Jatin Koorgi, CFO of South Trading Ltd., is working on the financial plans and projections for his next board meeting. South Trading trades in coffee and tea produced across India, and is one of the world’s largest suppliers for multinational tea and coffee brands. It now plans to acquire coffee plantations in Asia, South America, and Africa and vertically integrate its supply chain. It is expected that this vertical integration will allow South Trading more control on the quality and supply of varieties of tea and coffee and charge premium prices for its products.

South Trading is expected to invest 6 billion in this plan. Jatin’s immediate task is to brief the board on the possible ways of raising this required capital for this expansion.

So far, South Trading has been operating as a private company, mostly using internal sources of capital and borrowing from its bankers to finance any capital investments.

Jatin has outlined two possible options for the board to consider.

Option 1: South Trading could approach its banker, DFHC Bank, with whom it has a long-term relationship. The firm has ongoing long-term loans with this bank and uses its seasonal credit lines for procurement on a regular basis.However, Rajesh Kumar, DFHC Bank’s representative to South Trading, has informed Jatin that it is unlikely for the bank to lend the entire sum of 6 billion to the firm.

Rajesh has further explained that DFHC will gather a group of banks and each bank will share a portion of that loan. As a condition to lending such a large sum, the group of banks will demand that South Trading limits further borrowing and provides DFHC with periodic financial disclosure so that the group of banks can monitor the firm’s financial condition.

Option 2: Jatin has contacted some of his friends in investment banking and they have suggested that South Trading can get converted into a public company and go for an IPO. Given the firm’s excellent financial performance, the IPO is expected to issue shares at a premium price and investors in the market are likely to purchase its shares readily.

In addition to raising capital, becoming a public company will also allow South Trading to start offering its shares as an incentive to its managers and employees in the form of stock options. This will create stronger incentives for managers to help the firm succeed. On the other hand, Jatin also knows that public companies are required to provide extensive disclosure to the stock exchange and general public, something South Trading has never needed to do. There are also some concerns that once the shares start trading in the secondary market, individuals or institutions with nefarious objectives may start accumulating these to take over control of South Trading.

TO DO

a. What are the benefits and drawbacks of Option 1? Prioritize what you have identified and explain the biggest benefit and the biggest drawback of this option.

b. Do the same exercise for Option 2.

c. Which option do you think Jatin should recommend to the board and why?