Mad Vlad Microbrewery

Mad Vlad Microbrewery is owned by Sam and Sadie, craft brewers. They began producing their special brand of craft beer in Transylvania County. When they were getting started, Mad Vlad was produced in a small facility owned by a family member with production primarily sold in their hometown. Over time, as the craft beer industry grew, and microbreweries were in increasing demand, Sam and Sadie began to expand in response to demand for their product.

Within the last two years, Mad Vlad relocated to a small business incubator facility in Raleigh, the state capital. Mad Vlad had to move to the incubator because they had landed a contract to supply a local grocery store with six locations in the state. Over the past several months, Sam and Sadie have been working to obtain contracts for distribution through Ingles Stores, a larger regional grocery store with two hundred locations. Recently, Ingles contacted Sam and Sadie with the good news that their stores will begin to distribute Mad Vlad products.

In order to meet the production demands of the new regional grocery store, Sam and Sadie will need an additional capital infusion of $38,500 just to meet demand. They are concerned 1) for the next couple of years while they increase production their available cash will just barely meet their operating needs, and 2) that they will have other needs for financing in about three years (related to updating their production equipment). They talked about selling additional stock, but Sadie has a controlling interest (51%) and no additional capital. She fears that if they sell more stock, she will lose her control in the company. So, they have decided to forego issuing more stock and to consider their debt options.

Sam and Sadie have done some of their research and come up with the following options. First, Mad Vlad can issue a 4-year, $46,800 zero-interest bearing note to Simpson Company. Mad Vlad would receive $38,500 for the note when issued. Alternatively, Sam and Sadie can go to their primary bank, Origin Bank, and borrow $38,500 at 4.5% for 4 years. Origin Bank has insisted on debt covenants related to working capital and prohibiting additional debt with which Mad Vlad would have to stay compliant. As a related party, Simpson Company, has no similar requirement.

Sam and Sadie are very confused about their options. Their biggest concerns are controlling their cash flow and their expenses to that their financial statements remain as healthy as possible. Please write them a memo that answers the following questions and provides your recommendation to them:

1. What is a zero-interest bearing note? Isn’t that automatically better than a note borrowed from a bank?

2. What does either option do to the income statement? What about cash flow?

3. The bank mentioned debt covenants. What does that mean to Sam and Sadie?

4. What is the better option for Mad Vlad?