Crowdfunding Case Studies

Crowdfunding Example – Sleeping & Drinking – A Short Tale of Two Tries

Written by Bill Hubbard
(This discussion is not meant to and does not constitute any investment advice which advice must be provided solely  by a registered investment advisor or other legally qualified person to a client based upon his, her, or its particular situation. No person may rely upon the materials herein which are meant for general business discussion of regulated crowdfunding.)

Arianna Huffington effectively proselytizes about the need for 8 hours of sleep per night; Bill Maher echoes her calls for pitch-black bedrooms. Booker Beam passionately promoted the luxurious taste of oak-aged Bourbon. Elements of each can be found in (at least) two of the first 36 nationally regulated Crowdfunding Offerings: Native Hostel and Cleveland Whiskey.

While general business reviews for each can be found on the nascent subscription-based www.stratifund.com, to its, I’ll overlay a portion of my thinking about each.

Sleeping. Native Hostel’s Approach: Pay investors Off The Top– IF Everything Works As Planned.

Reading between the lines, it seems to me that its three seemingly talented, experienced, and connected Austin founders have a sound concept for a new type of hostel venue (combining the traditional with community, food and beverage, plus an outdoor event venue) in one of if not the best U.S. cities for their business experiment.

It also seemed they, having made a go of it in a predecessor entity about a year ago, needed, as a minimum (having ostensibly invested about $300k [not sure if all cash]) about a year ago, that they needed an additional $500k to qualify for a $2.8 million build-out and business loan to get Native up and running.

Their business solution: offer investors 5% off the top of all gross revenue received–whether for rooms, food, beverage, services, or outside or other event fees–until each investor received double his or her investment, PLUS they added some hostel-related perks for investing at different level.

Native Hostel is seeking its investors through the as-yet unverified-by-me registered portal, www.wefunder.com”; as of June 2; Broker-Check did not then show whether www.wefunder.com (through it’s portal company, Wefunder Portal, LLC) is FINRA registered.

Two comments–one minor, one major:

Minor. They might have made the perks more egalitarian for the average investor (e.g. if investing the average amount of what a U.K. investor has invested on the U.K.’s most popular site, www.crowdcube.com, about $2,500, equal or exceed the perks provided to the highest investor category) by providing a transferrable discount on room rates per stay–say, 7.5% per night exercisable at any time by the investor by designated immediate family members and friends up to x amount of stays.

Major. An investment would seem to offer an IRR of about 20% or better if it is in fact paid by the end of 4 years. While the document calls for such a payment–if it hasn’t been paid out long before– if the financial forecast and fairly hefty profit margin don’t happen, the SBA involved lender’s first lien will likely mean no payments to investors until it is repaid in full or until lending covenants are changed to permit payment to the crowdfunding investors off the top each month.

I didn’t see a reference to any SBA subordination (or what would be needed in all events to ensure payments of the crowdfund investor’s 5% beginning after the startup period–or, if such payments are initially permitted as long as there is no default in the underlying loan agreement(s)).

In light of the total leverage and despite the frequently detailed presentation (though it wasn’t clear, in the time I spent reviewing, if Other Fixed Costs was really meant to include General and Administrative Costs which otherwise was lacking, nor what sums, and incentives, would be paid to management, including the founders, and who, actually, would be managing the property), I would want some more questions answered.

That said, especially in light of the likely SBA personal guarantees by the founders to the bank and their respective community reputations, the proposal did not seem unfair to an investor. Thoughts of a relatively sound sleep would not seem unreasonable given a balance of the opportunity and the likely risks.

Drinking. Cleveland–a city which might come to be known for its whiskey–Cleveland Whiskey.

Crowdfunding is typically associated with start-ups with no operating history; it won’t be. Cleveland Whiskey is one of those businesses in which the founders have succeeded, at substantial personal costs and some government help, to get the business up and running. If they’ve done it right, they’ll see their market niche expand and be able to exploit their twist to develop and exploit their patented technology and trade secrets.

