Fiona Pham graduated from Central Washington University in 1994. She set to work opening a coffee shop in Tacoma called Blue Moon and found a perfect location in a new development. Using a $50,000 inheritance to finance the venture together with her own sweat equity, she started the business on August 1, 1996 as a sole proprietorship. The shop was profitable in the first year. Fiona found, however, that the quality of her coffee was not as high as she had initially envisioned. She discussed this issue with one of her regular customers, Melany Wyler. On the spot, Melany offered to help finance the purchase of a roasting machine. By roasting the beans herself, Fiona could produce higher-quality coffee and, in addition, expand the business by offering beans for sale.

Expansion.After looking carefully at the financials in 1997, Fiona determined that she would need an investment of $75,000 from Melany to undertake this expansion. In exchange for this investment, Fiona offered her a 40% share in the business. Melany accepted the offer and the business was incorporated with two owners. The equity consisted of 1,000,000 shares in total, with Melany owning 400,000 shares and Fiona owning 600,000 shares. By the end of the second year, the business was doing extremely well. Revenue from the sale of beans soon began to rival beverage sales. In response to this success, Fiona and Melany decided to expand to five stores over the next two years. Rather than using equity financing, they decided to seek bank financing. Each new store required an investment of $100,000. Opening the stores took longer than planned, but by the end of 1999, there were five Blue Moons in Tacoma employing 30 people. As planned, this expansion was financed solely with debt that was ultimately consolidated into a $500,000 term loan due in 2004.

Venture Capital.In early 2000, the two owners decided to take a weekend retreat and reevaluate their initial business plan. Perhaps the biggest surprise was the popularity of beans; almost 80% of revenue was attributable to bean sales alone. Furthermore, a buyer from a local supermarket chain had approached Blue Moon with a proposal to sell the beans in the chain's stores. However, Blue Moon was currently at its capacity limits-it could barely roast enough coffee for its five stores. More importantly, to enhance the coffee quality further, Fiona proposed that they buy beans directly from coffee farmers in Vietnam, where she would be able to monitor quality closely. However, the supermarket proposal would require a significant increase in the production of roasted beans. By the end of the retreat, Fiona and Melany had decided to change the focus of the business from retail beverage and bean sales to wholesale roasted coffee beans. Rather than build new stores, they decided to invest in a state-of-the-art roasting facility. In the next few weeks, Fiona approached White Knight Partners, a local venture capital firm. On the strength of the commitment from the supermarket chain to carry the coffee, White Knight agreed to invest $3 million to finance the construction of a high-capacity roasting facility in exchange for a 50% share of the company. To accomplish this, 1,000,000 new shares in Blue Moon were issued to White Knight.

Further Expansion.Fiona's intuition was correct-the quality of the coffee increased significantly. Within eight years, the company had grown to almost 200 employees and its strong reputation allowed it to sell its coffee for a 50% premium over other brands. To finance the expansion, White Knight made two more equity investments: It paid $4 million for 1,200,000 shares in 2003 and $8 million for 1,500,000 shares in 2006. Furthermore, the term loan was renewed for another five years when it came due in 2004, and in 2007 an additional 300,000 shares were issued to employees as part of their compensation.

IPO. At the beginning of 2008, the board of directors decided to expand the distribution of the coffee throughout the United States and finance this expansion from the proceeds of an IPO. The plan was to initially raise $20 million in new capital at the IPO and then, within a year of two, raise an additional $20 million in an SEO. White Knight planned on selling 10% of its stake in Blue Moon at the IPO and subsequently liquidating the rest of its investment by the end of 2009. The IPO was successfully undertaken in August 2008. All told, the company sold 2,000,000 shares for $12 per share at the IPO, including 10% of White Knight's stake (no other existing shareholder sold any shares at the IPO).

Case Questions

1. Melany is an example of what kind of an investor?

2. At each funding stage prior to the IPO (that is, 1997, 2000, 2003, and 2006) calculate the pre-money and post-money valuation of the equity of the company and fill in the blank below.

3. What fraction of the IPO was a primary offering and what fraction was a secondary offering?

4. Immediately following the IPO (same trading day), the shares traded at $14.50 at the closing price.

a. At this price, what was the value of the whole company (the sum of the book value of debt and the market value of equity) immediately following the IPO?

b. Expressed in percent, by how much was the deal underpriced?

c. In aggregate, how much did this underpricing cost all the selling shareholders?

d. Assuming that none of the owners purchased additional shares at the IPO, immediately following the IPO, what fraction of the equity did Fiona Pham own and what was it worth?

e. What was the company's debt-to-equity ratio-the ratio of the book value of debt outstanding to the market value of equity-immediately following the IPO?