Southwest Ventures is considering an investment in an

Austin Texas #2938

Southwest Ventures is considering an investment in an Austin, Texas– based startup firm called
Creed and Company. Creed and Company is involved in organic gardening and has developed
a complete line of organic products for sale to the public that ranges from composted soils to
organic pesticides. The company has been around for almost twenty years and has developed
a very good reputation in the Austin business community, as well as with the many organic
gardeners who live in the area. Last year, Creed generated earnings before interest, taxes, and
depreciation (EBITDA) of $ 4 million. The company needs to raise $ 5.8 million to finance the
acquisition of a similar company called Organic and More that operates in both the Houston and
Dallas markets. The acquisition would make it possible for Creed to market its private- label
products to a much broader customer base in the major metropolitan areas of Texas. Moreover,
Organic and More earned EBITDA of $ 1 million in 2015. The owners of Creed view the
acquisition and its funding as a critical element of their business strategy, but they are
concerned about how much of the company they will have to give up to a venture capitalist in
order to raise the needed funds. Creed hired an experienced financial consultant, whom they
trust, to evaluate the prospects of raising the needed funds. The consultant estimated that the
company would be valued at a multiple of five times EBITDA in five years and that Creed would
grow the combined EBITDAs of the two companies at a rate of 20% per year over the next five
years if the acquisition of Organic and More is completed. Neither Creed nor its acquisition
target, Organic and More, uses debt financing at present. However, the VC has offered to
provide the acquisition financing in the form of convertible debt that pays interest at a rate of 8%
per year and is due and payable in five years.a. What enterprise value do you estimate for
Creed (including the planned acquisition) in five years? b. If the VC offers to finance the needed
funds using convertible debt that pays 8% per year and converts to a share of the company
sufficient to provide a 25% rate of return on his investment over the next five years, how much
of the firm’s equity will he demand? c. What fraction of the ownership in Creed would the
venture capitalist require if Creed is able to grow its EBITDA by 30% per year (all else remaining
the same) and the VC still requires a 25% rate of return over the next five years?View Solution:
Southwest Ventures is considering an investment in an Austin Texas

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