This technical note introduces convertible note financing for early-stage start-up companies. These unpriced securities offer significant advantages related to delayed valuation, greater speed, and lower cost of completion compared to venture capital financing. As a result, the number of early-stage companies raising capital through convertible notes over the past decade has greatly increased. The note discusses the most frequently used terms and arrangements of early-stage convertible notes, the estimation of noteholders' equity ownership from delayed valuation, and the costs and risks of this form of financing to both entrepreneurs and investors. It offers a number of numerical examples that walk students through calculations of convertible note payoffs under different success scenarios and different valuation caps. It also explores how convertible notes affect subsequent equity rounds' pricing. Finally, the note offers statistical data on the state of convertible note issuance. This note is a successor to an older note, ""Convertible Notes: A Form of Early-Stage Financing"" (UVA-F-1925). The cases ""Should udu a Convertible Note?"" (UVA-F-2025) and ""MedMetri
In April 2023, Will Anderson, managing partner of SummitStone Capital, LP (SummitStone), received a copy of the management service agreement (MSA) between Artemis Capital (Artemis), a private equity firm, and Lucky Dice Casinos Inc., one of Artemis' recently acquired portfolio companies. SummitStone had invested in Artemis buyout funds since 2011 and was in the due diligence phase of allocating $75 million to Artemis' newest vehicle, Artemis Fund VII. But before Anderson could recommend the fund to his investment committee, he needed to understand the implications of the MSAs that Artemis was forging with its portfolio companies. The case allows students to (i) evaluate a typical MSA contract; (ii) analyze the existing evidence and academic research on MSAs; and (iii) explore possible avenues to adjust limited partnership agreements (LPAs) to align limited partners' (LPs') and general partners' (GPs') incentives in the presence of MSAs. Students can analyze the qualitative and quantitative implications of MSAs on all private equity fund stakeholders and develop a recommendation to an LP investment committee.
As the cofounder and CEO of Whole Foods, John Mackey had spent the better portion of his life rapidly growing the company from a niche natural grocery store in Austin, Texas, into the premier natural-foods grocer in the United States. Highly regarded as industry leader, Whole Foods contributed to the explosion in health-conscious eating sweeping the country. But not all good things lasted forever. Whole Foods had been treading increasingly choppy waters since early 2014. Increased competition in the natural-grocery space and broader macroeconomic factors wore on earnings and contributed to lackluster stock returns. Investors were becoming increasingly frustrated with company's leadership team. By the end of April 2017, Whole Foods had received a number of inquiries from both strategic and financial buyers. A full-blown sale process was launched, and though tech giant Amazon entered the bidding war late, its offer was fast and decisive, not giving Whole Foods much time to contemplate or find a competing bid. Now Mackey faces a decision that will not only shape the fate of his company, but the broader direction of the grocery industry for years or even decades to come.
In May 2023, partners from a private equity (PE) fund, Jefferson Capital, and a private (mezzanine) debt fund, Cavalier Capital, need to join forces to design their bid for Williams-Sonoma, Inc., to take the company private. May 2023's market environment looked unfriendly for LBOs: interest rates were steadily climbing as the Federal Reserve was trying to rein in inflation, the risk of the economy entering a recession was high, and banks themselves were under pressure from financial turmoil and were tightening their lending standards. Dealmaking at the top investment banks seemed to have frozen. At the same time, the PE industry was sitting on a record amount of dry power, and players were eager to move from the sidelines into the heat of the investing battle. Investing in iconic home-goods retailer Williams-Sonoma was the biggest opportunity of the year. Jefferson Capital's team knew that its initial 7.05x EBITDA bid was not super competitive. The fund had to apply all of its operational and financial engineering muscles, including expanding its debt financing to include mezzanine debt. Subdued before 2022 when investors had easy access to senior debt, mezzanine financing has regained popularity in early 2023, catalyzed by higher interest rates and reductions in the availability of traditional debt finance. Cavalier Capital and its mezzanine debt fund were perfectly positioned to aid Jefferson Capital in its aspiration to acquire Williams-Sonoma. The case is designed as a platform for a negotiation exercise between equity and mezzanine debt investors who need to put their heads together and form a bid to acquire Williams-Sonoma via an LBO. Students can be separated into paired equity and mezzanine teams. Faces with fixed amount of Tranche A and Tranche B debt (4x to 4.5x, depending on instructor risk appetite), each equity-mezzanine consortium needs to decide the amount of capital it is willing to invest and interest rates and warrant overage for the mezzanine