Cleveland Whiskey is seeking its investors through the as-yet unverified-by-me registered portal, www.wefunder.com; as of June 2nd, Broker-Check does not yet show whether www.wefunder.com (through it’s portal company, Wefunder Portal, LLC) is FINRA regulated.

While it lost over $500k in 2014, that had shrunk to about $100k for 2015. And it looks like it will both be profitable and growing its top line by over 30% of 2016– and be profitable. Moreover, CW states that in blind taste testings against Knob Creek, it won–54%–in a sample of over 3,500 tastes. It claims it’s process can both capture the Angels’ share (over 30% by volume) and eliminate the need for lengthy aging (using it’s patented temperature and pressure controlled processes).

The kickers and the Numbers

First, the kickers: it doesn’t satisfactorily narrate how the likely impact of the convertible debt is going to impact crowdfund investors. In short, it seemed to me if the Company sells (its targeting 3 to 5 years for an exit), if no conversion of the debt to equity, then the amount needed to payoff the two convertible notes goes to $1.25 mil from $500 k. If the debt converts, there goes $5 million of the sales price–yet the conversion terms, or likely effects, weren’t covered to my liking (though perhaps I missed it).

As to the numbers: the Company thinks it can quadruple sales to $8 mil in 4 years, $16 mil in 5, with ebitda numbers forecasted of $2 mil (25%) and $5 mil (30%), respectively. If one uses a customary 5 times ebitda multiple (as a conservative valuation if numbers are met) for sales of small middle-market companies without regard to any potential company and market-niche specific characteristics, that’s a potential sales price of $10 mil after 4 years, $25 mil after 5.

If one becomes aggressive–arguing it would then be trailing earnings, yet with expanding growth, brand recognition, technology advantages and the like–then one might look at a 10x ebitda multiplier. (No telling what the M&A market might then be–or the state of whiskey demand, though at this stage it looks like it will continue to expand).

Ok, so let’s assume, for talking purposes, 5x the 4 year ebitda figure on low side and 10 times the 5 year forecasted ebitda on the high (assuming sales will increase by a factor of 10 in the next 5 years, and profitability to about 30% of annual sales).This would result, on the low side, at a $10 mil enterprise value if Cleveland Whiskey would be sold as a business at a 5 times earnings of $2 million. It would result at a $50 mil enterprise value at the 10 times the $5 mil year five forecasted earnings.

So if, as a class, the crowdfunding shares would be, without any future dilution, about 10% of the net proceeds, then, at the $10 mil enterprise value I’d guess today’s crowdfund investors would lose money, getting back about $.70 for each dollar invested. (On a sale of a business, one typically need pay an investment banking fee, accounting and legal fees, pay off all debt and, usually, have a further subtraction from the sales price what’s known as a working capital adjustment. Plus, even without dilution due to share grants or options to management, there’s usually bonuses to management, sometimes non-management, all of which means the investors don’t see the full value themselves of the purchase price.)

This changes dramatically at a $50 mil enterprise value after 5 years. This would instead likely mean about $4.5 for each $1 invested in the crowdfunded interests, or over a 20% irr. And if the Canadian Whiskey management is right–higher multiples resulting in a yet higher price conceivably could apply (notwithstanding the small size of the company after 5 years contrasted with the companies referenced in Cleveland Whiskey’s discussion of the equity market).

Drinking, Sleeping, & Maybe Crowdfunding

You might consider sipping, over the weekend, on a shot of Cleveland Whiskey (available at Ezra’s in Chicago) and ponder its value proposition–and your and its prospects, as well as those of you might rest a bit when next in Austin.

About the author

Bill Hubbard

Business strategist and tactician focused on each client's "Next Level" achievements—after analysis of the business landscape and underlying complexity. Has historically served as outside trusted business advisor and general counsel to small and larger middle-market companies and their owners. Focuses on the crucial intersection of law, business, finance, taxes, risks, opportunities, emotions and decisions. Combines thorough analysis with instinct after thinking through various courses of action and their likely effects over time upon all stakeholders. Considers the needs of each client and the business—today’s and tomorrow's. While he has received some recognition, his focus remains on each client's successes.