Dr. Gertrude Stein has obtained a new patent for a material to be used in the wa

Question

Dr. Gertrude Stein has obtained a new patent for a material to be used in the wastewater treatment industry. Dr. Stein has been working for 10 years on her patent and is a tenured materials science professor at Hoboken University. Under the provisions of her contract, Dr. Stein is entitled to profit from her patent but she must pay the University a royalty of 4% of any sales related to the patent for the first 15 years she applies the patent and earns revenue. During the past two years, Gertrude has been working with the local United States Small Business Development Center, also connected with Hoboken U., to develop a business plan for her proposed company, Water Purity. The business plan shows that if the material can be manufactured at a competitive cost and that if it performs as promised, Water Purity will capture a very large share of the market and sales for the first six years of operation could exceed $30 million. The return on sales will be greater than 14 percent but Dr. Stein needs an initial investment of $2.4 million. Dr. Stein believes she deserves a large amount of any financial reward because of all the hard work she has invested. A large raw material processor have offered Dr. Stein the $2.4 million needed but need her to pledge all company assets as collateral and wants the money paid back in twelve equal payments over the first three years of operation plus 4% interest to be paid back in quarterly installments starting at the beginning of year two and ending at the end of year three. This processor also wants the right to buy up to 50% of Water Purity's output in the first five at a fixed price (still to be negotiated). A venture capitalist from Denver has offered to buy 45% of Water Purity in exchange for the $2.4 million. The venture capitalist wants to have two seats on the board of directors and an option to buy another 3% of Water Purity at a fair-market rate. Dr. Stein can also generate $1.8 million by using a home equity line of credit, cashing in a life insurance policy, liquidating all of her retirement investments, and agreeing to triple the royalty to Hoboken University. As Dr. Stein's favorite student, evaluate each option by creating as many calculations as you can. Also, suggest other potential financing options. At the end of the day, what recommendation do you have for Dr. Stein?

Explanation / Answer

Solution:

Option 1: Offer given by Hoboken University

Calculation

Sales for first 6 years = $30,000,000

For first 15 years = ($30,000,000 * 13)/6 = $65,000,000

Total amount that Dr. Stein is required to give back to the university = 4% of $65,000,00

= $2,600,000.

Option 2: Offer given by large raw material processor

Calculation

Amount repayable to the large material processor in addition to buying output at fixed price for first 5 years = Capital + interest = 1.04 * $2,400,000 = $2,496,000.

Option 3: Offer given by a venture capitalist from Denver

Option 4: Other alternatives

Evaluation of all the options

On close scrutiny, for all of the options above, Dr. Stein will end up paying back a lot more to the lenders.

Option 1: The University will take up more than the initial capital as royalty.

Option 2: The amount payable to the large raw material processor is also more. Pledging to sell products at a fixed price to the processor is actually a move which is not wise because the market conditions could fluctuate in a manner that does not favor the company and this could lead to great losses. This could as well limit the profitability of the company.

Option 3: This option would deny her the opportunity of having the freedom to grow her business in the ways that she would prefer. With 45% of the shares, it means that they will be involved totally in the decision making. This could have a negative effect in the long run.

Option 4: This is actually a wise move because after all, the money in excess will not end up benefitting anybody but herself.

Other Recommendations

However, there are various recommendations that could actually benefit Dr. Stein more. For instance, getting an angel investor to help out with her capital. Angel investors only require a suitable business plan which is promising. She already has this. In addition to that, these do not usually exploit their customers because their main aim is to see the investor to grow in the market. Once they are stable, they get back their full freedom and they are therefore able to develop the company in whatever way they deem fit.

Another suitable source of financing is a bank loan. With just the business plan and the promise for a better future, the bank is a good financing option. This is due to the fact that they have interest rates which are rather lenient, in addition to having a guarantee that the terms would not easily change, thus the reliability factor. Furthermore, with the bank, she would be able to choose a suitable payment plan for her loan.

Another source of finance which is very favorable for her is borrowing from family and friends. This offers room for flexibility in the repayment plan. This also translates to reduced interest payments if there are any.

Basically, it would be advisable to venture into those financing opportunities that are reliable and less exploitative.

Related Questions

Navigate

• Browse (All)
• Browse D
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.