company
3. Would enhance the company’s reputation and credibility
4. Strategies of rapid expansion
Cons:
1. A significant portion of the company’s control would have to be given
2. Business strategies might not align with the founders' convictions and Honest Tea core
values
3. Current equity owners and founders will have to give up significant ownership and future
profits
4. If a VC is appointed to the board, conflicts of interest could arise and compromise would
be necessary.

Strategic partnership
Pros:
1. Opportunities that enhance both businesses growth
2. Improvement of product quality, operations efficiency and customer base
3. Access to financial support
4. Leverage of distribution channels
Cons:
1. Risk of non-alignment of the core values and conviction of Honest Tea with the other
organization
2. A strategic partnership might be complex to arrange and achieve the stated terms such as
assuring a sustainable growth and profitability. The partnership must be clear and well-
stated as for the profit sharing
3. Partnerships usually require that a large portion of the shares be given to the partner.
IPO
Pros:
1. Would provide opportunities to merge or acquire other beverage brands
2. Would provide liquidity to investors
3. Would raise capital for future expansion

Cons:
1. Honest Tea is not large enough to currently go public.
2. A less traditional form of financing in the beverage industry
3. Would make the company leave the private sector and become a public business which
increases the amount of bureaucracy.
4. The current ROE-ROA are negative, which could discourage investors from seeing the
firm as a possible investment opportunity.
5. Currently, IPOs are extremely expensive and Honest Tea does not have the cash necessary
to pay for their IPO

Potential Structure of Financing


Common Equity
Pros:
1. Issuing Common Equity is an ideal source of financing for companies who do not wish to
record debt in their financial statements. Usually, companies that have a high debt to equity
ratio and low liquidity will opt for this option.
2. Common Stock is less expensive than issuing debt because an organization does not need
to make obligatory interest payments to investors and instead can make discretionary
dividend payments when it has extra cash.
3. Common stock is also less risky than debt because shareholders share the risk and if the
company has liquidity issues, it doesn’t have to repay the money back to the lender.
Cons:
1. Issuing additional shares into the financial markets dilutes the holdings of existing
shareholders and reduces their ownership in the corporation.
2. To raise money by selling stock, a firm must be willing to potentially lose some control
over the company and ownership as well. Some investors insist on having a representative
work for the business or become part of the board. The higher the ownership stake, the
more control over the direction and decisions of the company the investor usually wants.
3. Ideally, a company should avoid selling shares unless the potential to gain from financing
is extraordinary.
Debt
Pros:
1. Contrary to issuing shares, taking out a loan is temporary. The relationship between the
company and the investor ends when the debt is repaid. The lender does not have any say
in how the owner runs his business.
2. Loan interest is tax deductible, whereas dividends paid to shareholders are not.
3. Principal and interest payments are stated in advance, therefore, are predictable and allow
for better cash flow forecasting. Loans can be short, medium or long term.
Cons:
1. The company and the owner must have acceptable credit ratings to qualify
2. Principal and interest payments must be made on specified dates without fail. Businesses
that have unpredictable cash flows might have difficulties making loan repayments.
3. Taking on too much debt makes the business more likely to have problems meeting loan
payments if cash flow declines. Investors will also see the company as a higher risk and be
reluctant to make additional equity investments.
4. A company that decides to add debt but has a lot of money tied up in inventory and
increasing trade payables will become risky to the eyes of the investor.

Convertible notes/debt
Pros:
1. Less risk of default since the company does not need to pay back the loan.
2. The company can reinvest more money in its business.

Cons:
1. The company might not want to exchange a controlling interest in their company for a loan.
2. It can dilute the value of each share depending on the number of shares the investor is
promised.

