Example
Fred B. is sitting at the kitchen table drinking coffee when his neighbor and friend, Spark A., walked in. He is holding a copy of the AVAV Inc.'s business plan. Fred had finished reading it a few days ago and had been mulling over its contents. "I've read this thing a few times, Fred, and I'm excited about it. Can we evaluate this business together so we can assess if it's the goldmine we've been waiting for?” Spark asked.
Both Fred and Spark are successful producers and very efficiency-conscious. They have been increasing their land base and their net income over the past decade even as many of their neighbors took off-farm jobs to subsidize the farm. The two friends constantly trade ideas and will often get together to discuss how to further improve their farm businesses. Spark's argument has remained unchanged for years: remaining in the commodity business will not change producers' financial well-being. Although Fred agreed with him, they have yet to find an initiative that will provide them with an escape from producing and selling commodities. The "Goldmine Project," is what they call the project they are looking for. The search has been ongoing for more than five years, with a simple objective of identifying an innovative business model that can provide them with sustainable net income enhancement and equity growth opportunities. Because of their passion for their current agricultural businesses, they have limited their search to value-added initiatives that will leverage the efficiencies they have built over the years.
"These AVAV people want to employ this technology from the university to substantially transform grains and oilseeds into a product that will replace an input that is currently being used in the cosmetic industry. You know how they say ethanol adds 30 cents to the bushel? These guys are projecting adding at least 70 cents to the bushel," Fred explained.
"Careful now . . .we need to understand the whole business and evaluate it dispassionately so we can assure ourselves that this is the Goldmine Project. You know how many people have come through this town selling us dreams," Spark cautioned.
The business plan has placed the AVAV's value at $2.7 million and the proponents were committing 30 percent of that value and were looking to raise the remaining 70 percent from no more than 50 producers. The producer-investors were required to contribute a cash investment of $1.89 million in addition to committing a total of 25,000 acres grain and oilseed production to the company. The business plan noted that cash investment will be tied directly to acreage committed, i.e., a producer-investor cannot invest more cash than the equivalent required acreage and vice-versa.
"What this means is an average of 500 acres per producer and $37,800 in cash," Fred indicated. "Do you have $37,800 to put in this?"
Fred explained to Spark that the AVAV business plan had indicated that the total valuation of the company was $2.7 million, and the proponents have invested $810,000 for 30 percent and were looking for $1.89 million in exchange for 70 percent. However, they also indicated that they want the $1.89 million to come from producers who are willing to commit a total of 25,000 acres of identity preserved production. "How much is that worth?" he asked.
Fred then argued that if each producer-investor incurs a cost of $5,000 in installing, collecting and transmitting the required IP data to AVAV, then that cost should be capitalized into their investment. If it costs an extra $250,000 for the producers to put the infrastructure in place to implement the required IP system, then the company's valuation should be $2.95 million, and not $2.7 million. This implies that the investment of the proponents is actually only 27.46 percent and not 30 percent, and the producers' investment is equivalent to 72.54 percent. This is non-trivial if growth is factored into the investors' expectation. If the company's value should grow to $25 million, then the 2.54 percent is equivalent to $635,000, or 33.5 percent of the investors' original investment cash outlay. This is simple valuation math that causes a lot of inattentive investors to subsidize their attentive partners.
"I keep telling you not to focus completely on the money. What's important is the return on the investment. This business evaluation will help us decide if this provides a better return on investment compared to what we are currently getting, or can get elsewhere. If we find out it provides a better return than what we know, then we look for the money to invest. If not, we learned something."
"Yeah, we will learn how not to throw our hard earned money away," agreed Fred. And they set out to work on the evaluation of the AVAV business plan.
The two friends started applying the AgbizSMART Evaluator® tool to the AVAV project, constantly referring to the business plan for answers to questions that came up. They also called researcher friends at the university to confirm some of the information that they were not sure of and discussed each of the indicators extensively to come up with their raw scores -ranging from zero to 10. As they input their raw scores, AgbizSMART Evaluator® calculated the weighted score and the attractiveness of the categories and the investment attractiveness index.
AVAV has a proprietary technology that will produce a high quality input for the cosmetic market. If this technology provides AVAV with production processes that are uniquely efficient, then it can enjoy a competitive advantage until a competitor figures out how to copy or duplicate the technology. AVAV can use its first-mover advantage to entrench itself in the marketplace, avoid direct competition and challenge threats more efficiently.
By seeking to secure 50 top producers as its investors, AVAV is attempting to create committed input suppliers. The geographic distribution of these producers will provide an indication of the input risk management strategies that AVAV is pursuing. AVAV indicated in its business plan that it has already signed a supply agreement with three major manufacturers to use its products in their manufacturing process. The commitment from major customers indicates a strong market access and the fact that it has three of them implies that it is not in a hostage situation with a single major customer. Thus, it has minimized its customer risk by seeking commitment from more than one customer.
Spark felt that they needed to find out from people who have dealt with the company's management team members to see if they have integrity and are trustworthy. "This seems like hard work," Fred noted. "It seems I have to go out and actually find out about these people before I make a decision to participate in this business." Spark looked sternly at him and asked, "How hard did you work to put $37,800 in the bank?"
When they were done, the AVAV investment had an attractiveness index of 835.50, which, according to AgbizSMART Evaluator® was “OK” (Figure 1). But it is right on the border between BAD and OK. "So, what do you think?" Spark asked Fred.
Figure 1: AVAV Inc. Evaluation by Sparks and Fred
"I think I've made a lot of mistakes in the past in where I've put my money. I'm not going to do the same with AVAV. It seems to have good management, but everything else is just OK. I don't think this is the goldmine," Spark concluded.
"You know the guys from Owen are also seeking investments? Maybe we should run their business plan through the AgbizSMART Evaluator® to see how it performs," suggested Fred. He pulled the Owen project's business plan and they started working on it with the same painstaking effort they had spent on the AVAV project. They called people, searched the Internet for research articles and government documents, and when it was all done, the Owen project's investment attractiveness index was 920, a "GOOD" investment attractiveness according to AgbizSMART Evaluator®.
"Looks clear to me where we should consider hanging our hats," Fred said.
"Yes, but we have to get other potential investors to use the tool and see how they come out. If they concur with our evaluation, then we know we have one that can be the goldmine. If there are significant differences between our index and theirs, then we need to discover where the differences are and educate ourselves some more so we don't lose our shirts this time around."
"Why don't you get the AgbizSMART Evaluator® to the other producers to help us evaluate our goldmine?"
And with that Spark packed his computer, drained the remainder of the coffee in his mug and stood up, with his hand outstretched to Fred and said "good night." He walked out to his truck and within moment, Fred could hear the roar of the engine from the kitchen. He made his way to the bedroom to look for his wife and business partner.