2015

[ENTREPRENEURIAL FINANCE]
Eco-Products, Inc.
Study case

Student: Olaru Lorena Catalina

Year: 3
Group: 2

Eco-Products, Inc.

A. Describe Eco-Products early history (19902003). Would you view the firm during that
period as being a lifestyle business, an entrepreneurial venture, or something else? Why?
During the period 1990-2003 the company Eco-Products, Inc was a lifestyle business.
The founders Steve Savage and his father, Kent Savage entered the business environment
with the mission of providing eco-friendly paper and janitorial supplies to a community
(Boulder, Colorado) known for its support of environmental initiatives and natural
products. Also, the funds required for operating the business were supplied by family
members and friends until 2005. All this leads us to believe that the company is a
lifestyle business.
B. Discuss Eco-Products revenue growthbased business model that evolved over the
2004 through early 2008 period in terms of (a) production versus distribution, (b) product
line development, (c) branding, etc.
The company remained a local marketer of green janitorial paper and building supplies
until 2004 when the company was set on a new course with both business supply and
building supply divisions. The management team was expanded and sales in the business
supply division grew rapidly as a result of a focus on brand and Internet strategies.
a) During 2004-2005 Eco-Products remained the main distributor of eco-friendly
products, the inventory was purchased from diverse manufacturers (Fabri-Kal,
International Paper), even if the quality of the products wasnt the best, they were the
only one. The growing reputation exposed the company to a new market and led to a
change in the business model from retail sale to wholesale distribution. During 20052007 forced by circumstances they decided to manufacture their own products.
b) During 2005-2007, Eco-Products made the transition from marketing and distribution
to manufacturing and distributing their own product. Steve came with the idea to
develop a product line from a polyactide (PLA) resin. Product suppliers were selected
in China and Taiwan. In 2007 they had a wide array of uniquely designed, qualitative
line of friendly environment products.
c) The Eco-Products branded line of compostable cups and food containers entered the
market in March, 2007. Their logo was 100% Compostable. They could build their
brand based on the competitive advantage offered by a better quality, competitive
price and recognition.
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C. What is the size of the domestic and global markets for food service disposable
packaging? Who are the major competitors producing/selling environmentally-friendly
food service products. What intellectual property or competitive advantages does EcoProducts, Inc., possess?
The global food service disposable industry produces an estimated $30 billion in sales
annually. Biodegradable products represented the fastest growing segment of the industry
and had sales estimated to exceed $700 million in 2008.
Eco-Products main competitors are Fabri-Kal, International Paper, and Georgia Pacific
paper product lines. These firms became competitors after the company decided to
manufacture their own eco products.
Its difficult to gain a competitive advantage in such an industry because the production
technology is simple and there are just a few major competitors, but Eco-Products, Inc
did it by launching its own brand. Their products were more qualitative and more
accessible. Also, by using a very friendly environment material, polyactide resin (PLA),
in manufacturing its products. They never drifted from their mission in order to be more
profitable.
D. Tables 2 and 3 present Eco-Products financial statement information for 2005, 2006, and
2007. Prepare a ratio analysis of the firms financial performance over the 20052007
periods.
Short-term Solvency Ratios
1. Current ratio = Total current assets / Total liabilities
2005 Current ratio = 625,152 / 435, 696 = 1.43
2006 Current ratio = 1,352,875 / 1,781,218 = 0.75
2007 Current ratio = 4,633,427 / 4,111,887 = 1.12
2. Quick ratio = (Total current assets Inventory) / Total liabilities
2005 Quick ratio = (625,152 361,906) / 435, 696 = 0.60
2006 Quick ratio = (1,352,875 862,728) / 1,781,218 = 0.27
2007 Quick ratio = (4,633,427 2,415,916) / 4,111,887 = 0.53
Asset Management Ratios
3. Receivables Turnover = Sales / Accounts receivable
2005 Receivables Turnover = 3,649,799 / 101,690 = 35.89
2006 Receivables Turnover = 5,751,787 / 364,879 = 15.76
2007 Receivables Turnover = 10,867,104 / 1,330,562 = 8.16
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4. Inventory Turnover = COGS / Inventory