QUANTITATIVE ANALYSIS
Ratio analysis

Current Liquidity Ratios


In 1998, the current and quick ratios (127.7 ; 62.35) far exceed the same ratios for 1999
(4.41 ; 3.04) and 2000 (5.92 ; 3.29). Even though these ratios show excellent liquidity of the
company, they imply that the firm incurred an important amount of current liabilities. As for the
cash and cash burn ratio, the firm is doing very well. The 2000 cash ratio stands at 0.16 while the
cash burn ratio for the same year stands at 111.88 days. We can say that Honest Tea has an
acceptable liquidity position. (Please Refer to Appendix B 1.1 for the forecasted Ratios)

Forecasted Liquidity Ratios


The forecasted liquidity ratios show a decrease in the current ratio for 2001 (2.24) and 2002
(1.99) compared to what is observed for the year 2000. This can be explained by the increase in
liabilities of the company to support its operations. Similarly, the quick ratio of 2001-02 (0.89;
0.76) and the cash ratio (0.11; 0.07) show a decrease from the ratio calculated in 2000.
Unfortunately, we can observe an increase in the net liquid balance from 2001 to 2002 which
shows that the company becomes more dependent on financing. Nonetheless, Honest Tea remains
in a healthy position regarding liquidity.

Current Efficiency Ratios


As for the company’s efficiency ratios, we observe that the main problem comes mainly
from their DIH. If we look at the year 2000, their DIH is about 219.72 days, which is very high
and affects negatively their cash conversion period (215.02 days). Also, they are paying their
expenses faster than they are collecting their payments (DSO: 78.8 days; DPO: 83.5 days). Overall,
Honest Tea lacks in the efficiency of its cash management, more specifically with managing the
cash tied to inventory.

Forecasted Efficiency Ratios


As for the forecasted efficiency ratios, Honest Tea is expected to decrease its DIH to about
174.71 days and 178.54 days in 2001-2002 respectively. This improvement in DIH
counterbalances the expected increase in DSO and DPO to bring the CCP to 142.36 days and
132.25 days, which is a remarkable improvement in efficiency compared to the year 2000.
Current Leverage Ratios
As for leverage ratios, Honest Tea is financed a lot more with equity than debt at the
moment. This can be seen by looking at their debt to equity ratio which are both almost at 0 from
1998 to 2000. These can be explained by the fact that Honest Tea carries a very low amount of
debt compared to a high level of equity. On the other hand, their interest burden ratio is not
meaningful since their EBIT is negative and their almost nonexistent debt which would make the
ratio negative, and therefore implies that the firm cannot pay off their interest. Finally, the asset
turnover has been relatively well, over 1 for 1998 and 1999. However, it is declining and was at
0.47 in the semester ended on June 30. Hence, we observe that the leverage position of Honest Tea
is medium.

Profitability Ratios
If we look at the profitability ratios, the ROA and ROE are meaningless since EBIT and
net income are both negative throughout the three years. However, the gross margin has been
positive and has been increasing from 1998 (0.18) to 2000 (0.37), and is projected to keep on
growing according to the forecast until 2002. A similar growing trend can be observed for the
operating margin and the net margin. In 2002, both ratios are expected to turn positive at 0.067
and 0.07 for operating and net margin respectively. Therefore, it is significant to notice that
currently, Honest Tea is not in optimal profitability position, but according to the forecast, the
company should reach profitable activities in the upcoming years.

Warrants
To raise the equity, Honest tea is offering a package of a share with 2 half-warrants. The way this
package is created will be advantageous to both Honest Tea and its new shareholders. The
packages will give $37,000 each to raise the $2 million needed. On top of that, it is an attractive
package to shareholders because they have the option to exercise the warrants and obtain more
equity of the company if the warrants expire In-the-Money. This is also advantageous to Honest
Tea because the option makes the share more attractive to potential investors but they will also
receive extra liquidity since half the warrants will have a $50k exercise price and the other a
$75k price. Of course, an ITM option creates a loss for the underwriter of the option but the
trade-off here is that it will provide much-needed liquidity for the firm.