In December 2021, Valiant Capital Partners (VCP) is in the middle of bidding for Citrix Systems, Inc. (Citrix), to take the company private via a leveraged buyout (LBO). The auction of the renowned desktop-as-a-service (DaaS) company had attracted a number of bidders. VCP's initial bid of $15 billion ($92 per share) had allowed the fund to move to the final bidding round. Now with broader access to the company and its management, VCP has to revise its bid. Mohan Bhargav and William Hill, both with VCP and working on the Citrix deal, learn that Vista Equity Partners (Vista) has partnered with Elliott Investment Management (Elliott) to enter the bidding. Elliott bidding was not a big surprise. This activist investor had a subsidiary private equity (PE) firm created specifically to pursue private investments in mature tech companies. Plus, by December 2021, Elliott had amassed more than 10% of Citrix shares. Joined by Vista, an established leader in the field of technology-focused PE investments, the pair made a formidable opponent. It didn't help that one of Vista's portfolio companies, TIBCO, was a perfect roll-up candidate to pair with Citrix. In this David-versus-Goliath situation, Bhargav and Hill needs to figure out how much higher they can push VCP's bid and what the chances are that the VistaElliott consortium could outbid VCP. The case offers an opportunity for students to (a) evaluate classic LBO structures, cash flows, incentives, returns, and risks; (b) introduce the related roll-up PE investing strategy and associated risk/return investment profiles; and (c) evaluate the role of leverage in LBOs' success.
In July 2022, Ashley Sudjianto, a partner at Adelaida Technology Capital (ATC), had to make a recommendation to ATC's investment committee on how much money ATC should lend to CarboCaptor Inc., an emerging chemical-manufacturing start-up that had a patented, cost-effective solvent that captured carbon dioxide (CO2) from the air. In late 2021, CarboCaptor had been well on the way to launching a new vertical: chemical compounds to aid CO2 storage in concrete. Now, CarboCaptor's CEO had reached out to ATC for $6.5 million in debt financing, $2.3 million of which was to fund equipment purchases, and $4.2 million of which was to finance CarboCaptor's growth strategy and working capital needs. ATC was a perfect partner to reach out to. An East Coast venture leasing investor, the fund specialized in small-scale biotech and manufacturing equipment financing. It typically acquired these tangible assets and leased them to companies, receiving in return a promise of scheduled payments as well as warrants to purchase start-up stocks. CarboCaptor's equipment needs were exactly what ATC aimed to finance. There was just one catch: CarboCaptor's board of directors had decided to offer ATC its two core patents as collateral for the financing. The patents had 13 years of useful life remaining and were crucial for CarboCaptor's ability to produce its most popular product, CO2 solvent. But ATC had never used patents as collateral for a venture leasing transaction before. On all accounts, CarboCaptor's two core patents were valuable. Could Sudjianto convince her partners to use patents as collateral in exchange for funding the full $6.5 million CarboCaptor had requested? And if she could, what terms and deal structure would be the best to account for the riskiness of the venture?
In this field-based case, the founders of udu, Inc. (udu-pronounced "you-do"), a company whose proprietary technology helped private equity clients source deals by identifying target companies and overlooked opportunities, and by shortening the business-development cycle. Clients who had found success with udu's help raved about the technology, but despite their product's promise, the founders were still struggling to find a scalable and profitable application for it, and to grow revenue for the company. The founders eventually sought funding in the amount of $5 million to boost udu's growth potential, but Jay Sarcone, a general partner at Brotherhood Park Ventures, had said udu wasn't ready for that amount because it would not result in a desirable company valuation, and made a far lower offer: $1.3 million in convertible note financing. All three founders agreed that $1.3 million fell far short of their hopes, and that udu would need another fundraising round in a year. But any money, at this point, would help udu progress. Should the founders accept Sarcone's offer, or risk alienating a trusted ally by seeking $5 million elsewhere? And if they did seek $5 million, would it result in a low valuation for udu?