2005 Inventory turnover = 2,584,326 / 361,906 = 7.14
2006 Inventory turnover = 3,684,492 / 862,728 = 4.27
2007 Inventory turnover = 7,726,455 / 2,415,916 = 3.19
5. Total Assets Turnover = Sales / Total assets
2005 Total Assets Turnover = 3,649,799 / 795,465 = 4.58
2006 Total Assets Turnover = 5,751,787 / 2,103,478 = 2.73
2007 Total Assets Turnover = 10,867,104 / 5,647,015 = 1.92
Debt Management Ratios
6. Debt Ratio = Total Debt / Total Assets
2005 Debt Ratio = 435,696 / 795,465 = 0.54
2006 Debt Ratio = 1,781,218 / 2,103,478 = 0.84
2007 Debt Ratio = 4,111,887 / 5,647,015 = 0.72
7. Debt-Equity Ratio = Total Debt / Total Owners Equity
2005 Debt-Equity Ratio = 435,696 / 359,769 = 1.21
2006 Debt-Equity Ratio = 1,781,218 / 322,260 = 5.52
2007 Debt-Equity Ratio = 4,111,887 / 1,535,128 = 2.67
Profitability Ratios
8. Profit Margin = Net Income (Loss) / Sales
2005 Profit Margin = 237,336 / 3,649,799 = 0.07
2006 Profit Margin = 41,946 / 5,751,787 = 0.007
2007 Profit Margin = (36,199) / 10,867,104 = - 0.003
9. Return on Assets (ROA) = Net Income / Total Assets
2005 Return on Assets = 237,336 / 795,465 = 0.3
2006 Return on Assets = 41,946 / 2,103,478 = 0.02
2007 Return on Assets = (36,199) / 5,647,015 = - 0.023
10. Return on Equity (ROE) = Net Income / Total Owners Equity
2005 Return on Equity = 237,336 / 359,769 = 0.65
2006 Return on Equity = 41,946 / 322,260 = 0.13
2007 Return on Equity = (36,199) / 1,535,128 = - 0.023
It is very visible that all the margins decreased from 2005 to 2007. This is because of the change
in the business model of the company. From 2005 to 2007 the assets turnover decreased, this
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shows a poor management of assets. Also, the inventory turnover ratio shows that the company
is experiencing difficulties in turning its inventories in sales.

E. Table 4 presents Eco-Products statement of cash flows for 2007. Was the firm building
or burning cash in its operating activities? When also considering cash flows from
investing activities, was Eco-Products in net cash build or burn position in 2007?

Using the equation from Chapter 5 we can compute the cash build/ burn for Eco-Products. The
general equation for measuring cash burn is:
Cash burn = Income statement Based operating, Interest and Tax expenses + Increases in
Inventory (Changes in payables and accrued liabilities) + Capital expenditures

First we calculate the cash operating expenses using the amount from the income
statement (Table 2).
Cash operating expenses = COGS + Administrative expenses + Sales and Marketing
Expenses
= 7,726,455 + 1,102,437 + 1,822,206
= 10,651,098
To this amount we add interest expenses and tax expenses to compute the value of
income statement.
Income statement = 10,651,098 + 186,726 + 187,918
= 11,025,742
Then from the balance sheet we compute the changes for inventories, payables and
accrued expenses and capital expenditure.
The change in inventories = 2,415,916 862,728
= 1,553,188
The change in payables and accrued liabilities = 568,131 526,555
= 41, 576

The change in capital expenditure = 1,349,702 971,177

= 378,525
Cash burn = Income statement Based operating, Interest and Tax expenses + Increases
in Inventory (Changes in payables and accrued liabilities) + Capital expenditures

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Cash burn = 11,025,742 + 1,553,188 41,576 + 378,525 = 12,915,879

Cash Build = Net sales Increase in Receivables

Increase in Receivables = 1,330,562 364,879
= 965,683
Cash build = 10,867,104 965,683
= 9,901,421

Net cash burn = Cash burn Cash build

= 12,915,879 9,901,421
= 3,014,458

Taking into consideration the investing activities the results are the following:
Net cash build/burn = Net cash from operating activities Net cash from investing activities
= (-2,891,887) (-356,745)
= -3,248,632

