Question:

Evaluate these finance options for Two Seasons. What should Stuart Roberts do? Explain your reasoning.

Option Two: Fund growth through bank debt The finances for the growth to-date of Two Seasons were built on prudent cash flow management and a strong relationship with their bank. The bank had always supported Two Seasons when it had asked for further growth funding. For example, as the business expanded, the level of bank loan funding had kept up: it was 177,697 in 2003 and 985,839 (overdraft, 281,989; current portion of debt, 350,000; borrowings due after more than 12 months, 353,850) in 2007. Stuart saw real benefits in bank debt finance. "Having control over your own destiny and ownership kept the team very focused and fosters an independent attitude that takes responsibility for its actions". Using bank debt and retained earnings, Two Seasons had organically grown step-by-step, which meant that they were able to control and plan out their resources. This discipline had stood Two Seasons in good stead: "When you have your own money on the line it concentrates the effort and really focus's your cost commitments. We had seen other companies expand recklessly through mis-reading the market. This had led to their demise so we were nervous of outside intervention". However, Stuart saw risks in what had been a winning strategy. He knew that his business was inevitably seasonal. Consequently, cashflow fluctuated, making it potentially difficult to service bank loans. Although Stuart had always paid back his loans on time, he also knew that banks could and did make hard decisions about whether to loan further or even to call in loans when they were nervous about the financial performance of a business. Illustrative of this was Stuart's earlier experience: "In the months prior to the Billabong offer, there was an opportunity to acquire a competitor. It had two stores. One of these was hemorrhaging money but the other one was very profitable. I knew it was the right opportunity. I went to the bank and they were keen to lend to me but they wanted my house as security. I talked to my wife. I explained that it could be a step too far but she saw the logic of the opportunity. My family were also supportive but in the end, it was my house on the line. I wasn't nineteen anymore with only having to worry about funding my next ski trip. I had my wife and kids to think about". Stuart had recently been to his bank to discuss if they were willing to fund the future growth of the business. He had already scoped a strategy where he would grow turnover to 10.4 million in the coming year with an operating profit of between 250-300,000. While he could continue to pick up off-centre stores that had gone into liquidation and fit them out for as little as 30,000, a more aggressive approach was to go into mainstream malls where the footfall was much higher. He had recently opened in a new store in a prime location in Derby (see Exhibit One). In the first three weeks of opening, footfall was 7,000 per week, compared to between 2,000-3,000 people coming through the doors of his other stores. The price, though, was that the mall landlords did not put in furnishings and shop fittings. To fit out the outlet had cost Two Seasons 260,000. If he were to add four more shops over the next four years, this would cost 1 million. Stuart had ambitious plans for the business. He had a good relationship with his bank and he could ask them for further funding. However, would it meet his business needs and how much more funding wouid the bank support? Option Three: Fund growth through equity finance Stuart knew that equity finance could sustain the rapid growth of Two Seasons. The urban lifestyle retailer, Fat Face, grew via successive rounds of venture capital finance. Although Fat Face's owners had seen their equity stake being diluted over time, they had still been able to walk away with 90 million when it was sold to a private equity firm. Private equity could provide finance for Two Seasons to invest in its business systems, fund further acquisitions and/or open up further new sites. Larger sales volumes meant it could go back to suppliers and negotiate even harder on price. The real potential of equity funding, though, was that it could lead Two Seasons to develop its own brand. Stuart had seen a competitor, JD Sports, successfully develop their own brand. He had seen how this vertical integration of the supply-chain had improved profit margins. Having a brand also meant that the business would be more appealing to investors in any further equity finance rounds. antur of hucinarrar out there who have Stuart, though, could see dangers: "There are plenty of businesses out there who have tried to develop their own brand and failed. We would have to invest a lot and our core expertise was in retailing. Sure, we could develop this expertise but it was time consuming, expensive and uncertain". There were also issues about the appropriateness and availability of equity finance. For the next stage of the business growth, Stuart was interested in finding investors willing to put between 1-5 million into the business. A 1 million equity injection would