Youth Entrepreneurship Case
ABDUCTION PRODUCTIONS
For:
Youth Entrepreneurship Case Project
Acadia Institute of Case Studies
Acadia University
By:
Brian McKenzie BA, MBA
Faculty of Business
University of Victoria
PO Box 1700 Stn CSC
Victoria, B.C., V8W 2Y2
Phone: 250-472-4138
Fax:
250-656-7862
Acadia Youth Entrepreneurship Case
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THE CASE
Introduction
Paul McTaggart sat at his desk. Behind him, the computer screen flickered with the
home page of his exciting new website: abductee.net. In front of Paul were two folders.
One was clearly labeled "Bank", and contained a funding proposal from the Business
Development Bank of Canada; the other was marked "Venture Capital", and held a
proposal from a possible partner.
Paul knew he had to make a decision: which folder was he was going to go with. He
had to make the decision soon if his website was going to be more than just a home
page. However, neither of the folders contained the financing package he was looking
for. Paul stared at the folders and thought back to the events that had led up to this
moment of decision.
The Young Entrepreneur
When Paul McTaggart graduated from university in 1996, two of his instructors predicted
he would be a millionaire by the time he turned thirty.
Although Paul's academic record was about the middle of the class, his record as a
budding entrepreneur was truly amazing. Paul started his first business when he was in
grade nine. By the time he graduated from high school, he had built this venture:
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Student Lawn and Yard Maintenance to the point where he had four employees. Paul's
skill as a salesman and a promoter drove the growth of Student Lawn and Yard
Maintenance. However, it was the operating systems Paul created for the business on
his personal computer that drove the success of the venture. While other maintenance
firms worked on an ad hoc basis, Paul created a complete lawn maintenance operating
system. Paul's database tracked the frequency of mowing, the application of fertilizer,
the watering schedules and the garden refuse removal. As a result, he was able to
increase his customers' satisfaction by giving them a full and specific description of the
work his crew had performed; and he was able to increase his profitability by accurately
tracking his costs.
Paul's goal, when he entered the University of Victoria1 in 1992, was to learn about the
use of computers in business. In his first year, he fit as many Computer Science
courses into his schedule as he could. That summer, he got a job selling computer
hardware and software. However, the most important thing Paul discovered that year
was the internet. Through the university computer labs, Paul discovered he could send
and receive e-mail around the world. More important, he discovered surfing the web
using the new program created at the National Center for Supercomputing Applications
at the University of Illinois2. This program was called Mosaic3, and Paul realized it was
about to change the way the internet worked.
When Paul entered the UVic Commerce program, he knew his future in business would
be tied to the internet. He set out to learn everything he could about networks. During
his first coop term, Paul got a job working as a Computer Network Assistant at the
1
2
http://www.uvic.ca/
http://www.ncsa.uiuc.edu/
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university. When Netscape4 was launched by Marc Andreessen5 in 1994, Paul knew
electronic-commerce was about to be born, and he wanted to be a part of it. Throughout
the final two years of his commerce degree, Paul developed his skill as a network
specialist and closely followed the development of the internet.
The Opportunity
Paul's business training had taught him the importance of developing a clear competitive
strategy before pursuing a new venture. Paul remembered his professors pointing out
there are three generic competitive strategies6. The first is cost leadership. In this
strategy, the business does everything it can to produce goods or services at a lower
cost than their competitors. Paul knew most examples of this strategy were large
companies. He didn't think it was likely he could achieve cost leadership in a new,
internet-based business venture. The second generic strategy is differentiation. In this
strategy, the business creates a product that is perceived by customers to be unique in
some way. This was the strategy which allowed Student Lawn and Yard Maintenance to
charge a premium price for gardening services. The third generic competitive strategy is
focus. In this strategy, the business identifies and serves the needs of a limited
customer group or segment. Once the business has identified the group (or market
segment) it is targeting, it can choose a cost leadership or a differentiation approach
directed to this particular group.
Paul thought about the way commerce was likely to develop on the internet. He
believed a focus strategy was probably best suited to this new media. The internet was
3
http://www.ncsa.uiuc.edu/SDG/Software/Mosaic/NCSAMosaicHome.html
http://www.netscape.com/
5 http://www.dnai.com/~thomst/marca.html
4
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full of special interest groups. From a business point of view, each of these interest
groups was really just a self-selected market segment. Paul felt that if he could find a
large interest group on the internet, whose needs were not being met, he would have
found a self selected market segment; and a huge business opportunity.
