m-s U0 I-.f.v.LUrftTHi'JN Snuthwest Ventures is cnnsidering an investment in an Austin. Texasbased startup firm called Creed and Cnmpany. Creed and Cnmpany is in- vnlved in nrganic gardening and has develnped a cnmplete line nf nrganic prnducts fnr sale tn the public that ranges frnm nn-mpnsted snils tn nrganic pesticides.The enm- pany has been arnund fnr almnst twenty years and has develnped a very gn-nd repu- tatinn in the Austin business cnmmunity, as well as with the many nrganic gardeners whn live in the area. Last year. Creed generated earnings befnre interest. tastes. and depreciatinn [EEITDAJ nf $4- millinn. The cnmpany needs In raise 35.8 millinn tn finance the acquisitinn nf a similar cnmpany called Organic and vanre that nperates in bnth the Hnustnn and Dallas markets. The acquisitinn wnuld make it pnssible fnr Creed tn market its private-label prnducts In a much brnader custnmer base in the major metrnpn-litan areas nf Texas. Mnrenver. Organic and Mnre earned EEITDA nf $1 millinn in 2015. The nwners nf Creed view the acquisitin-n and its funding as a critical element nf their business strategy. but they are cnrncemed abnut hnw much cf the cnmpany they will have tn give up In a venture capitalist in nrder tn raise the needed lnds. Creed hired an experienced nancial cnnsultant, whnm they trust, tn evaluate the prnspects nf raising the needed funds. The cnnsultant estimated that the nnmpany wnuld be valued at a multiple nf ve times EEITDA in ve years and that Creed wnuld grew the cum- bined EElTDAs cf the twn cnmparlies at a rate 111.20% per year nver the next five years if the acquisitinn nf Organic and Prime is cnmpleted. Neither Creed nnr its acquisitinn target. Organic and Mnre. uses debt nancing at present. Hnwever. the VC has nffered tn prnvide the acquisitinn nancing in the fnrm nf cnnvertible debt that pays interest at a rate nf 8% per year and is due and payable in ve years. a. What enterprise value dn ynu estimate fnr Creed [including the planned acquisi- tinn]I in ve years? It. If the VC nffers tn finance the needed funds using cnnvertible debt that pays 8% per year and cnnverts tn a share nf the cnmpany sufcient tn prnvide a 25% rate nf return an his investment nver the next five years. hnw much cf the fitrn's equity will he demand? c. What fractinn nf the nwnership in Creed wnuld the venture capitalist require if Creed is able tn grnw its EElTDA by SETH: per year [all else remaining the same} and the VC still requires a 25% rate of return ever the next ve years'? 1e-s LED 'IIMJJATION Randy Dillingwater is the chief investment ofcer for lIt'l'learstone Capital. Clearstone is a private equity rm located in Orlando. Florida. that specializes in what Randy describes as make-over or fixer-upper insestments.The rm tries to nd privately held rms whose owners tried to grow their business too fast and ran into liquidity problems. Clearstone has been in this business for eleven years and has had reasonable success. lClearstone is now completing the investment of iLs second fund and considering the acquisition of a local manufacturing and distribution company. Flanders Inc. Flanders was founded by Mark Flanders eighteen years ago and grew rapidly. Recently. how- ever, the firm made a large acquisition ofa competitor rni,and the problems the rm encountered when assinlilating the acquisition led to nancial difficulties for Flanders. The owner has recently voiced his interest in a buyout proposal to his local banker, who notified Randy [his nest-door neighbor} of the opportunity. Randy contacted Mark. and the two decided to open a dialogue about the possible acquisition of Mark's rm. After several meetings. Marl: decided to solicit an offer from Clearstone. In response to Randy's request. Marl: supplied him with the following set of proforma inconie statements spanning El to Ell-2ft: Pm Farms Income Statements Illl 21M? 21MB It'll? EBITDA $- lJ.fJIle.flllf.|_f.|f.| 5- Jllflllf 3 llllflf $ I4.fr4].flll.flfl Less: delweciation {symptom} mammoth: mammalian [5. mam-um: EBIT $- T.lfl.flllf.|_f.|f'.| E Tllllf 3 Hlfltl $ 9.54Jfll1flfl Less: interest mammoth: [Heisman [smazsssm (stamens; Earltiugsl'vefore Lasts E smnmm 5 1.564.4ffj $ E.59.?ll.m 3 lj Less: taxes remnant]: {469.320.1113 mamas: [1. esteem; Netinmme 5 smtmm $ l.fl'93.[t.m 3 LWSJ'QIS-t $ 2.93.33.n3 men 5 15. [Eli] mm [SSH'LDII'K'LM] 5 mam mm [sisalnssm s 5.445.99l [trassssssi E 3.3I2.19?2T ln additien, Rand}.r asked Mark tn estimate capital expenditures fer each ef the next ve years. Mark indicated that he thought the rm weuld have ten spend abeul $4 millien a year and that the new capital weuld have a ten-year depreciable life. [Depreciatien expense fer 215 1eras 53.5 millien se the additien ef 54 millien in capital expenditures will add SAMJ'H} in added depreciatien expense fer 2016.} Mark indicated te Randy that his research suggested that a ve-tinies-EBITDA multiple 1.imuld be apprepr'tate. Randy. heweuer. was net sure that Clearstene ceuld afferd te- pay this much fer the firm. He decided te de a quick analysis using the LED rnethnd ef x'aluatien based en the fellen-'ing assumptiens: I The firm can he purchased fer ve times the rm's 2E} ] 5 EBITDA efSlt'lrnillien and reseld in ve years fer the same multiple ef the rm's year 5 EBITDA. I Clearstene will finance 911% cf the purchase price using debt that carries a 14% rate ef interesLThe debt will require a cash sweep se that all available cash flew will ge teward the repayment ef the nete. l A. tax rale at 30% is assumed in all ealculalinns l lIt'lapital expendilures [CAPEX} are esttnlaled tn be 5.4 millinn per year, and n0 net new investments in wnrking capital are anticipated. l Flanders dries nn-t carry any excess sash and has ne nannperating assets a. What is the prnjected enterprise value at Flanders in ve years? What is the estimated value at Clearwaler's equity in the rm at the end at ve years if ey- erylhing wn-rks nut as planned? b. What rate at return sl'muld Clearslnne expect an its equity in [he acquisitinn under the prnjectiens made abnye'l' 1: After further review. Randy eslirnated that the rm's nperating expenses could he shaved by roughly 5'] million per year. Haw wnuld this affect yeur answers tn Prnblern Nil-9(a) and {h}