F. Describe the early rounds of financing that occurred from Eco-Products inception
in1990 through 2006. Beginning in 2007, the need for external financing began to
increase. Describe the sources, amounts, and types of financing obtained during 2007 and
the early part of 2008.
At the beginning of the business friends and family provided financial support for business
operations until 2005. In 2005 Steve wanted to buy more stocks and develop the business
supply division. So, he resorted to debt financing and opened a credit line in 2005 with his
personal guarantee, borrowing $30,000 which increased by 2007 to 4 million dollars.
The sources, amounts and types of financing during 2007 2008 are:

Date
2007
2007 2008

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Sources
Type of financing
14 Investors
Friends and family,
Equity financing
Angels
30 Angel investors
during the PPM
Equity financing
Local and out of state

Amount
$220,000

$2,500,000

G. In mid-2007, Eco-Products management prepared a five-year (20072011) projection of

revenues and expenses (see Table 1). What annual rates of growth were projected for net
sales? Make a back-of-the-envelope estimate of the amounts of additional assets
needed to support the sales forecasts. How might these assets be financed? Prepare a
rough estimate of the possible size of external financing needed to support these sales
projections.

Using the amounts of the net sales projected in Table 1 the annual rates of growth are:
Year
2007
2008
2009
2010
2011

Forecasted Sales
$9,200
$22,000
$38,000
$55,000
$78,000

Annual growth rate

140%
73%
45%
42%

Annual growth 2008 = (22,000 9,200) 1*100 = 140%

Annual growth 2009 = (38,000 22,000) 1*100 = 73%
Annual growth 2010 = (55,000 38,000) 1 * 100 = 45%
Annual growth 2011 = (78,000 55,000) 1 * 100 = 42%

In order to find out the additional amount of needed assets we have to compute the sales
to total assets ratio.
Sales to total assets ratio =

2007 Sales to total assets ratio = 10,867,104 / 5,647,015

= 1.924 times
2007 Total assets to sales ratio = 5,647,015 / 10,867,107
= 0, 52
I used the actual amount of sales from 2007, not the forecasted one.
We can observe that for each increase in sales of $1, Eco-Products has to invest an
amount of $0,52.
Estimates of the changes in sales and assets for the forecasted period 2007 2011.
Year
2007
2008
2009
2010
2011

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Sales
10,867
22,000
38,000
55,000
78,000

Change in Sales
11,333
16,000
17,000
23,000

Assets/Sales
x
x
x
x

0.52
0.52
0.52
0.52

Change in assets
=
=
=
=

5,789
8,320
8,840
11,960

So, in 2008 Eco Products will have to acquire $5,789,000 in assets, in 2009 app. 8 mil, in
2010 $9mil and in 2011 $12 mill, in order to support the forecasted sales.
A part of financing for the additional assets that it needs to support the forecasted sales
will come from the income, but will not be enough. So the remaining part can be financed
through debt and equity.

H. Eco-Products management developed a Confidential Private Placement Memorandum

(PPM) dated October 16, 2007, in an attempt to raise $3,500,000. Appendix A contains
excerpts from the PPM.
1. What is meant by a Regulation D offering? What is an accredited investor and how many
investors can participate in the PPM? [You may wish to review materials from Chapter 8 and
its appendices when answering these PPM-related questions.]
2. Considering the planned use of proceeds, discuss the pros and cons of trying to raise
$3,500,000 in increments as small as $50,000 each.
3. Summarize the risk factors listed by management in the PPM. Which factors do you
believe are the most crucial in determining the future success of Eco-Products?
Answers:
1.
Regulation D offering is a Securities and Exchange Commission (SEC) regulation that
governs private placement exemptions.
A Regulation D offering allows to smaller companies the opportunity to raise money
faster and without having to register their securities with the SEC.
Accredited investors can be: banks, private business development companies and high
net-worth individuals. In general high net-worth individuals are those whose net-worth
exceeds $1mil or has $200,000 income in excess in the last 2 years and expects the same
level of income in the current year.
In a PPM can participate maximum 35 unaccredited investors and an unlimited number
of accredited investors.
2. Pros and cons of trying to raise $3,500,000 in increments as small as $50,000 each.

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Taking in consideration that Eco - Products needs the money quickly to buy
inventory in order to make sales, raising money in small amounts like $50,000
will take time, effort and costs.