Paul continued surfing the internet. He dropped in on chat groups and followed pointers
from all kinds of sites. One day he happened onto a really cool site that had just been
set up by NASA7. Within the NASA site he found the Search for Extra-Terrestrial
Intelligence (SETI) Institute8. Paul had always been interested in the possibility of extraterrestrial life, but had wondered about the scientific accuracy of most of the claims.
This site was an eye-opener for Paul. Here was a government agency-supported site
looking into the possibility of aliens.9 A little more research led Paul to discover that 54%
of all North Americans believe in the existence of extra-terrestrials10. Here was a huge
untapped market.
Over the next few months, Paul kicked a series of ideas around with two of his friends.
Together, the three young men created the outline for a website they thought would
capture the interest of people who want to take part in the mystery of extra-terrestrial
life.11
6
Hill & Jones 1995.
http://www.nasa.gov/
8http://www.seti.org/
9 SETI was the inspiration for the movie: Contact. Based on the best-selling book by the late Carl
Sagan, Contact presented audiences with a startling view of what contact with an intelligent
extraterrestrial culture might be like. U.S. Congress eliminated SETI funding when Senator
Richard Bryan of Nevada amended the NASA appropriation bill of 1994 to kill SETI. The SETI
Institute continues in existence using private funding. The amendment saved one tenth of one
percent of NASA's budget. NASA's budget is about 5% of what the U.S. spends on defense.
10 Globe and Mail, Truth is Out There, July 1, 1997.
11 http://www.abductee.net
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Personal commitment
In the spring of 1996, Paul graduated from UVic with a Bachelor of Commerce degree in
Entrepreneurship. He was offered a job as a marketing assistant with a national stock
brokerage firm and accepted the position in spite of his desire to start the internet firm.
Paul simply could not turn down the attractive salary, and the promise of interesting work
in marketing. When he accepted the job, Paul thought this job might have enough
security, prestige and challenge to satisfy him. If the job did not turn out to be satisfying,
he would have time to build his business plan and enough money to launch his own
business.
As much as he enjoyed the buzz of working in the securities industry, Paul could not
stop dreaming about his internet business idea. In October of 1997, Paul quit his job to
work full-time on the start-up of Abduction Productions.
While Paul was working as a stock broker, two of his friends had started up a webdesign company: AtomicCrayon.12 Paul got together with Dale Campbell and Ryan
Cawker and worked out a proposal for the development of his web site. The web site
would be a simulation of an alien space platform. The web-surfer travels through the
platform and is led to a room that offers a full line of products with an alien theme such
as tee shirts, polo shirts, ball caps, wool hats, jewelry, models, posters and books. The
three friends were excited about the potential of the site: Paul as a business venture and
the two web designers as an artistic creation. All that was left was to raise the money to
go ahead.
12
http://www.atomiccrayon.com/
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Developing a Business Plan
Paul had written several business plans as school projects, so sitting down to the task of
writing out his ideas was not a big problem. Of course, Paul turned to the internet for
help. On the net, he found a couple of free interactive business planning tools: the
interactive business planner at the Canada/BC Business Service Centre13 and the Big
Idea at the Royal Bank site.14 He also discovered that CIBC sold "Business Focus" a
business plan writing software package at about one third the price of other business
plan writing software packages such as PlanMaker,15 Business Plan Pro,16 and Biz Plan.
Paul began by outlining his vision. What Paul saw was the creation of a brand name
"Abductee" associated with extra-terrestrial products, entertainment and research.
"Abductee" will be to believers in extra-terrestrial life what Nike is to sports"17 The
"Abductee" logo would stand for mystery and quality. Paul envisioned a full line with
the "Abductee” logo.
Next, Paul outlined the overview of the company. The key to worldwide distribution of
this line of products would be a powerful internet site and the use of international courier
service. The beauty of e-commerce, Paul realized, was that he could build a virtual
corporation: Abduction Productions. This global company could be operated out of the
basement of his home. Paul saw his job was to act as the coordinator of a team made
up of marketers, web designers, manufacturers, order fulfillment personnel, and support
staff.