deliver around four new prime location sites while 5 million would allow the development of 10 new stores. He knew that he could get 5 million from venture capitalists but they often did not invest only 1 million in a business. Similarly, although business angels did invest smaller amounts into promising businesses, they often were wary - either as an individual or as a syndicate of investing up to 1 million if only because this was beyond their usual investment levels. Equity finance could also potentially change the nature of Two Seasons. It was a family business that had invested significantly in management and staff: "I have always believed that our staff-from those who work in the store through to buyers and support staff and senior management team - need to see a future for themselves. Developing the people side is often key in developing a business". The challenge with outside investors is that they may be capricious: "The issue with business angels is it is all on the individual. They could be fantastic or they could turn out to be like a football chairman who decides that he is not happy with the team's performance and decides to take his ball home". Venture capitalists might not be much better. If things got sticky, they were likely to replace the management team. Finding the correct match for Stuart was critical. They needed to be someone who "could understand the business and give us the freedom to continue to drive our own vision." Luckily, Stuart had recently been approached by both business angels and venture capitalists. One of his friends had access to a group of ultra-high net worth investors, many of whom had interests in retail, and could also be a potential source of equity investment and guidance. His presentation to these potential investors had been favourably received and he believed that there was an appetite to invest in Two Seasons. The problem, though, was finding the right balance between the level of investment and the equity stake that Stuart, his staff and his family would have to give up. One key upside was that equity finance could allow him to really drive the business forward. One downside, though, was the loss of business control. Although neither Stuart nor any equity financiers had discussed it yet, he wondered how he, his staff and family would react if they wanted more than 50 per cent of Two Seasons. Person Stuart Roberts David and Janet Roberts (parents) Helen Roberts (sister) Alun Roberts (brother) Adrian Flowers 11 store managers Ownership per cent 35 18 15 15 6 11 Exhibit Five: Profit and Loss Account for Two Seasons, 2003-2007 Revenues Cost of Sales Gross Profit Admin Expenses (excl depreciation) Depreciation Other operating Income Operating profit Bad debt write off Interest received Interest paid Profit Before Tax Tax Profit After Tax Dividends Retained Profits 31/07/2003 31/07/2004 31/07/2005 31/07/2006 31/07/2007 E 3,465,202 3,983,974 4,516,885 4,618,690 6,023,461 2,059,853 2,296,623 2,627,220 2,659,841 3,430,777 1,406,349 1,687,351 1,889,665 1,958,849 2,592,684 1,161,018 1,516,844 1,683,361 1,786,859 2,427,394 91,255 88,499 89,645 89,158 96,522 12,000 15,000 4,888 60,237 20,130 166,076 97,008 121,547 143,069 88,898 -29,292 -1,904 3,346 1,108 4,761 1,937 957 4,828 4,160 9,985 13,824 32,002 164,594 64,664 114,419 131,182 57,853 32,838 35,739 34,008 34,196 29,826 131,756 28,925 80,411 96,986 28,027 51,069 39,780 44,250 58,250 97,000 80,687 -10,855 36,161 38,736 -68,973 Profit c/f 521,250 510,395 546,556 585,292 516,319 31/07/2003 31/07/2001 31/07/2005 31/07/2006 31/07/2007 E E 589,990 597,633 594,387 643,481 1,029,006 Fixed Assets Current Assets Inventories Receivables (debtors) Prepayments Cash at hand 581,506 25,603 25,567 9,753 642429 764,195 25,158 28,259 895,083 14,783 917450 10,352 47,517 1,341,263 4 95,080 39,179 817,612 949,045 975,319 1,436,347 Creditors Overdraft Payables (creditors) Current portion of debt 523,472 12,000 535,472 106,957 696,947 165,697 531,250 96,871 597,744 50,000 744,615 72,997 670,630 150,235 520,395 171,682 530,474 100,000 802,156 146,889 741,276 184,720 556,556 195,552 472,545 150,000 818,097 157,222 800,703 205,411 595,292 281,989 902,354 350,000 1,534,343 -97,996 931,010 353,850 577,160 Net current assets Total assets less current liabilities Borrowings falling due after more than 12 months Net assets Capital and Reserves Share capital (E1) Revaluation Reserve Profit and loss reserve Shareholder's Funds 10,000 10,000 10,000 10,000 10,000 50,841 516,319 577,160 521,250 531,250 510,395 520,395 546,556 556,556 585,292 595,292 Cash from operations Cash from investing activities Cash from financing activities Cash flow for the year Cash at the start of the year Cash at the end of the year 2003 2004 2005 2006 2007 E 206,366 52,817 16,437 90,273 146,958 -60,877 -81,142 -81,511 -78,015 411,076 -143,389 -78,299 -9,737 -36,128 177,681 2,100 -106,624 -74,811 -23,870 -86,437 7,653 9,753 -96,871 -171,682 -195,552 9,753 -96,871 -171,682-195,552 -281,989 Exhibit Nine: Benchmark and market information Sports Direct as Benchmark firm Price/revenue EV/EBITDA Price earnings Price to book Beta Market information UK Government 5-year yields Estimated equity