Overview of current financing needs
In the first year of operations, Flawless Flex operated at a loss. As a result, the business needs external financing to support its operational activities and purchase assets to generate revenues. The revenues generated in the first year were $220,004, and the operating expenses were $364,800. The deficit is $144,796 ($220,004-$364,800). Moreover, the company requires assets worth $82,882 to support its operations, in addition to a net-working capital of $14,330. In total, the amount of funding required is $242,008 ($144,796+$82,882+$14,330) in the first year.
Evaluation of funding required for the 1st year to the 5th year
When calculating the funding required to finance the company’s operations for the first five years, the assumptions are that revenue will increase by 30% each year and operating expenses will increase by 5% annually. In addition, the management estimates that the current asset will increase by 20%, current liabilities by 2%, and non-current assets by 10%. The funding need analysis showed that the company requires external financing worth $640,144 to support its activities for years 1 to year 4. In Year 5, the company will generate enough revenues to finance its operations. See appendix A showing the company’s financing needs for the five years.
Current funding request
Since the business is in its initial stages, the management uses equity financing instead of debt. Though the cost of equity is higher than debt, there is no requirement to repay it, increasing the cash flow available to finance its operations (Mande, Park, & Son, 2011). Debt financing requires a regular payment of the principal amount and interests, which would drain cash from the company, and lower profits reported annually. Exposure to litigation would be inevitable if it failed to honor its debt obligations. That could mutate into liquidation and eventual business closure (Shim & Changsoo Kang, 2012).
Equity financing does not expose the company to liquidation risks. Investors appreciate the risk of the business running at a loss and are willing to wait until the business is profitable to earn dividends (Kang, Koh & Park, 2021). Blomkvist, Korkeamäki, and Takalo (2020) note that dividend payout is not mandatory, and directors are free to exploit profitable ventures instead of paying out dividends, making equity funding a preferred option for Flawless Flex business.
Terms of equity issuance
The investors will receive a 30% stake in the company in exchange for funding $620,144 required to finance the company’s operation in the first four years. The shareholders should provide the funds at the beginning of the financing year, and ownership will increase annually once the funding is received. Table 1 shows the funding needs for year1 to year 4.
Table 1: Funding requirements and growth in equity share
Table 1 shows that as the investors’ share capital increases, the company’s ownership also increases. By the end of the fourth year, the equity investors will have a 30% controlling interest in the company.
Dividend payout
The company will issue at least a 10% dividend annually when generating profits. No dividends payment will occur when the company generates a loss in a financial year.
Share re-purchase
The shareholders reserve the right to sell their shareholding to the company after 15 years. However, the company may decline that offer if it does not have enough cash flows to honor such a request.
Transfer of shares
A shareholder reserves the right to sell his/her shareholding at a price agreed upon with the prospective buyer. The transfer should be notified to the company a week before the execution of the deal to facilitate changes in the company’s shareholding documentation.
Uses of acquired funds
The company anticipates using funds generated from equity financing to boost its operation activities, including meeting the deficit between revenue and expense, funding the deficit in working capital, and acquiring assets. Appendix A shows that the company’s net income and net working capital were negative from the first year to the third year of operation. The net income and net working capital are positive in the fourth year. However, since the company acquired additional assets worth $110,316, it ended up with an overall financing deficit of $45,889 in the fourth year.
Plans for buyouts
In the first five years of operations, the management will focus on growing the company’s value organically. No buyout plans exist within this period. Besides, the company will not have generated enough cash flows to finance such a buyout. Moreover, the management appreciates that the company’s bargaining power within the first five years would be low, hence not the right time to consider a buyout. However, beyond five years, as the company’s profitability and cash flows grow, the possibilities of buyouts would help in increasing the company’s market share.
Selling or exit plans
There are no plans to sell the business. Instead, the vision bearers believe that the business will grow and eventually be listed with sound management practices in the next 20 years. Following that ambition, the long-term strategic plan entails acquiring other companies along the same line of business to have significant control on the market share.
References
Blomkvist, M., Korkeamäki, T., & Takalo, T. (2020). Staged Equity Financing. Web.
Kang, J., Koh, J., & Park, J. (2021). Does Firms’ Equity Financing Benefit Debtholders? Evidence from Private Placements of Equity. Web.
Mande, V., Park, Y., & Son, M. (2011). Equity or Debt Financing: Does Good Corporate Governance Matter?. Corporate Governance: An International Review, 20(2), 195-211. Web.
Shim, H., & Changsoo Kang, C. (2012). Beating Earnings Benchmarks Between Equity-Financing and Debt-Financing Firms. Korea International Accounting Review, (42), 123-142. Web.