Kamalesh Saha: MBAF 698 - Entrepreneurial Finance

Honest Tea
1. How is Honest Tea doing? Give me SPECIFICS.
Response: They are doing pretty well. Sales increased 349% between 1998 and 1999. However, sales
seem to be flat in 2000 (2 quarter results) which can be a result of the cold spell of 2000 December.
They invested a lot in R&D, SG&A, and Marketing activities in 1999 (explains their net loss) which is the
right strategy for a growing company since they want to take advantage of the growing market. The only
minor concern is their COGS is 60% and 58% of their sales in 1999 and 2000 respectively.

2. What does Honest Tea need to do to become a successful company?

Response: They should continue doing what they were doing successfully so far making a healthy
beverage, one that provides genuine natural taste without artificial sweeteners. They should look at the
organic bottled tea since it goes with the company objective. They should start looking different varieties
of tea on top of the 8 bottled varieties that already have. They should look at non-tea products as well,
lemonade for example. They should not go for venture capital firm initially and stick with individual
investors. They should avoid manufacturing the tea themselves and instead, should work on building
their brand.

3. How was the past financing structured between the founders and why?
Response: Honest Tea was launched with $300,000 start-up investment by Goldman and Nalebuff.
Though the founders had done a financial projection and were pretty confident of their success, they
were entering uncharted waters. The investors were not certain the company would take off since the
target market did not exist at that time. Thus the founders went ahead with warrants that will give them
greater fraction of the company if they did well. If they didnt do so well, the investors would own a larger
piece of the company. Since the funders were confident of their success, warrants made more sense.

4. Whom should Goldman and Nalebuff explore for financing in the current round?
Response: They should not go for the venture capital firm that offered them $5 million dollars with a
pre-money valuation of $5 to $7 million. The VC will get 40 to 50% of the company. They will be giving
up a major part of the company and also may have to compromise their principles as well. They need to
carefully explore taking funds from his customers. Even though the customers love the product and want
to invest, they may not have the financial knowledge of running a business and will need a significant
amount of handholding. The best option is to gather funds from angel investors who have some
knowledge in the industry. They will not only need less explanation, they can also help them in making
better business decisions.

5. Does the current proposed valuation by Goldman make sense and why? Why might it be
on the high side? (Use P/E and P/S ratios with the data given for other companies in the
industry.)
Response: The current proposed valuation of Goldman doesnt make sense. Its on the higher side.
The comparable for the 4 companies are as follow:
P/S
P/E
Avg P/S
Avg P/E
TRIARC COS INC
-0.195
-16.475
SARATOGA BEVERAGE
0.236
6.890
0.2275
6.895
NATIONAL BEVERAGE CORP
0.219
6.899
CLEARLY CANADIAN BEVERAGE INC
0.646
-2.382
Clearly Triarc and Clearly Canadian Beverage are not doing so well. Leaving them aside, Saratoga and
National beverage corp have almost identical P/E and P/S ratio. The average P/S and P/E ratio is
mentioned in the table above. In 2001, their projected earning is negative. In 2002, their projected
earning is $1,105,100. Thus the value of the company in 2001 is negative, while in 2002 it is around
$7.5 million ($7,619,664 = 6.895*1,105,100). Based on P/S ratio, their 2001 valuation ~= $1.9 million
and 2002 valuation ~= $3.6 million. This is much less than their post-money valuation of $15 million.
The venture capital firm offered to invest $5 million dollars with a pre-money valuation of $5 to $7
million. This gives them a post-money valuation of $10 to $12 million, which is also high looking at the
projected financials.

Kamalesh Saha: MBAF 698 - Entrepreneurial Finance

Takeaways:
- Value for H. T.: (1) New segment (concept), (2) Niche brand need for distribution. Valuation of $7.5
M based on average P/E ratio and earnings (Goldman said $15 M).
- VCs gave Pre-Money at $5 or $7 w/$5 M investment. Went with customers at 1.2 M/4 M valuation