Question

Chapter Eight Assignment

LOOKING FOR CAPITAL

When Joyce and Phil Abrams opened their bookstore one year ago, they estimated it would take them six months to break even. Because they had gone into the venture with enough capital to keep them afloat for nine months, they were sure they would need no outside financing. However, sales have been slower than anticipated, and most of their funds now have been used to purchase inventory or meet monthly expenses. On the other hand, the store is doing better each month, and the Abramses are convinced they will be able to turn a profit within six months.

At present, Joyce and Phil want to secure additional financing. Specifically, they would like to raise $100,000 to expand their product line. The store currently focuses most heavily on how-to-do-it books and is developing a loyal customer following. However, this market is not large enough to carry the business. The Abramses feel that, if they expand into an additional market such as cookbooks, they can develop two market segments that—when combined— would prove profitable. Joyce is convinced that cookbooks are an important niche, and she has saved a number of clippings from national newspapers and magazines reporting that people who buy cookbooks tend to spend more money per month on these purchases than does the average book buyer. Additionally, customer loyalty among this group tends to be very high.

The Abramses own their entire inventory, which has a retail market value of $280,000. The merchandise cost them $140,000. They also have at a local bank a line of credit of $10,000, of which they have used $4,000. Most of their monthly expenses are covered out of the initial capital with which they started the business ($180,000 in all). However, they will be out of money in three months if they are not able to get additional funding.

The owners have considered investigating a number of sources. The two primary ones are a loan from their bank and a private stock offering to investors. They know nothing about how to raise money, and these are only general ideas they have been discussing with each other. However, they do have a meeting scheduled with their accountant, a friend, who they hope can advise them on how to raise more capital. For the moment, the Abramses are focusing on writing a business plan that spells out their short business history and objectives and explains how much money they would like to raise and where it would be invested. They hope to have the plan completed before the end of the week and take it with them to the accountant. The biggest problem they are having in writing the plan is that they are unsure of how to direct their presentation. Should they aim it at a banker or a venture capitalist? After their meeting with the accountant, they plan to refine the plan and direct it toward the appropriate source.

QUESTIONS

1.      Would a commercial banker be willing to lend money to the Abramses? How much? On what do you base your answer?

2.      Would this venture have any appeal for a venture capitalist? Why or why not?

3.      If you were advising the Abramses, how would you recommend they seek additional capital? Be complete in your answer.

Answer 1

1. The commercial banker would not be willing to lend them money. This is considering the fact that banks have strict credit analysts and regulatory compliance which would not allow them to do the lending even if they wanted to. They require borrowers who are showing positive cash flows and have the capability to pay the EMI on an ongoing basis. Thus the Abramses are already cash strapped and they would be more burdened by the regulations of the bank even if we consider the mortorium period offered by the bank because what if the business does not take off before the moratorium period. The bank would then have claim on the assets i.e. the books etc.

2. Yes, a venture capitalist can look at entering the business now with certain amount of capital and keep in mind a time frame say 3 years to exit the business. 3 years is a good amount of time and it is believed that the abramses would be in a comfortable position then to allow the venture capitalise to exit with some profit. ALso the time horizon would give the abramses some peace w.r.t. operations of the business and some experimentation also.

3. Any amount less than $100,000 would be less as that is what the Abramses have calculated. They know the business better than the advisor. It is our job to provide them ways to raise that. Thus additional funding and relatively lower giveaway in terms of the equity would be beneficial for them as they woudl retain control and be able to work with a free mind rather than bothering about the lost share. Thus any amount over and above $100,000 is advisable as long as it gives them enough freedom to raise capital and work positively.