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VC VALUATION: SOUTHWEST VENTURES IS CONDIDERING AN INVESTMENT IN AN AUSTIN, TEXAS-BASED START-UP FIRM CALLED CREED AND COMPANY.
1. VC VALUATION: SOUTHWEST VENTURES IS CONDIDERING AN INVESTMENT IN AN AUSTIN, TEXAS-BASED START-UP FIRM CALLED CREED AND COMPANY. CREED AND COMPANY IS INVOLVED IN ORGANIC GARDENING AND HAS DEVELOPED A COMPLETE LINE OF ORGANIC PRODUCTS OFR SALE TO THE PUBLIC THAT RANGES FROM COMPOSTED SOILS TO ORGANIC PESTICIDES. THE COMPANY HAS BEEN AROUND FOR ALMOST 20 YEARS AND HAS DEVELOPED A VERY GOOD REPUTATION IN THE AUSTIN BUSINESS COMMUNITY, AS WELL AS WITH THE MANY ORGANIC GARDENERS WHO LIVE IN THE AREA.LAST YEAR, CREED GENERATED EARNINGS BEFORE INTEREST, TAXES, AND DEPRECIATION (EBITDA) OF $4MILLION. THE COMPANY NEEDS TO RAISE $5.8 MILLION TO FINANCE THE ACQUISITION OF A SIMILAR COMPANY CALLED ORGANIC AND MORE THAT OPERATES IN BOTH THE HOUSTON AND DALLAS MARKETS. THE ACQUISITION WOULD MAKE IT POSSIBLE FOR CREED TO MARKET ITS PRIVATE-LABEL PRODUCTS TO A MUCH BROADER CUSTOMER HASE IN THE MAJOR METROPOLITAN AREAS OF TEXAS. MOREOVER, ORGANIC ANDMORE EARNED EBITDA OF $1 MILLION IS 2009. THE OWNERS OF CREED VIEW THE ACQUISITION AND ITS FUNDING AS A CRITICAL ELEMENT OF THEIR BUSINESS STRATEGY, BUT THEY ARE CONCERNED ABOUT HOW MUCH OF THE COMPANY THEY WILL HAVE TO GIVE UP TO A VENTURE CAPITALIST IN ORDER TO RAISE THE NEEDED FUNDS. CREED HIRED AN EXPERIENCED FINANCIAL CONSULTANT, IN WHOM THEY HAVE A GREAT DEAL OF TRUST, TO EVALUATE THE PROSPECTS OF RAISING THE NEEDED FUNDS. THE CONSULTANT ESTIMATED THAT THE COMPANY WOULD BE VALUED AT A MULIPLE OF FIVE TIMES EBITDA IN FIVE YEARS AND THAT CREED WOLD FROW THE COMBINED EBITDAS OF THE TWO COMPANIES AT A RATE OF 20% PER YEAR OVER THER NEXT FIVE YEARS IF THE ACQUISITION OF ORGANIC ANDMORE IS COMPLETED. NEITHER CREED NOR ITS ACQUISITION TARGET, ORGANIC AND MORE, USES DEBT FINANCING AT PERSENT. HOWEVER, THE VC HAS OFFERED TO PROVIDE THE ACQUISITION FINANCING IN THE FROM OF CONVERTIBLE DEBT THAT PAYS INTEREST AT A RATE OF 8% PER YEAR AND IS DUE AND PAYABE IN FINE YEARS. A. WHAT ENTERPRISE VALUE DO YOU ESTIMATE FOR CREED (INCLUDING THE PLANNED ACQUISITION) IN FINE YEARS?B. IF THE VC OFFERES TO FINANCE THE NEEDED FUNDS USING CONVERTIBLE DEBT THAT PAYS 8% PER YEAR AND CONVERTS TO A SHARE OF THE COMPANY SUFFICIENT TO PROVIDE A 25% RATE OF RETURN ON HIS INVESTMENT OVER THE NEXT FIVE YEARS. HOW MUCH OF THE FIRM’S EQUITY WILL HE DEMAND?C. WHAT FRACTION OF THE OWNERSHIP IN CREED WOULD THE VENTURE CAPITALIST REQUIRE IF CREED IS ABLE TO GROW ITS EBITDA BY 30% PER YEAR (ALL ELSE REMAINING THE SAME) AND THE VENTURE CAPITALIST STILL REQUIRES A 25% RATE OF RETURN OVER THE NEXT FIVE YEARS?