risk premium 0.5-0.8 7.5-9.7 8.0-15.2 2.7-3.8 1.92 3.98% 6% Option Two: Fund growth through bank debt The finances for the growth to-date of Two Seasons were built on prudent cash flow management and a strong relationship with their bank. The bank had always supported Two Seasons when it had asked for further growth funding. For example, as the business expanded, the level of bank loan funding had kept up: it was 177,697 in 2003 and 985,839 (overdraft, 281,989; current portion of debt, 350,000; borrowings due after more than 12 months, 353,850) in 2007. Stuart saw real benefits in bank debt finance. "Having control over your own destiny and ownership kept the team very focused and fosters an independent attitude that takes responsibility for its actions". Using bank debt and retained earnings, Two Seasons had organically grown step-by-step, which meant that they were able to control and plan out their resources. This discipline had stood Two Seasons in good stead: "When you have your own money on the line it concentrates the effort and really focus's your cost commitments. We had seen other companies expand recklessly through mis-reading the market. This had led to their demise so we were nervous of outside intervention". However, Stuart saw risks in what had been a winning strategy. He knew that his business was inevitably seasonal. Consequently, cashflow fluctuated, making it potentially difficult to service bank loans. Although Stuart had always paid back his loans on time, he also knew that banks could and did make hard decisions about whether to loan further or even to call in loans when they were nervous about the financial performance of a business. Illustrative of this was Stuart's earlier experience: "In the months prior to the Billabong offer, there was an opportunity to acquire a competitor. It had two stores. One of these was hemorrhaging money but the other one was very profitable. I knew it was the right opportunity. I went to the bank and they were keen to lend to me but they wanted my house as security. I talked to my wife. I explained that it could be a step too far but she saw the logic of the opportunity. My family were also supportive but in the end, it was my house on the line. I wasn't nineteen anymore with only having to worry about funding my next ski trip. I had my wife and kids to think about". Stuart had recently been to his bank to discuss if they were willing to fund the future growth of the business. He had already scoped a strategy where he would grow turnover to 10.4 million in the coming year with an operating profit of between 250-300,000. While he could continue to pick up off-centre stores that had gone into liquidation and fit them out for as little as 30,000, a more aggressive approach was to go into mainstream malls where the footfall was much higher. He had recently opened in a new store in a prime location in Derby (see Exhibit One). In the first three weeks of opening, footfall was 7,000 per week, compared to between 2,000-3,000 people coming through the doors of his other stores. The price, though, was that the mall landlords did not put in furnishings and shop fittings. To fit out the outlet had cost Two Seasons 260,000. If he were to add four more shops over the next four years, this would cost 1 million. Stuart had ambitious plans for the business. He had a good relationship with his bank and he could ask them for further funding. However, would it meet his business needs and how much more funding wouid the bank support? Option Three: Fund growth through equity finance Stuart knew that equity finance could sustain the rapid growth of Two Seasons. The urban lifestyle retailer, Fat Face, grew via successive rounds of venture capital finance. Although Fat Face's owners had seen their equity stake being diluted over time, they had still been able to walk away with 90 million when it was sold to a private equity firm. Private equity could provide finance for Two Seasons to invest in its business systems, fund further acquisitions and/or open up further new sites. Larger sales volumes meant it could go back to suppliers and negotiate even harder on price. The real potential of equity funding, though, was that it could lead Two Seasons to develop its own brand. Stuart had seen a competitor, JD Sports, successfully develop their own brand. He had seen how this vertical integration of the supply-chain had improved profit margins. Having a brand also meant that the business would be more appealing to investors in any further equity finance rounds. antur of hucinarrar out there who have Stuart, though, could see dangers: "There are plenty of businesses out there who have tried to develop their own brand and failed. We would have to invest a lot and our core expertise was in retailing. Sure, we could develop this expertise but it was time consuming, expensive and uncertain". There were also issues about the appropriateness and availability of equity finance. For the next stage of the business growth, Stuart was interested in finding investors willing to put between 1-5 million into the business. A 1 million equity injection would deliver around four new prime location sites while 5 million