Prepare projected financial statements (income statement, statement of retained earnings, balance sheet) based on the case facts for Q3 and Q4 of 2017. In doing so, use the working capital loan as a plug figure on the projected balance sheet.

For Case Study: DEWGOOD URBAN FARMS: DEBT FINANCING FOR AN ENTREPRENEURIAL VENTURE

In July 2017, Alison Kastenholz, agricultural banking associate at Northern Lights Credit Union (NLCU), was reviewing a loan request from two recent university graduates, Cameron More and Joe Millman, who had recently founded an urban agriculture company, Dewgood Urban Farms Inc. (Dewgood). In the first six months, the two friends had tested operations and laid the foundation for the future growth of the business, but to achieve their planned growth targets, they required significant additional financing.

Kastenholz had been promoted to the associate role only two months earlier. Therefore, it was critical for her to make an appropriate recommendation to her new manager about Dewgood's application for a $500,000 five-year loan.1 Since Dewgood's operations deviated from those of the traditional farming businesses NLCU usually dealt with, this loan application was somewhat atypical for Kastenholz. She needed to perform more research than usual to ensure that Dewgood's creditworthiness met NLCU'srequirements. To be approved for a loan from NLCU, all applicants needed to demonstrate viable operations, capacity for loan repayment, and strong character.

DEWGOOD OPERATIONS

Operating in Ontario, Dewgood was a producer and distributor of hydroponically grown vegetables, leafy greens, and herbs, such as lettuce, spinach, kale, basil, rosemary, chard, radishes, oregano, and thyme. The company launched pilot operations at the beginning of 2017. Dewgood's plan was to own and operate modular shipping-container greenhouses, located on university campuses, in which the produce would be grown and then distributed to university eateries at wholesale prices. Additionally, the company planned to manage a membership-based weekly food club so university students would have greater access to fresh produce.

HYDROPONICS

Hydroponics was a form of hydroculture that entailed growing plants without soil. Instead, plants were grown in water around supportive growing mediums such as rockwool, clay pellets, foam, or gravel. The plants were fed a nutrient solution to fuel growth. Hydroponic growing systems were not new. In fact, hydroponic ocean plant growth during the earth's formation predated soil growing, and experts believed the first agricultural usage of hydroponics dated back to the ancient city of Babylon and its hanging gardens.2 Today, hydroponics allowed producers like Dewgood to vertically stack growing arrangements, saving space, increasing yields, reducing costs, minimizing the effects of adverse weather, and improving crop quality. This system offered hydroponic producers a competitive advantage over traditional farmers.

THE FOUNDERS

More and Millman had both graduated in 2016 from the prestigious honours business administration (HBA) program at Western University's Ivey Business School (Ivey). During their studies at Ivey, the partners had become friends and developed their passion for entrepreneurship. They decided to combine this and their mutual passion for sustainable agriculture and food systems to start Dewgood.

The partners had complementary backgrounds and experiences that would serve them well in starting and running Dewgood. Millman had a background in the finance and food industries from his previous work in the private equity and consumer packaged goods sectors. Prior to graduating from Ivey, More had completed an honours bachelor of science degree in biochemistry from McMaster University. He had developed a passion for the adoption of sustainable farming practices while growing up in rural Ontario.

UNIVERSITY EATERIES AND STUDENTS

Dewgood's operating model was based on two distinct customer groups and revenue streams. Although university eateries and hospitality departments were typically focused on keeping costs low, many were also increasingly required to adhere to sustainability mandates within university procurement guidelines. Therefore, More and Millman positioned Dewgood as the first-mover hydroponic crop producer in the institutional hospitality sector, growing non-genetically modified, pesticide- and herbicide-free crops directly on its clients' campuses.

Through the planned membership-based weekly food club, Dewgood targeted students of partner universities as the company's secondary market. More and Millman felt that this customer group would align well with the sustainable operating model employed by Dewgood. The founders believed that expanding to other universities and colleges in other parts of Canada and into the United States could offer other avenues for growth.

CANADIAN VEGETABLE FARMING INDUSTRY

The Canadian vegetable farming industry had experienced steady growth between 2011 and 2016, mainly because vegetables were a staple in the average Canadian's diet. Demand for the industry's products had been supported by a growing awareness of the health benefits associated with vegetable consumption and greater per capita disposable income. Demand from food service industries had also boosted the industry's growth. Consequently, total industry revenue had increased at an annualized rate of 2.8 per cent over the past five years and had seen a 2.5 per cent increase in 2016. Average industry after-tax profits were healthy at 18.6 per cent of revenue in 2016.^3

More and Millman noted a few key trends that affected the industry in which Dewgood operated. One of these trends was the link between general economic conditions and Canadians' consumption of vegetables. Since field-grown vegetables were typically of lower quality than those grown in consistent, regulated greenhouses, field-grown vegetables were commonly purchased at lower prices and used as inputs for juices and canned or frozen products. After the 2008 recession, cash-strapped Canadians substituted fresh vegetables with their frozen and canned counterparts, eating into the demand for greenhouse-grown crops.