13
http://www.sb.gov.bc.ca/smallbus/cbcbsc/ibp.html
http://www.royalbank.com/business/tools/bigidea.html
15 http://www.planmaker.com/
16 http://www.palo-alto.com/businessplanpro/index.cfm
17 Abductee Business Plan Copy #1, January 1998
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As Paul developed the marketing plan, he analyzed the industry and potential
competitors. He developed a profile of his target market: individuals aged 18-45, with
post-secondary education and family income over $40,000. He inferred that these
consumers would be motivated to buy "Abductee" products because they needed and
wanted to be a part of something bigger than themselves.18 Paul analyzed the strengths
and weaknesses of his competitors' products, and concluded that "Abductee" products
had two decided advantages: a strong brand name and superior quality.
Finally, Paul laid out the next steps for the implementation of "Abduction Productions".
Based on his strategic plan, he had to build the website, formalize his production
processes and then publicize the "Abductee" brand name like mad. First, he had to
get the money to do all of that.
Paul sat down and worked out a set of pro-forma financial statements. The results can
be seen in the Appendices.
Raising Capital
The pro-forma statements indicated Paul would need $85,000.00 to comfortably finance
the new venture. He already had $20,000.00 in savings, so he knew he had to raise
$65,000.00.
Debt
Paul remembered some of the basic ideas about borrowing money from his Business
School classes; but to borrow that kind of money, he needed to talk to someone who
18
ibid
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really knew the way bankers worked. Paul contacted Chris, one of his classmates from
UVic, who had taken a job as a manager-in-training at one of Canada's major chartered
banks and invited him out for lunch. They met at one of Paul's favorite restaurants.
Paul felt comfortable asking Chris how he should approach the banks. "The thing you
have to realize is that banks are not very keen on start-ups," Chris explained to Paul19.
"Banks are low risk lenders, and they see start-ups as being inherently risky." He
continued: "All bankers are restricted by the Bank Act, and by Lending Guidelines issued
by the bank's credit departments…so you have to fit into their criteria."
"So how do I find out what the bank's loan criteria is?" asked Paul.
"In your case, Paul," said Chris, "the most important factor in getting a loan is going to be
your personal creditworthiness. You have to rely on your past credit record, your
personality and the strength of your proposal to the bank."
"But how do I know what my credit record looks like?" asked Paul.
"Most banks use the services of Equifax20 for credit reports. Equifax is huge: it has
almost 1,500 employees across Canada." Chris explained. "They will send you a copy
of your personal credit file if you write to them and enclose copies of two pieces of
identification. I've got their address right here…" Chris said, and pulled out a rumpled
business card. It read:
Equifax Canada Inc.
Consumer Relations Department
19
20
This material is taken from interviews with Bank officials who wished to remain anonymous
http://www.equifax.ca/default.htm
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Box 190 Jean Talon Station
Montreal, Quebec, H1S 2Z2
Fax: (514) 355-8502 - Phone: 1 800 465-7166
"The big thing in banking today is credit scoring." Chris was getting heated up talking
about the banks. Paul looked confused and asked, "What is credit scoring?"
"Credit scoring began with a company called Fair Isaac,21" Chris said pedantically. "A
couple of former Stanford Research Institute researchers, Bill Fair and Earl Isaac, set up
shop in 1956 with the idea of using computers to make credit risk decisions. Fair and
Isaac used statistical analysis to determine what factors accurately predicted loan
failure. They then built credit applications that tested for these factors, and applied their
theories to the lending practices of several California financial institutions. The success
of credit scoring has increased its accuracy. As more and more financial institutions
take on Fair Isaac credit scoring, the size of the data sample gets larger and larger. A
larger sample means increased accuracy."
Their meeting was drawing to a close but Chris hadn't finished yet. "I was reading a
memo the other day about a study that talked about the three things most likely to cause
a loan to be turned down. They were: not being a manufacturing firm, not doing
personal banking where the business banking is being done and having experienced
financial difficulty within the previous three years.22" Paul thought about that and
realized that at least he had two out of the three things going for him.