Cash Flow Statement Analysis & Forecast


We projected what the balance sheet and the cash flow statement would look like if
Honest Tea decided to raise $2 million through equity with angel investors and additional funds
from their current investors. (please refer to Appendix A 1.1 balance Sheet and 1.2 Cash flow
Forecast)
The equity raised will be used to finance investments and the growth in working capital
and production. We used the projections that Goldman gave himself and that he is confident in.
The company would be cash flow negative in 2001 (net change in cash= -34,937) but cash flow
positive in 2002 (net change in cash= $41,677). Raising only $2 million dollars in equity would
be sufficient to keep the company cash flow positive by 2002, but it comes with risks. The firm
will not be extremely cash flow positive in 2002 and it will be close to break-even change in
cash. When looking at the projected liquidity ratios, we see that the firm will maintain a solid
current ratio and quick ratio (2001: 2.24x & 0.89x and 2002: 1.99x & 0.76x) but it has a very
weak cash ratio and liquid balance (2001: 0.11x & -$1,488,575 and 2002: 0.07x & -$3,231,910).
While Goldman’s projection may likely to be right, there is always a risk that they are erroneous
and that sales or net income are not as big as he projected. To visualize what would happen to
Honest tea’s cash flow position and balance sheet if net income doesn’t fall in line with
Goldman’s projections, we built a sensitivity analysis to look at the liquidity ratios. (please refer
to appendix A 1.3 Sensitivity Analysis).
From the sensitivity analysis, we can witness that the company will be cash flow negative
if net income is less than what Goldman predicted. The cash ratio, in particular, will be in the
negative because the firm will run out of cash if they don’t do something to change its cash
position. But even if net income is 30% less than expected for the two years, the cash ratio will
only be at -0.10x at its worse. This is easily fixable by either, getting a short term loan from a
bank or tweaking with their CCP. The CCP of the company is very large and thus, is capturing a
lot of cash. Factoring part of their receivables or getting a floating lien on their inventory could
provide the necessary liquidity. This will allow the firm to cover its cash needs to become cash
flow positive again and continue operations until net income becomes large enough to sustain the
organic growth of the company and pay for their obligations.
What if the firm took the $5 million bid from the Venture Capital firm? (please refer to
Appendix A 1.4 Balance Sheet 2.0 and 1.5 Cash flow Forecast 2.0). The firm will have a much
better liquidity position. (please refer to Appendix A 1.6 Ratio Forecast 2.0) They will be able to
sustain a lot more events. They won’t have any problems of liquidity if net income happens to be
heavily negative in 2001 and 2002. Their cash ratio will be 1.90x in 2001 and 0.93x in 2002.
This will make the company very stable in any case. This would be an attractive offer for the
firm but the problem is that the current owners will have to give up a lot for this type of
financing. $5 million at a valuation of $5-7 million means that they will have to give up almost
all their equity, and thus the future profits that the company could provide. While this strategy
will provide very solid liquidity, the cost for the owners of the firm makes it a last resort option.

Current Valuation of the Company


Pre-money Valuation
Enterprise value = (Equity +Debt) - cash and cash equivalents
EV 1998 = 215,635 - 33,578 = $182,057
EV 1999 = (912,129 + 1,843) - 450,173 = $463,799
EV 2000 = (1,342,011 + 1,833) - 220,982 = $1,122,862
Post-money Valuation
2001 valuation to investors
(8,094,000*2) + (7*898,400) + 750,000 = $23,226,800
2002 valuation for investors
(15,361,200*2) + (7*1,527,300) + 750,000 = $42,163,500
With Angel and Current investor funding (refer to Appendix A 1.1)
EV 2001 = (2,442,317 + 1833) - 186,045 = $2,257,105
EV 2002 = (3,786,032 + 1833) - 227,722 = $3,560,143
With Venture Capital funding (refer to Appendix A 1.4)
EV 2001 = (5,441,317 + 1833) - 3,186,045 = $2,257,105
EV 2002 = (6,786,032 + 1833) - 3,227,722 = $3,560,143

