Reference no: EM131058900

"When the Bank Cuts the Cord."

Read the case thoroughly.

In 150-200 words, briefly summarize the key points of the case.

Then, in 1-2 well-developed paragraphs each, address the three questions at the end of the case. Be sure to use specific terminology and concepts from the text chapters.

Finally, in 150-200 words, conclude the case analysis with any other recommendations that you can suggest.

QUESTIONS

1. Kevin Semcken identified some possible alternatives solutions to his financing problem. Did he come up with all alternatives, or can you think of more?

2. Do you agree with board members Rob Cascella, who told Kevin to concentrate on producing headphones and put off Sound Fit for later...or do you agree with Kevin, who sees Sound Fit as the future Able Planet? Defend your choice.

3. As a small business consultant, what would you advice Kevin Smecken do to guide Able Planet though its financial storm?

Case Study:

WHEN THE BANK CUTS THE CORD

Kevin Semcken was wandering the aisles and browsing the booths at a technology conference in Denver in 2004. At the time, he was the head of Health Tek Ventures, a venture capital firm in Evergreen, Colorado. Semcken came across a two- person start-up company named Able Planet with a promising idea- headphones embedded with a magnetic coil to enhance sound quality- but a lousy business. Since Semckenonly has partial hearing in his left ear, he was intrigued. He was hardly ever able to hear high-frequency sounds like those produced by cymbals. They guys at the Able Plant booth gave him two headsets- one with the coil and one without- while he listened to Dean Martin's "You're Nobody Till Somebody Loves You." When I switched to the Able Planet headphones, I could hear the cymbals, "says Semcken. "I was instantly a fan."

Being a venture capitalist, Semckenbelieved in the product so much he not only invested in Able Planet but also he eventually took over as CEO and chairman. In 2006, Able Planet's LINX headphones won an award for innovation at the Consumer Electronics Show. Soon, the calls began pouring in. By 2008, revenue had jumped more than 1,000 percent, to $2 million.

In the first week of January 2009, Semcken got a call that every small business owner dreads. The loan officer of the bank Able Planet used was changing the terms of the $2.5 million line of credit it provided to Semcken's Wheat Ridge, Colorado-based audio-equipment business.

Under the new terms, the bank would no longer provide funding for the cost of raw material and manufacturing. Able Planet had been a customer of that bank for almost three years and had never missed a payment. And though Able Planet was not generating a positive cash flow, Kevin was understandably stunned. Without those funds, he would have no way to pay for inventory demanded by retailers such as Walmart and Costco. "They waited to the last minute and dropped it on us, "Semcken says.

Up until the moment of that phone call, Able Planet's business plan had been fairly simple. The company used the bank line of credit to fund the manufacturing of Linx Audio headphones with a price range of $24 to $299a pair. For more than a year, Semcken had been using some of the funds generated by the headphones to produce more of them and some of it to develop a promising new technology.

The promising new technology was called Sound Fit, which would expand his product line beyond headphones-like hearing aids and Bluetooth devices. Sound fit is a listening device designed to fit snugly in the opening of the ear canal, eliminating nearly all ambient noise. Semcken got the idea for Sound Fit from a previous investment in a company developing a balloon-like stent that expanded and contracted to prevent debris from blocking small arteries during heart surgery. Semcken thought something similar could work for the ear. He urged Able Planet's audiologist to create an inflatable disk that could conform to the size of an individual's ear canal. Such a device wouldn't fall out during jogging or other activities like earbuds. They wouldn't rest awkwardly against the ear like Bluetooth devices. And Sound Fit would not require a costly fitting procedure like hearing aids.

Semcken had secured nondisclosure agreements from 30 potential customers for Sound Fits who were interested in seeing more. But before Semcken could move forward with any of these negotiations, he needed funds to create production-quality prototypes, as well as operating cash for the headphone business.

After Semcken finished the headphone conversation with his banker, he did what all good business owners facing a problem do: identify all his alternatives. A common funding source for manufactures is known as a factor. A factor loans against or purchases accounts receivable, but they charge a very high interest rates. He could shop for a less risk-averse bank. The company also had more than 20 angel investors who has recently kicked in $1.4 million. But that money was gone. What were the chances those investors would be willing to pitch in more so soon? Previously, Sound Fit potential customers might have been willing to fund the development of the prototypes in exchange for a sweeter deal in the event that the technology panned out. Five companies seem particularly hot on the product, but in a recession, none wanted any extra risk.

The timing of the bad bank news was especially unfortunate. High school and college graduation season was coming soon-one of the busiest times of the year. Following this, there would be back to school sales and the Christmas, which account for some 60 percent of annual sales. No money to fund production in January meant no significant revenue for almost the entire year.

Semcken sat down with two of Able Planet's board members, Rob Cascella and Steve Parker, both investors in the business. They advised Semcken to put Sound Fit on hold and redouble his efforts on Linx Audio. "When you're at the point where you're not generating operating cash flow," says Cascella, "you have to worry about today or you're not even going to be there in three years."

But Semcken wanted to continue negotiating with all 30 of Sound Fit's prospects. "The way you get a partner committed is out of fear they're going to lose it," he says. He was open to pushing Linx harder, but if he couldn't finance production of the headphones for existing customers, then expanding the line and finding new accounts would be out of the question. When he told Cascella and Parker that he wanted to ask Able Planet's other angel investors for a loan, they gave him the go-ahead. His offer: For every $100,000loan they guaranteed, investors would get warrants for 30,000 shares at $3 apiece. Within three days, Smecken had a dozen takers. A representative at U.S. Bank, where Semcken kept his personal account, offered to make the loans, but only up to a certain amount. Semcken was hoping to raise some $1.5 million this way.

Trying to cover all his financial bases, Semcken had been scrambling to find a replacement for the company's $2.5 million line of credit. He traveled around the country to meet with 15 banks-but none were yet stepping up.