Three co-founders formed Metastasis Magnetics Corp. (MMC) a company that has created a cancer detection device that uses magnetics to pull cancerous cells from the blood stream. This will revolutionize the ability to early detect a wide range of cancers much sooner than current methods. 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. 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 having been inspired by the Alex Honnold movie, Free Solo has run off to San Francisco to free solo the Salesforce buildingand 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, travel 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 smaller doctor office unit (D1) for $50,000. The ratio of H1 to D1 unit sales will be 1 to 10. When they are available, 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 D1 products. Gross margins will be 65% and 55% for H1 and D1 respectively.

Sales and Marketing

Each salesperson will be able to sell $9 million worth of producteach 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

MMC has determined that they will ultimately need an R&Dteam 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,MMC 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

Rent for manufacturing space will be $3.50 per square foot per month. Businesses of similar type require need 250 sq. ft. per headcount. Due to the rental market for this type of space, theyneed 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 with 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.

Videoconferencing for the three founders and each salespersonis 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 $200,000 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 30 days.

Inventory: The company will need to have 2 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 the total monthly 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 in debt with $4m in 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 $5 million provided the founders set aside 15% of the companys ownership as an option pool for current and future employees.

The assignment

Using the template left behind by the temp CFO, finish the 12-month plan, pro forma capital and option schedules (10 pts).

Q1) In rounded millions, how much combined debt and equity,at a minimum, needs to be raised for the first year? (2 pts)

Q2) The three founders collectively put up $3,000 for 100% of their company. If they accept the Series A term sheet, their ownership will be significantly diluted. What is their theoretical post-money combined ownership value 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 need to be in year 5? What will be the value of the options held by a single engineer at that time? (2 pts)

Q4) Using sensitivity analysis, which of the following variables will have the greatest impact on cash in this financial plan? Show proof of your position (4 pts)

a. Price per unit of H1/D1

b. DSO

c. Engineering salaries

d. Debt/equity ratio