As the majority of Canadians became more aware of the benefits of a healthy lifestyle, they placed a greater emphasis on the consumption of fresh fruits and vegetables. In response, downstream retail giants like Walmart Inc. invested in expanding their selection of fresh produce, including organic varieties. This move drove demand for the cultivation of higher-quality vegetables, which carried premium prices. However, many Canadians had hectic schedules, which limited the time available to prepare fresh meals, so many continued to consume fewer vegetable and fruit servings than was recommended by Canada's Food Guide.

COMPETITION

Dewgood's operating model meant that it functioned as a producer, wholesaler, and retailer of fresh produce. The company faced varied competition in each of these areas (see Exhibit 1). For instance, as a producer, Dewgood faced competition from other start-up shipping-container greenhouse operators such as Smart Greens, which operated out of Cornwall, Ontario. Another company, Local Roots, operated shipping- container greenhouses in California, distributing their produce to independent eateries. Local Roots had begun onsite operations on some company campuses, including those of the National Aeronautics and Space Administration (NASA) and SpaceX. Local farmers, large greenhouse operators, and businesses such as Amazon Fresh were other competitors that More and Millman investigated when deciding how to best position Dewgood for success.

FINANCIAL AND OPERATIONAL BACKGROUND

Dewgood was founded in January 2017, when the two co-founders purchased office equipment and started their business. Upon being granted the necessary approvals and contracts, Dewgood began pilot operations at a local Ontario university at the beginning of March 2017. At this time, the business purchased its first shipping-container greenhouse to house its vertically stacked, hydroponic growing operations. Upfront capital investments were financed by the two co-founders themselves with a $90,000 equity infusion into the company at its inception. While the first month of operations in the first quarter of 2017 was unprofitable, the company had already surpassed its break-even point by its second quarter, with a 7.2 per cent profit margin (see Exhibits 2-6).

As they operated the shipping-container greenhouse for the full three-month period in the second quarter of 2017, and sales grew, More and Millman also made a variety of operational adjustments. For instance, they increased marketing expenditures while also managing increased utility costs. In addition, while the two had run operations in the container themselves during the first quarter, they realized the time demands of running their own business made this practice unsustainable in the longer term. Consequently, they hired their first part-time employee to assist with greenhouse operations. The new employee worked 20 hours per week at a rate of $16 per hour for the three months of the second quarter.

If Kastenholz decided to approve More and Millman's loan request, it would be the first long-term loan for the recently founded business. However, NLCU had already granted Dewgood a working capital loan during the first quarter of 2017. The limit associated with this loan was $10,000 and was not expected to change in the coming periods.

PROPOSED EXPANSION PLANS

After experiencing success with their pilot operations, More and Millman wanted to capitalize on the growing demand and begin full operations by expanding Dewgood's presence to other universities in Ontario. In fact, the two founders had strong relationships and letters of intent (LOIs)4 in place with six additional university hospitality departments.

The $500,000 five-year loan5 More and Millman were requesting would allow Dewgood to purchase four new greenhouse containers, which could be installed at the four universities the company deemed most suitable based on geography, the company's relationship with the hospitality department, and student demographics, among other factors. Each container would cost $125,0006 and would have a useful life of 10 years. Arrangements to purchase the new greenhouses were already in place, and the greenhouses would be acquired right away if NLCU's financing were granted. This would allow expanded operations to begin immediately.

Kastenholz wanted to project the short-term growth of the company over the upcoming two quarters. More and Millman estimated that, as a result of the proposed expansion, total sales in the third quarter of 2017 would quadruple over sales in the second quarter. They also expected an additional 10 per cent revenue growth in the fourth quarter. The founders predicted the institutional versus food-club sales breakdown would be the same in the coming quarters as in the second quarter.

Although the expansion would increase Dewgood's purchasing power, the partners nevertheless projected that the cost of goods sold would remain at the same percentage of sales as in the second quarter. With the business adding a variety of new client partners in the coming two quarters, More and Millman believed that the age of accounts receivable would return to first-quarter levels. They also felt that the age of inventory would remain the same as in the second quarter. With the various financial pressures of expansion, the partners also believed that it would take Dewgood four more days to pay their suppliers in the third and fourth quarters of 2017, when compared to the second quarter.