The leadership of Union Pacific Corporation (UPC), the largest public railroad transportation company in the United States, needed to decide whether the company should reestablish its share-buyback program. The freight recession of 2019 and the decline in shipping volumes caused by the start of the COVID-19 pandemic in 2020 had not been gentle on the freight industry overall, and UPC had been no exception. The company had been able to maintain its dividend policy, but suspended its share-repurchase program during the second half of 2020. By the end of 2020, UPC's management saw signs of V-shaped economic recovery. Was it time for UPC to reinstate the company's share-repurchase program? Dividends and share repurchases were important avenues through which UPC returned value to its shareholders. UPC's growth opportunities had become limited over the previous 50 years, and management had focused on efficiency, cost cutting, and generating cash flows that the company channeled back to shareholders. This case has been successfully taught at the University of Virginia Darden School of Business in the Enterprise Valuation module of the course ""Financial Management and Policies,"" which is an integral part of Darden's core curriculum for MBA students. The case integrates a variety of subjects including forecasting, financing, and investment analysis. Students are asked to calculate the implied enterprise value and share price of a corporation by building a DCF model.
In early 2019, the executive leadership of Chipotle Mexican Grill, Inc. (Chipotle), gathered to discuss the company's 2018 performance and align the company's capital structure policy and its growth aspirations going forward. Over the previous year, the company had enjoyed a lot of success. Its same-store sales had increased 6.1%, fueled by a 2% rise in traffic, and margins that had risen to nearly 19%, reaching gourmet restaurant levels. Chipotle's mission to deliver "Food with Integrity" resonated with its customers-primarily millennials, they valued quality over price and were constantly on the go with limited time to spare for eating. The company capitalized on healthy eating trends. Its recipes relied on just 53 ingredients that people could both recognize and pronounce and did not include any artificial colors or flavors. Chipotle successfully marketed its brand by utilizing digital channels and social media alongside traditional television events and sponsorships. Yet in the long term, the company still underperformed. Chipotle stock was $431 per share-about half of the $757 per share it had reached in August 2015. The company's roughly 7% margin was a far cry from its historical 18% levels. Only 83 new locations had opened in 2018, considerably fewer than the historical average of around 200 per year. Despite all the accomplishments over the last 12 months, the executive team continued to face pressure to increase the value Chipotle delivered to company shareholders.
As the cofounder and CEO of Whole Foods, John Mackey had spent the better portion of his life rapidly growing the company from a niche natural grocery store in Austin, Texas, into the premier natural-foods grocer in the United States. Highly regarded as industry leader, Whole Foods contributed to the explosion in health-conscious eating sweeping the country. But not all good things lasted forever. Whole Foods had been treading increasingly choppy waters since early 2014. Increased competition in the natural-grocery space and broader macroeconomic factors wore on earnings and contributed to lackluster stock returns. Investors were becoming increasingly frustrated with company's leadership team. By the end of April 2017, Whole Foods had received a number of inquiries from both strategic and financial buyers. A full-blown sale process was launched, and though tech giant Amazon entered the bidding war late, its offer was fast and decisive, not giving Whole Foods much time to contemplate or find a competing bid. Now Mackey faces a decision that will not only shape the fate of his company, but the broader direction of the grocery industry for years or even decades to come.
This case explores the considerations of an executive compensation analyst as he finalizes a report to the compensation and benefits committee of Charter Communications (Charter), a leading broadband and communications company, on the appropriate compensation structure for Charter's CEO, Thomas Rutledge. Charter's board clearly wanted to retain Rutledge, but in the world of executive compensation, it was not enough to have the biggest payment package. Proper incentives and moving performance targets were essential for companies that wanted their executives to strike the right balance between risky maneuvers and safe, consistent success. The analyst must be careful to cover all of his bases in his report, balancing outright monetary rewards with proper long-term incentives.
Founded in 2006, the B Lab, a nonprofit organization, created the certified B Corporations (B Corps). B Corps are businesses that satisfy a set of standards and benchmarks defined by social and environmental impact. B Corps and their supply chains are assessed on their policies and procedures around governance, workers, community, environment, and disclosures to the public. Certification means the company is a "purpose-driven" business that creates benefits for its stakeholders. By the end of 2018, over 2,700 companies across 60 countries and 150 industries have been certified as B Corps. This technical note discusses the founding of the B Lab and its certification process, including public disclosure; legal requirements and US state laws governing benefit corporations; and B Corp self-assessment. It explores benefits to B Corps and criticisms of the process as well as additional endeavors that resulted from the B Lab's collaborative efforts, including Global Impact Investing Network (GIIN), Impact Reporting and Investment Standards (IRIS), and Global Impact Investing Ratings System (GIIRS).