Feed Resource Case

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School

California State University, Northridge *

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310

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Finance

Date

Jan 9, 2024

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pdf

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Uploaded by Ravenfight23

Feed Resource Case 1. What is the product/service being offered? How is revenue generated? "The feed system, known as the R2, would utilize anaerobic digestion (AD), a clean, safe, and proven technology, to turn biodegradable waste into fuel (biogas) for a distributed electricity generation unit. It’s a “fully automated system that enables customers to process waste and generate energy onsite without changing current waste disposal behavior.” The company generates revenue through its feed system “R2” in which it sells its fully automated electric generation unit to grocery stores and supermarkets for around $300k/unit. Any extra electricity that businesses don't need could be sold back to electrical grids. The feed system also produces nutrient rich compost which could be sold to farmers. 2. What are the critical risks? There are many critical risks associated with a system like the “R2”. First the feed system doesn't have a 2-year payback period that companies like Walmart and other grocery chains were looking for and most of the venture capitalists were looking for quick gains and technology that was already fully developed and the “feed system” was much newer technology and was still in the early stages of implementation (there being only a patent) and a functioning prototype still needed to be developed to prove its validity. While it’s true that the company won a few pitch competitions and had strong interest from venture groups and businesses it was unproven technology and they desperately needed “$250,000 to build a prototype” or else they would never get their company off the ground. Rather than trying to make an expensive prototype for $250k they should put together a cheaper prototype with lower costing materials and technology to showcase with. This will help them overcome their cost constraints and enable them to be more flexible. Another point to bring up is that the company did win a grant from “MTC” for $195,000 but unfortunately after conducting a feasibility study it was found that their sponsor “The Ring Brothers” did not produce enough food waste to meet the minimum energy output of 50 kw that was needed to be eligible for the grant. As a result, Feed had to inform “MTC” that they were not going to accept the grant. 3. How can Shane raise the capital he needs? Examine the pros and cons of each option below:

2 Shane can raise the capital he needs through many different sources including the SBIR (Small Business Innovation Research Program), VentureWell, debt/equity financing and through creative sources like customer financing. SBIR Pros: Provides non-dilutive funding in the form of grants, so Shane would not have to give up equity or pay back the money compared to debt/equity financing options. Awards typically range from $50k to $250k 6-12 months (Phase I), $250k to $1mm 1-2 yrs (Phase II) and no funding for Phase III which is devoted to commercialization of products. Structured in phases (Phase I for proof of concept, Phase II for prototype development, Phase III for commercialization of products), so Shane can access smaller amounts in phase 1 testing project feasibility before pursuing larger phase II awards. Funding from SBIR also does not negatively impact ability to raise from venture capital firms. Cons: Highly competitive program, with typically only 10-20% of applicants receiving awards. Shane's company would need to stand out. Requirements around company size, ownership structure, and project phases add complexity to the application process and the business would need to be for profit, operate primarily within the U.S. and include more than 50% ownership by U.S. citizens and less than 50% foreign participation. Grant funding is tied to specific project milestones, so Shane would have less flexibility than unconditional investment capital and application and administration requirements take time away from developing the technology. VentureWell Pros: Provides grants rather than equity investments, so no loss of ownership or control and does not require repayment. Grant amounts in the $25k-$75k range can help extend runway in early stages. Focus on supporting early stage scientific research and innovation specifically. Have a variety of grant programs aimed at different development phases (proof of concept, prototype, growth and scaling). Independent non-profit foundation that supports faculty and innovators at US-based colleges and universities through funding, training, and building a vital I&E community and expanding representation within underrepresented communities. Cons: Highly selective program with low acceptance rates. Shane's proposal would need to stand out significantly to win a grant. Grant amounts are relatively small, usually between $25k - $75k. This would likely not provide enough capital on its own. Additional funding needed. Grant funding is tightly restricted to predefined project milestones and scope limitations. Less flexible

3 than broader equity financing. Most VentureWell grants focused on early proof of concept and prototype stages. Limited support for commercialization and scaling activities. Time intensive application and ongoing reporting requirements for the small team. Can divert focus from execution. Uncertainty and often lengthy delays in finding out grant decisions. Makes financial planning difficult. Grant funding has finite end dates. Need to line up follow-on financing for continued operations. Loss of management control compared to equity financing - oversight tied to grant compliance/milestones. Doesn't build relationships or networks like angel/VC investors may. Debt Financing Pros: Shane retains ownership and control - no loss of equity or dilution like equity financing. Can access larger amounts of capital than equity options if assets & revenues support debt service. This includes being able to access bank loans from accounts receivables & inventory (which can be used as working capital) along with equipment financing and collateralized loans/lines of credit. Interest rates are usually more favorable for startups than mature companies. Established loan application process with more predictable terms and timelines. Interest payments are tax deductible expenses which lowers effective costs and interest payments will force companies to meet repayment schedules forcing financial discipline. Cons: Requires ability to repay principal + interest through cash flow or reserves. Adds fixed cost. Collateral often required, usually tangible assets. Can be challenging for early startups. More stringent credit requirements than with equity financing. Usually requires proven concepts. Debt covenants can impose operating restrictions on finances and strategy. Higher risk of insolvency if cash flow stalls. Missed payments can be default triggers. Personal guarantees may be required from founders/CEOs putting their personal assets at risk. Overall higher cost of capital compared to equity options. The right debt financing deal can provide capital while retaining control, but also introduces financial risk and rigid obligations. Works best for companies with established cash flows and assets to leverage. Earlier stage startups likely need equity financing first or grants because of being cash poor which is why creative sources are required. Equity Financing Pros: Raises capital without debt or repayment obligations. You don't have to pay the money back or make interest payments like you would with debt financing options.