The proposed expansion to four additional Ontario university campuses would also increase some of Dewgood's expenses. After discussing the expansion plans with their broker, the partners learned that their insurance costs were projected to increase by $2,000 for the third quarter, with no change thereafter.7 Expansion would also cause legal fees to increase to the first-quarter amount in the third quarter, but these would fall back to the second- quarter figure again in the fourth quarter. More and Millman also believed that hiring another part-time worker for each new greenhouse would help ensure smooth operations at each new location.8 All other expenses were expected to remain either at the same dollar level or at the same proportion of sales.

DECISION

Kastenholz continued to think about Dewgood's loan request as she sat in traffic on her commute home from work. Although she did not personally know More and Millman, their entrepreneurial drive and their passion for their business were evident. She was unsure whether other financial institutions had reviewed Dewgood's debt financing request. Nevertheless, she had to justify and support her decision on the loan application to her new manager at a meeting scheduled for first thing the next morning. She was eager to use this opportunity to prove herself in her new associate role.

EXHIBIT 1: COMPETITOR VALUE CHAIN SUMMARY Competitor Producer Wholesaler Retailer Dewgood Urban Farms Smart Greens Local Roots Local Organic Farmers Large Greenhouse Operators Amazon Fresh Source: Company files. EXHIBIT 2: STATEMENTS OF EARNINGS AND FINANCIAL RATIOS (UNAUDITED) (IN CA$) For the quarters ending June 30 and March 31, 2017 Q2 Q1 Revenue Institutional Sales* $ 16,309 52.4% $ 5,126 51.2% Student Food-Club Sales 14,835 47.6% 4,876 48.8% Total Revenue 31,144 100.0% $ 10,002 100.0% Cost of Goods Sold $ 7,612 24.4% $ 2,650 26.5% Gross Profit $ 23,532 75.6% $ 7,352 73.5% Operating Expenses Administrative Expenses $ 6,957 22.3% $ 4,349 43.5% Depreciation 2,400 7.7% 1,067 10.7% Insurance 500 1.6% 500 5.0% Legal fees 848 2.7% 1,695 16.9% Marketing 2,618 8.4% 579 5.8% Miscellaneous 1,084 3.5% 276 2.8% Utilities 2,643 8.5% 513 5.1% Wages 4.128 13.3% 0 0.0% Total Operating Expenses 21,178 68.0% 8,979 89.8% Net Income Before Tax $ 2,354 7.6% $ (1,627) (16.3%) Income Tax $ 118 0.4% $ 0 0.0% Net Income $ 2,236 7.2% $ (1,627) (16.3%)EXHIBIT 3: STATEMENTS OF RETAINED EARNINGS (UNAUDITED) (IN CA$) For the quarters ending June 30 and March 31, 201? Beginning Retained Earnings Add: Net Income Less: Dividends Ending Retained Earnings Source: Company les. oz $ (1327) 3230 0 $ 609 Q1 $ 0 (1,627) 0 $ (1.527) EXHIBIT 4: BALANCE SHEETS (UNAUDITED) (IN CA5) At the quarters ended June 30 and March 31, 201? ASSETS Current Assets Cash Marketable Securities Accounts Receivable Inventory Prepaid Expenses Total Current Assets Fixed Assets Greenhouse Container, Cost Less: Accumulated Depreciation Greenhouse Container, Net Ofce Equipment, Cost Less: Accumulated Depreciation Office Equipment, Net Total Fixed Assets Total Assets LIABILITIES Current Liabilities Working |Capital Loan Accounts Payable Total Current Liabilities Long-Term Debt Total Liabilities SHAREHOLDER'S EQUITY Common Stock Retained Earnings Total Shareholder's Equity Total Liabilities & Equity 02 $ 1453 3044 3962 1241 1000 $ 10410 $ 80,000 2,667 77,333 8,000 800 7,200 $ 84,533 $ 2329 1705 4334 l 69-69-69-049 4,334 $ 90,000 609 $ 90,609 01 $ 2n23 0 L6?5 233 1500 s 3531 $ 80,000 667 79,333 8,000 400 7,600 $ 86,933 =====g 3,633 458 4,091 4,091 '69 90,000 [1,6271 $ 88,3?3 EXHIBIT 5: SELECTED FINANCIAL RATIOS Q2 Q1 Profitability Return on Equity 2.5% N/A Liquidity Current Ratio 2.40 : 1 1.35 : 1 Acid Test 1.88 : 1 0.93 : 1 Efficiency* Age of Receivables 12 days 15 days Age of Inventory 15 days 8 days Age of Payables 20 days 16 days Stability Net Worth to Total Assets 95.4% 95.6% Interest Coverage N/A N/A Growth Sales 211.4% Net Income N/A Equity 2.5% Total Assets 2.7%