Garnett Jackson, the founder and CEO of Tech Tune-Ups, stared out the window as he finished his customary peanut butter and jelly sandwich, contemplating the dilemma currently facing his firm. Tech Tune-Ups is a start-up firm, offering a wide range of computer services to its clients, including online technical assistance, remote maintenance and backup of client computers through the Internet, and virus prevention and recovery. The firm has been highly successful in the 2 years since it was founded; its reputation for fair pricing and good service is spreading, and Mr. Jackson believes the firm is in a good position to expand its customer base rapidly. But he is not sure that the firm has the financing in place to support that rapid growth.
Tech Tune-Ups' main capital investments are its own powerful computers, and its major operating expense is salary for its consultants. To a reasonably good approximation, both of these factors grow in proportion to the number of clients the firm serves.
Currently, the firm is a privately held corporation. Mr. Jackson and his partners, two classmates from his undergraduate days, have contributed $250,000 in equity capital, largely raised from their parents and other family members. The firm has a line of credit with a bank that allows it to borrow up to $400,000 at an interest rate of 8%. So far, the firm has used $200,000 of its credit line. If and when the firm reaches its borrowing limit, it will need to raise equity capital and will probably seek funding from a venture capital firm. The firm is growing rapidly, requiring continual investment in additional computers, and Mr. Jackson is concerned that it is approaching its borrowing limit faster than anticipated.
Mr. Jackson thumbs through past financial statements and estimates that each of the firm's computers, costing $10,000, can support revenues of $80,000 per year but that the salary and benefits paid to each consultant using one of the computers is $70,000. Sales revenue in 2011 was $1.2 million, and sales are expected to grow at a 20% annual rate in the next few years. The firm pays taxes at a rate of 35%. Its customers pay their bills with an average delay of 3 months, so accounts receivable at any time are usually around 25% of that year's sales.
Mr. Jackson and his co-owners receive minimal formal salary from the firm, instead taking 70% of profits as a â€œdividend,â€ which accounts for a substantial portion of their personal incomes. The remainder of the profits are reinvested in the firm. If reinvested profits are not sufficient to support new purchases of computers, the firm borrows the required additional funds using its line of credit with the bank.
Mr. Jackson doesn't think Tech Tune-Ups can raise venture funding until after 2013. He decides to develop a financial plan to determine whether the firm can sustain its growth plans using its line of credit and reinvested earnings until then. If not, he and his partners will have to consider scaling back their hoped-for rate of growth, negotiate with their bankers to increase the line of credit, or consider taking a smaller share of profits out of the firm until further financing can be arranged.
Mr. Jackson wiped the last piece of jelly from the keyboard and settled down to work.
Can you help Mr. Jackson develop a financial plan? Do you think his growth plan is feasible? Specific calculations are not necessary, but you should describe any specific calculations one may use to assist Mr. Jackson.