Mary Fernandez is a student in the Fall Quarter class of Enterprise Finance. It is now 7:30 AM and she is attending the October meeting of the San Diego Venture Group. There are approximately 300 people attending the meeting: bankers, accountants, lawyers, headhunters and entrepreneurs. Mary is a bit lost and wanders to the back of the room to get a cup of coffee. Looking for the cream for her coffee she stumbles into John Thompson.

John is the son of a real estate developer and majored in business at UCLA. He has relocated back to San Diego.

John has been working with Bill who received his degree in engineering at UCSD. Bill has developed a software product which will enable a property owner to monitor the energy usage of all his properties down to the level of a wall socket.

Working with his Father, who is a commercial real estate property owner and manager, John has tested the product successfully. The results have been overwhelmingly positive. The next step is for John to raise some money and build a company but he is at a loss as to how to build the financial statements required for presentations to Angel Investors and Venture Capitalists.

Mary tells John that she would be happy to build the model. John mentions that he will need to hire 3 additional engineers to continue to refine and expand the product. Each engineer makes approximately $120,000 per year. In addition, he will need two VPs of marketing. Each VP will command a salary of $150,000 per year. In addition, they will manage 3 sales people each, six total within the Company, at approximately $80,000 per annum. The marketing budget, for advertising and other materials, will be $700,000 for marketing per year. Marketing expenses are expected to be spent in an equal amount per month. The initial back office will contain an accountant @ $80,000 and two receptionists/secretaries @ $40,000. Additional salary expenses, including payroll taxes, health insurance and other benefits, are budgeted at 25% of total salaries. John and Bill hope to make a salary of $175,000 per year. Annual office expenses including occupancy are expected to be $25,000. John expects the company’s expenses to increase by 20% in the second year.

Capital expenses include a computer for each individual, $1,000, two network printers for the entire company at $1,000 per printer, telephone, $1,000, two servers, $5,000 each, software, $10,000, and networking, $1,000.

John expects to sell the software with the first sale coming after six months. Each sale will be for $15,000 with a $6,000 per year software maintenance contract per customer. He believes that he will have 10 customers after six months (In month 6) and then the customers will be added according to the following schedule.

Month 7 5 new customers
Month 8 5 new customers
Month 9 5 new customers
Month 10 10 new customers
Month 11 10 new customers
Month 12 10 new customers
Month 13 15 new customers
Month 14 15 new customers
Month 15 15 new customers
Month 16 20 new customers
Month 17 20 new customers
Month 18 20 new customers
Month 19 25 new customers
Month 20 25 new customers
Month 21 25 new customers
Month 22 30 new customers
Month 23 30 new customers
Month 24 30 new customers

The cost of goods sold is equal to 20% of revenues not including the service contract revenue.

Please complete an initial model for John’s company for the first two years. (This will require a month by month analysis.) What is the amount of capital needed? Assuming a required rate of return by investors of 20% per annum and the sale of the company at the end of the second year at seven times Year 2 EBITDA what is the company worth? (Please note that when discounting monthly cash flows you will need to divide the interest rate by 12.) What do you think about this deal? What questions do you need to ask if you were an investor?