BUS 170

Financial Planning Case Study

Covid Treatments

Three co-founders formed Covid Treatments (COVID T) a company that has created a low cost portable intensive care treatment facility which can be used in both a strip mall parking lot as well as a hospital. To make their business a reality they need to raise enough capital through debt and equity to support the company from inception until cash break-even. Since manufacturing a Covid treatment facility is considered an essential business, the company will be allowed have its employees in a combined office and factory. As a part of the process of raising the capital, they originally hired a temp CFO to help them to create a financial plan to include in their fund-raising pitch deck and to help them work out a pro forma capitalization table to assess any potential inbound investor term sheet. But that temp CFO was stuck on a cruise ship off the coast of Florida and left behind a financial plan that was incomplete. The founders, being Spartan alums, decided to hire BUS 170 students to finish the work. They have provided following information:

Income Statement:

General Assumptions:

Employee benefits and taxes are 25% of salaries

Sundry costs per headcount are $200/month (food, coffee, office supplies, personal protection equipment etc.)

Recruiting cost will be a flat $15,000 for each new hire.

Revenues

The company anticipates building two products, a hospital version (H1) that will sell for $250,000 and a strip mall unit (SM1) for $12,500. The ratio of H1 to SM1 unit sales will be 1 to 20. When they are available for sale, the month after R&D creates a commercially viable product, the initial number of H1 units sold will be two for the first month and then the company will increase the number of units per month by one unit per month thereafter (e.g. month 2 will be 3, month 3 will be 4).

Cost of Goods

The company will use a contract manufacturer for both the H1 and SM1 products. Gross margins will be 65% and 55% for H1 and SM1 respectively.

Sales and Marketing

Each salesperson will be able to sell $9 million worth of product each year. A salesperson needs to be on staff three months before they start selling for training purposes. Base salary is $100,000 per year with an 8% commission. Commissions are earned and paid in the same month.

Marketing program expense will run $200,000 per month for 3 months prior to initial sales, then will drop to $40,000 per month thereafter.

Research and Development

COVID T has determined that they will ultimately need an R&D team of 10 scientists and engineers who will collectively need 70 person months of work before producing a commercially viable product. Given the constraints of a very tight job market, COVID T expects that they cannot hire more than 2 new R&D staff members per month. Once they reach 10 staff, they will stop hiring. The average cost of these highly skilled individuals is $150,000 per year for salary plus a 0.25% (.0025) share of post money share of ownership in the form of stock options. At this time no other options are granted to other employees.

In R&D they also estimate spending $20,000 per month in noncapitalizable prototypes.

General and Administration

Office rent will be $3.50 per square foot per month. Typical businesses of similar type require 250 sq. ft. per headcount. Since the rental market is so tight, they need to rent the maximum space up front. Additionally, the landlord will require a large deposit of three months rent. Utilities are built into the rent.

Basic business insurance is $500 per month until they begin to sell product. Then the add-on of product liability insurance will triple the monthly cost.

Legal costs are in two parts, $1,000 per month in general corporate legal matters (IP, contacts, board assistance etc.) and issuance costs. Counsel estimates issuance costs to be $80,000 for the Series A round and will be an offset against the proceeds in the equity section of the balance sheet.

From inception, the company will need to hire a half-time office manager/bookkeeper for $90,000 per year annualized (or $3,750/month). The office manager/bookkeeper is a friend of one of the founders so there is no recruiting cost.

Video conferencing for the three founders and each salesperson is estimated to be $1,000 each per month.

There will a once per year cost of $5,000 by the outside CPAs to produce the companys tax return due and payable in April.

The cofounders each will take a $180,000 per year salary. They will have titles of CEO, CTO and CFO respectively.

Taxes will be at 21% of net income

No interest will be earned on excess cash

Balance Sheet

Accounts Receivable: will average 60 days.

Inventory: The company will need to have 3 months of inventory on hand and its contract manufacturer does not need any advance notice for orders

Fixed Assets: Each new headcount will require $5,000 in additional capitalizable furniture and computing equipment. Assume depreciation is straight-line over 3 years with no salvage value.

Accounts Payable will be equal to one months operating expenses exclusive of salaries and benefits plus the current month of cost of goods.

Equity and Debt: The company will be founded on 1/1/xx at the same time of its closing a Series A round. Simultaneously with the Series A, a venture debt round is placed for 1/3 of the total capital (As an example if the company needed $6m in total capital, the financial mix would be $2m debt with $4m equity). Venture debt will have an annual interest rate of 7.25% with interest only for 6 months, then amortized over 30 months. There will be no issuance cost for the debt.

At the time of inception, each founder will contribute $1,000 for 1,000,000 shares of no par common stock.

The founders have received a term sheet for a $10 million Series A investment at a pre-money valuation of $15 million provided the founders set aside 15% of the companys ownership as an option pool for current and future employees.

1. Using the template left behind by the temp CFO, finish the 12-month plan. (10pts)

2) Also, pro forma the post money capital schedule based on the Series A terms offered. (5 pts)

Q1) In rounded millions, how much combined debt and equity needs to be raised to not run out of cash in the first year? (4 pts)

Q2) What is post money combined ownership of the three founders after the Series A? (2 pts)

Q3) If there no other changes in the capital structure and the Series A investors have a required return of 50% in 5 years, what will the value of the company be in year 5? (2 pts)

Q4) Using sensitivity analysis, which of the following variables will have the greatest impact on cash? Show proof of your position (2 pts)

1. Price per unit of H1/SM1
2. DSO
3. Engineering salaries
4. Debt/equity ratio