SimStar Manufacturing Co. needs $ 500,000 to fund its growth opportunities. The founder of the firm has

Question:

SimStar Manufacturing Co. needs $ 500,000 to fund its growth opportunities. The founder of the firm has approached Morningstar Ventures (a Phoenix-based venture capital firm), which has expressed an interest in providing the financing if acceptable terms can be worked out.
The venture capitalist asked SimStar€™s CFO to provide an EBITDA forecast for the next five years. The forecast found below depicts the rapid growth opportunities the firm anticipates:

If the VC provides the needed funds, she will plan on an exit after five years, at which time she believes that the firm can be sold for six times EBITDA. Moreover, based on pro forma financials and the above projections, the VC estimates that SimStar will have approximately $ 1.2 million in debt outstanding, including $ 1 million in interest-bearing debt, at the end of the planned five-year investment. Finally, SimStar expects that it will have $ 200,000 in cash at the end of five years.
The VC is considering three ways of structuring the financing:
1. Straight common stock, where the VC receives no dividends for a period of five years but wants 49% of the firm€™s shares.
2. Convertible debt paying 10% interest. Given the change from common stock to debt, the VC wants only 30% of the firm€™s equity upon conversion in five years.
3. Redeemable preferred stock with an 8% dividend rate plus warrants for 40% of the firm€™s equity in five years. Moreover, the exercise costs for the warrants total $ 100,000. Note that because this is €œ redeemable preferred,€ the investor not only receives an 8% dividend for each of the next five years plus the face value of the preferred stock but can also purchase 40% of the firm€™s equity for $ 100,000. Which of the alternatives would you recommend that SimStar€™s founder select? Explain your decision.

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their... Face Value
Face value is a financial term used to describe the nominal or dollar value of a security, as stated by its issuer. For stocks, the face value is the original cost of the stock, as listed on the certificate. For bonds, it is the amount paid to the...