would allow the development of 10 new stores. He knew that he could get 5 million from venture capitalists but they often did not invest only 1 million in a business. Similarly, although business angels did invest smaller amounts into promising businesses, they often were wary - either as an individual or as a syndicate of investing up to 1 million if only because this was beyond their usual investment levels. Equity finance could also potentially change the nature of Two Seasons. It was a family business that had invested significantly in management and staff: "I have always believed that our staff-from those who work in the store through to buyers and support staff and senior management team - need to see a future for themselves. Developing the people side is often key in developing a business". The challenge with outside investors is that they may be capricious: "The issue with business angels is it is all on the individual. They could be fantastic or they could turn out to be like a football chairman who decides that he is not happy with the team's performance and decides to take his ball home". Venture capitalists might not be much better. If things got sticky, they were likely to replace the management team. Finding the correct match for Stuart was critical. They needed to be someone who "could understand the business and give us the freedom to continue to drive our own vision." Luckily, Stuart had recently been approached by both business angels and venture capitalists. One of his friends had access to a group of ultra-high net worth investors, many of whom had interests in retail, and could also be a potential source of equity investment and guidance. His presentation to these potential investors had been favourably received and he believed that there was an appetite to invest in Two Seasons. The problem, though, was finding the right balance between the level of investment and the equity stake that Stuart, his staff and his family would have to give up. One key upside was that equity finance could allow him to really drive the business forward. One downside, though, was the loss of business control. Although neither Stuart nor any equity financiers had discussed it yet, he wondered how he, his staff and family would react if they wanted more than 50 per cent of Two Seasons. Person Stuart Roberts David and Janet Roberts (parents) Helen Roberts (sister) Alun Roberts (brother) Adrian Flowers 11 store managers Ownership per cent 35 18 15 15 6 11 Exhibit Five: Profit and Loss Account for Two Seasons, 2003-2007 Revenues Cost of Sales Gross Profit Admin Expenses (excl depreciation) Depreciation Other operating Income Operating profit Bad debt write off Interest received Interest paid Profit Before Tax Tax Profit After Tax Dividends Retained Profits 31/07/2003 31/07/2004 31/07/2005 31/07/2006 31/07/2007 E 3,465,202 3,983,974 4,516,885 4,618,690 6,023,461 2,059,853 2,296,623 2,627,220 2,659,841 3,430,777 1,406,349 1,687,351 1,889,665 1,958,849 2,592,684 1,161,018 1,516,844 1,683,361 1,786,859 2,427,394 91,255 88,499 89,645 89,158 96,522 12,000 15,000 4,888 60,237 20,130 166,076 97,008 121,547 143,069 88,898 -29,292 -1,904 3,346 1,108 4,761 1,937 957 4,828 4,160 9,985 13,824 32,002 164,594 64,664 114,419 131,182 57,853 32,838 35,739 34,008 34,196 29,826 131,756 28,925 80,411 96,986 28,027 51,069 39,780 44,250 58,250 97,000 80,687 -10,855 36,161 38,736 -68,973 Profit c/f 521,250 510,395 546,556 585,292 516,319 31/07/2003 31/07/2001 31/07/2005 31/07/2006 31/07/2007 E E 589,990 597,633 594,387 643,481 1,029,006 Fixed Assets Current Assets Inventories Receivables (debtors) Prepayments Cash at hand 581,506 25,603 25,567 9,753 642429 764,195 25,158 28,259 895,083 14,783 917450 10,352 47,517 1,341,263 4 95,080 39,179 817,612 949,045 975,319 1,436,347 Creditors Overdraft Payables (creditors) Current portion of debt 523,472 12,000 535,472 106,957 696,947 165,697 531,250 96,871 597,744 50,000 744,615 72,997 670,630 150,235 520,395 171,682 530,474 100,000 802,156 146,889 741,276 184,720 556,556 195,552 472,545 150,000 818,097 157,222 800,703 205,411 595,292 281,989 902,354 350,000 1,534,343 -97,996 931,010 353,850 577,160 Net current assets Total assets less current liabilities Borrowings falling due after more than 12 months Net assets Capital and Reserves Share capital (E1) Revaluation Reserve Profit and loss reserve Shareholder's Funds 10,000 10,000 10,000 10,000 10,000 50,841 516,319 577,160 521,250 531,250 510,395 520,395 546,556 556,556 585,292 595,292 Cash from operations Cash from investing activities Cash from financing activities Cash flow for the year Cash at the start of the year Cash at the end of the year 2003 2004 2005 2006 2007 E 206,366 52,817 16,437 90,273 146,958 -60,877 -81,142 -81,511 -78,015 411,076 -143,389 -78,299 -9,737 -36,128 177,681 2,100 -106,624 -74,811 -23,870 -86,437 7,653 9,753 -96,871 -171,682 -195,552 9,753 -96,871 -171,682-195,552 -281,989 Exhibit Nine: Benchmark and market information Sports Direct as Benchmark firm Price/revenue EV/EBITDA Price earnings Price to book Beta Market information UK Government 5-year yields Estimated equity risk premium 0.5-0.8 7.5-9.7 8.0-15.2 2.7-3.8 1.92 3.98% 6%