By raising just $3.5 mil can benefit from the Regulation D, which states that the
limit offering is of $5 mil.
Because the limited number of unaccredited investors is of 35, they will only raise
from the $1,750,000 (50,000*35). The rest will have to be raised from accredited
investors.

3. The risk factors listed by management in the PPM are:

Development of the new product is a must.
They are subject to patent infringement laws.
Rely on imports of products from overseas suppliers.
The competition will grow.
The availability of raw materials can constrain the supply process.
They are subject to federal, state and foreign regulations.
Subject to product liability claims.
They have to hire and retain skilled personnel.
The have to manage the growth of the company.
The economic conditions.
Restriction of stocks transfers and no public market for the stocks.
The offering price is determined arbitrary.
The dividends are not expected to be paid in the foreseeable future.
The most important risks are those which can be controlled and predicted, like the development
of the new product, the competition which is growing and the supply chain. But the others are
important too and must not be overlooked, because they will lead to success too.

I. Identify and discuss the factors and developments that led to the previously unexpected
revenue growth during the first-half of 2008 by Eco-Products. Is such growth likely to be
sustainable in the near future? What possible developments might interrupt or change this
rapid rate of sales growth?
The factors and developments that led to the revenue growth of Eco-Products in the early
2008 are:
Consumer trends and needs turned to the green industry, so the demand for
ecological products increased.
The price of the oil increased, this led to an increase in the price of plastic based
products resulting in a higher demand for substitute products, eco-products.
Eco Products built a stronger brand than the competition, offering qualitative
products at competitive prices.
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This king of abrupt growth is difficult to maintain in the long-term without the
necessary resources. As it happened in 2008 for Eco-products, even if the sales
skyrocketed they experienced a cash shortfall because of the higher demand and low
inventory stocks. Also, they intended to finance product development to gain
competitive advantage.
Other developments that could lead to a change in the rapid growth of the sales could
be: competition, changes in consumer attitude and preferences, recession etc.

J. Explain Eco-Products supply chain model that existed in early 2008. Describe the
strengths and weaknesses of such a model from an operations viewpoint. What are the
implications of this supply chain model on Eco-Products working capital financing
needs and its cash conversion cycle?

Eco-Products moved from selling products from other manufacturers to a business

model where they manufactured and sold their own products so the supply chain
model changed too. It became a long supply chain cycle, raw materials were bought
in U.S or other countries, then sent in Asia to be manufactured and then back in the
U.S. This long supply cycle led to shortfall because suppliers required prepayment,
customers had payment terms and inventory was always too low or in excess.

To see the changes that the new model of supply we compute the Assets to Sales ratio
and Inventory to sales ratio for 2005, 2006, 2007 and 2008.
Total Assets to sales ratio =
2005 Total assets to sales ratio = 795,465 / 3,649,799 = 0.2179 = 22%
2006 Total assets to sales ratio = 2,103,478 / 5,751,787 = 0.365 = 37%
2007 Total assets to sales ratio = 5,647,016 / 10,867,104 = 0.5196 = 52%
2008 Total assets to sales ratio = 18,903,838 / 34,378,138 = 0.5499 = 55%
Inventory to sales ratio =
2005 Inventory to sales ratio = 361,906 / 3,649,799 = 0.099 = 10%
2006 Inventory to sales ratio = 862,728 / 5,751,787 = 0.1495 = 15%
2007 Inventory to sales ratio = 2,415,916 / 10,867,104 = 0.222 = 22%
2008 Inventory to sales ratio = 12,222,801 / 34,278,138 = 0.355 = 36%

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We can observe that between 2005 and 2008 total assets to sales ratio increased from 22% to
55% and also, the inventory to sales ratio increased from 10% in 2005 to 36% in 2008. All these
results suggest a poor management of inventory caused by the supply chain.

Cash conversion cycle (CCC) for 2005, 2006, 2007.