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4 Investors provide expertise. Equity investors often provide strategic advice, mentorship, industry connections in addition to capital. Less restrictive than debt financing. Equity financing does not usually come with strict covenants or restrictions like those imposed by banks or lenders. Cons : Loss of control and ownership stake. Selling equity means giving up ownership percentage, which can lead founders and original owners to lose some measure of control in decision making. More expensive way to raise money. The cost of capital is higher with equity financing because investors take on risk and want greater reward. Risk of dilution. As more equity is issued in future fundraising rounds, the ownership stake and value of existing shareholders will be diluted unless they buy additional equity. Investors expect high growth and returns. Equity investors expect exceptionally high revenue growth and market potential which puts pressure on the company to financially perform. Customer Financing Pros: “Companies like defense contractors, building contractors, and management consulting firms typically divide their large projects into a series of stages and require payment as they complete each stage." This significantly reduces the cash they require and allows more capital upfront to subsidize investments. "With some companies, customers pay weeks or months in advance for everything they buy and Many mail ‐ order operations are financed this way.” Cons: Limits total collectable amount, likely insufficient as sole source of capital. Risks overpromising to early customers if unable to deliver. Customers may negotiate discounted pricing in return for pre-payment. Accounting complications in treating pre-launch payments. Adds administrative workload pre-launch and lots of due diligence has to be done in advance to make sure that everything runs smoothly. 4. What should Shane do? The biggest obstacle holding Shane back is the lack of a prototype. 1st Shane should strongly consider developing a cheaper prototype with less costly materials and technology and apply for more grants from local, state and federal governments including from universities and nonprofits. They should consider more pitch competitions and customer financing from large grocery chains through presales and exclusive deals. To keep costs to a bare minimum while also funding their operations they should consider a "negative cash conversion cycle" and just-in-time inventory

5 until sales or presales come in to pay suppliers. This enables faster inventory turnover and more efficient use of working capital and allows for economically larger inventory purchases and sales volumes. Then they should follow it up with loans/donations from friends & family including from private connections and collateralized loans from banks backed by business assets (patents) or by personal assets. Shane should consider getting credit cards because they’re an easy way to receive financing and build credit. Donations through GoFundMe, crowdfunding campaigns on social media or platforms like Indiegogo can also be considered. This will help Shane get the financing he needs for his business. Then once he achieves his short term goals, Shane should use a combination of different capital sources including "trade credit, unsecured and secured bank loans, accounts receivable financing, and inventory financing" to supplement some of their cash needs and support their business expansion. This allows entrepreneurs to use their experience and subjective opinion to put together a short-term financial package that will have a reasonable cost that can partially be supplemented by their operating profits, grossing assets and accounts receivables/inventories. No need to take on equity financing and dilute your shares if you can supplement your business with other alternatives. Decisions should be based on current situation and requirements, current and future costs of alternatives and future situations and requirements.

6 Appendix: The cash conversion cycle (CCC) is a metric that measures the number of days it takes for a company to convert its investments in inventory and other resources into cash flows from sales. It is calculated by adding the days inventory outstanding (DIO) to the days sales outstanding (DSO) and then subtracting the days payable outstanding (DPO). The formula looks like this: CCC = DIO + DSO - DPO Where: - DIO (Days Inventory Outstanding) measures the average number of days a company holds its inventory before selling it. - DSO (Days Sales Outstanding) measures the average number of days that a company takes to collect payment after making a sale. - DPO (Days Payable Outstanding) measures the average number of days a company takes to pay its suppliers. A negative cash conversion cycle means that a company is able to pay its suppliers after it has already converted its inventory into cash through sales to customers. Effectively, the company is utilizing supplier financing to fund its operation; its cash outflow to pay suppliers occurs after the cash inflow from customers. In essence, in a negative cash conversion cycle, suppliers are essentially financing the company's inventory by allowing the company to pay later. This can happen in industries where the suppliers offer extended payment terms, customer funds occur before accounts payable are due or where the company has significant bargaining power. It can also be prevalent in industries where just-in-time (JIT) inventory systems are used, which minimizes the time inventory is held by the company before it is sold.

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