Investment and Investor Decision Recommendation


The firm should go the path of raising cash through angel investors instead of the venture capital
firm and other options. They can raise 1 Million with existing angel investors who already
committed this amount of capital at an 8.5 Million $ valuation which translates into ownership of
11.7% of Honest Tea.
The firm should try to raise 1 Million through Investor’s Circle which demonstrates a similar vision
and mission as Honest Tea and already has experience in helping socially responsible companies
grow. IC has mentioned it would be willing to commit 500,000$, however, we believe it would be
ideal if Honest Tea could secure 1 Million commitment using the warrants offering. While $1
million is larger than what Goldman expects to raise from IC by $500,000; we believe that Honest
Tea can find another angel investor or a competing firm who has experience in the market and can
provide help in the management of the company. The competing firm or a member of their board
will only own a small part of the firm and thus this would not constitute a merger, it will only be
a small investment of $500,000.
This capital structure will allow the current owners and founders to keep control and retain a
significant part of the company but allow them to raise the necessary cash to grow the company
and bring it to profitability.

PLAN OF ACTION

1. A meeting should be scheduled with existing angel investors to accept the committed
capital of 1 Million at a pre-money valuation of $13.113 million Valuation.
2. A proposal should be typed addressed to Investor’s Circle making them aware of
management’s interest in having them as a part of their shareholders.
3. After Investor’s Circle has had the time to analyze Honest Tea’s proposal and financials (1
Month) a meeting should be scheduled to negotiate the following terms:
a. 1 Million in exchange for 10% of Honest Tea in common equity.
b. If they decline, Honest Tea could make a counteroffer for 1 Million in exchange of
15%, but not more.
4. After the 2 Million in committed capital is secured, the company may begin to approach
large retailers and commence national marketing efforts to be able to optimize production
at Three Rivers Production facility.

APPENDIX A
1.1
Balance Sheet Forecast
1.2
Cash Flow Statement Forecast
1.3
Sensitivity Analysis

1.4
Balance Sheet 2.0
1.5
Cash Flow Forecast 2.0
1.6
Ratio Forecast 2.0

APPENDIX B
1.1
Forecasted Ratios

APPENDIX C

Ratios
1998 1999 2000 ended June 30

Current ratio 127.7 4.41 5.92

Quick ratio 62.35 3.04 3.29

DIH 161.61 145.73 219.72

DSO 81.37 52.24 78.8

DPO 2.49 106.58 83.5

CCP 240.49 91.39 215.02

Cash ratio 0.15 0.4 0.16

Cash burn ratio 55.1 220.46 111.88

Interest burden NM NM NM

leverage 0 0.002 0.0015

Asset turnover 1.26 1.09 0.47

ROA NM NM NM
ROE NM NM NM

1998 1999 2000 ended 2001 2002


June 30

Gross margin 0.18 0.29 0.37 0.43 0.45

Operating -0.75 -0.68 -0.34 -0.11 0.067


margin

Net margin -0.75 -0.72 -0.36 -0.1 0.07

Ratios for Triarc Cos Inc


1998 1999

Net margin 0.02 0.01

Operating margin 0.15 0.14

Asset turnover 0.8 0.76


Current ratio 2.03 2

Debt/Equity ratio 1.52 2.04

ROA 0.12 0.11

ROE 0.03 0.02

Ratios for Saratoga Beverage


1998 1999

Net margin 0.1 0.03

Operating margin 0.17 0.1

Asset turnover 1.18 1.23

Current ratio 2.55 2.57

Debt/Equity ratio 0.22 0.89

ROA 0.2 0.12

ROE 0.12 0.07


Ratios for National Beverage Corp
1998 1999

Net margin 0.03 0.03

Operating margin 0.07 0.06

Asset turnover 2.23 2.16

Current ratio 2.23 1.93

Debt/Equity ratio 0.24 0.22

ROA 0.16 0.14

ROE 0.08 0.09

Ratios for Clearly Canadian Beverage Inc.


1998 1999

Net margin 0.008 -0.27

Operating margin 0.06 -0.08

Asset turnover 0.93 1.08

Current ratio 2.81 1.81


Debt/Equity ratio 0.44 0.92

ROA 0.06 NM

ROE 0.02 NM