In order to compute the cash conversion cycle first we must calculate the following:
a. The inventory to sale conversion period
b. The sale to cash conversion period
c. The purchase to payment conversion period

a. Inventory to sales conversion period =

2005 Inventory to sales conversion period = 361,906 / (2,584,326/365) = 51.1 days

2006 Inventory to sales conversion period = 862,728 / (3,684,492/365) = 85.5 days
2007 Inventory to sales conversion period = 2,415,916 / (7,726,455/365) = 114.1 days
b. The sale to cash conversion period =

2005 Sale to cash conversion period = 101,690 / (3,649,799/365) = 10.2 days

2006 Sale to cash conversion period = 364,879 / (5,751,787/365) = 54.8 days
2007 Sale to cash conversion period = 1,330,562 / (10,867,104/365) = 44.7 days
Based on these computations we can observe that in 2005 Eco-Products took 10.2 days to collect
its credit sales and in 2007 it took 44.7 days.
c. Purchase to payment conversion period =

2005 Purchase to payment conversion period = 123,429 / (2,584,326 / 365) = 17.4 days
2006 Purchase to payment conversion period = 526,555 / (3,684,492 / 365) = 52.2 days
2007 Purchase to payment conversion period = 568,131 / (7,726,455 / 365) = 26.8 days
Cash conversion cycle = Inventory to sale conversion period + Sale to cash conversion
period Purchase to payment conversion period
2005 CCC = 51.1 + 10.2 17.4 = 43.9 days
2006 CCC = 85.5 + 54.8 52.2 = 88.1 days
2007 CCC = 114.1 + 44.7 26.8 = 132 days
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The cash conversion cycle increased from 43.9 days in 2005 to 132 days in 2007. This is
a consequence of the change in the business model from distribution and seller to a
manufacturer and wholesaler.

K. In mid-2008, Eco-Products management sought to quickly (hopefully) raise an

additional $2 million in external financing through a single private equity investment.
The term sheet prepared by Greenmont Capital is presented in Appendix B.
1. After considering a number of possible private equity investors, Greenmont Capital
was selected by Eco-Products management. Discuss the pros and cons of selecting
small locally-based private equity firm relative to a larger private equity investor.
2. Review the investment terms presented in Appendix B and comment on any factors in
the term sheet that might be deal breakers. If you were representing Eco-Products
top management, which terms might you want deleted or modified from the term
sheet? If you were representing Greenmont Capital, which terms would be important
in protecting its investment capital?
3. Some analysts use a relative value method that uses multiples from comparable firms
to estimate the value of a target venture. Table 9 contains enterprise value to-sales
information for a number of possible comparable firms for the purpose of valuing
Eco-Products. Estimate the enterprise value of Eco-Products. What portion of equity
ownership should Eco-Products be willing to give up for the $2 million Greenmont
Capital investment?
Answers:
1. The biggest advantage of a large private equity investor is that can invest a larger amount
more easily and faster, but this has a drawback too. Being a large private equity investor
means that has more projects to invest in, so they are not very flexible and personal.
To the opposite lane are the small equity investors. A small equity investor is more
dedicated to the venture and gets involved personally. Also, being local the meetings are
easier to schedule and will be face to face. They understand better the industry, like in the
case of Greenmont which is considered by Steve to be managed by industry veterans.
The disadvantage of small private equity investors is that they offer smaller amounts of
money.
2. If I would be representing Eco-Products the terms that I would want to modify or delete
from the term sheet are:

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Warrants I would modify the amount of warrants that Greenmont wants to be offered,
that is 25% warrant coverage, which will give Greenmont the right to purchase 333,333
additional series A Preferred shares at a price of $1.5.
Dividends I would modify the dividends provision too, which provides cumulative
dividends of 8% per year.
Anti dilution This provision interferes with Eco-Products future needs of financing.

In case of the Greenmont Capital for protecting the investment I would stick to the warrants
provision and dividends provision.

3. The enterprise value of Eco-Products using enterprise value to sales multiple of 1.57 is:
The value of the enterprise = Sales x Multiple
12 Months trailing sales Value = 19,700,000 x 1.57 = $30,929,000
Managements Forecast Value = 45,000,000 x 1.57 = $70,650,000
The portion of equity ownership that Eco-Products be willing to give up for the $2
million Greenmont Capital investment is of 6.33%.
-

Pre-money shares = 29,587,500 / 1.50 = 19,725,000 shares

Shares issued = 2,000,000 / 1.50 = 1,333,333
Post-money shares = 19,725,000 + 1,333,333 = 21,058,333
Greenmont ownership = (1,333,333 shares) / (21,058,333 shares) = 6.33%

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