21
http://www.fairisaac.com/
Riding, A., & Haines, G. H. (1994). The Canadian Small Business-Bank Interface: A Recursive
Model. Entrepreneurship: Theory and Practice, 18(4), 5-25
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Preferred Lending
Paul went home from his meeting with Chris with a new vision of how he was going to
raise the money to start Abduction Productions. If he matched his $20,000 of equity with
a bank loan, he would still be short $40,000 from his target. The problem with raising
equity is that he would have to share the profits of the company. The middle ground, he
realized, was to find a source of funds that would allow him higher leverage.
Paul searched the web and found a couple of great sites that offered funding for
technology firms,2324 but Abduction Productions lacked the "product" focus to qualify for
these grants and loans. However, in the process of searching, Paul came across a very
unique resource: Canadian Youth Business Foundation.25 CYBF is a private
foundation, sponsored by the Royal Bank and CIBC, which offers low interest loans of
up to $15,000 to young (age 18-29) entrepreneurs. To qualify, candidates must have a
sound business plan and agree to work with a mentor. From the web-site, Paul found
the University of Victoria was providing the coordination of CYBF's loan program in the
Victoria area and made an appointment to submit his application.
Paul brought two copies of his business plan, an unbound executive summary of his
business plan and a letter outlining his proposal to the meeting. With the coordinator, he
filled out a simple one-page application, and was told that the Loan Approval Team
would review his case within the next week. CYBF applications are reviewed by a
committee, which consists of volunteers from the local business community.
23
http://www.sfu.ca/~mvolker/biz/moneylnk.htm
http://strategis.ic.gc.ca/sc_mangb/sources/engdoc/homepage.html
25 http://www.cybf.ca/main.htm
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Two weeks later, two members of the Loan Approval Team met with Paul to review his
application. One was a lawyer with a practice specializing in corporate law, the other
was a local businesswoman. They went over Paul's business plan with him and pointed
out several weaknesses. In particular, they suggested that Paul create best, worst and
most-likely case scenarios of his cash flow projections.
A week after the meeting with the Loan Approval Team members, Paul received a
phone call from the CYBF coordinator telling him that his loan had been approved. That
afternoon, Paul met with the coordinator to fill out the necessary forms. Together, they
worked through a list of prospective mentors and found a local businessman who had
done a lot of work with internet companies. The coordinator arranged for an introductory
meeting.
Paul now had $35,000 of the $85,000 he needed to start Abduction Productions. More
important, he had an approved loan in his pocket. Now it was time to go to the bank.
Obtaining a Bank Loan
Paul followed the advice his friend Chris had given him. He phoned the main branch of
one of the chartered banks and asked to speak to their technology specialist. He was
connected to a Loans Officer named Jan, and made an appointment to meet with her the
next day.
Paul prepared for the meeting by carefully packing his briefcase. He packed his laptop,
which had a mock-up of the site loaded. He also packed a resume, personal financial
statements, last year's tax statements, and a fresh copy of his business plan. Paul also
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took along his letter of acceptance from CYBF and a financing proposal. In this
proposal, he asked for a term loan of $15,000 and line of credit of $20,000.
Paul felt that the meeting went well. He demonstrated his web site, filled in a loan
application and agreed to a credit check. The experience with CYBF had helped
prepare Paul for this meeting. The loans officer said that she would get back to him after
she had reviewed the loan with the Manager of Commercial Lending.
Four days later, Paul still had not heard back from Jan, so he called to ask about the
status of his loan application. He was surprised when she told him that his term loan
had been turned down. However, the bank was prepared to issue Paul a personal credit
line26 27 for his business. This loan was in the form of a special purpose card that had a
$25,000 limit. The preferred credit line was at an attractive rate for new business loans:
prime + 2%. (Prime is the rate that banks give to their very best big business
customers.)
Paul was disappointed but accepted the offer. He now had $60,000 of his targeted
$85,000.00. All that was left was to raise the last $25,000. He decided on a two
pronged attack on this last amount. First, he would approach the Business Development
Bank of Canada (BDC), and second, he would try to find a private investor.
Paul had discovered the BDC Young Entrepreneur Financing Program at the BDC website28. Paul phoned and made an appointment with a loans officer at the local branch.
Paul also made an appointment to visit Vancouver Island Advanced Technology Centre
26
27
http://www.cibc.com/needs/business/BusinessConvenience.html
http://www.royalbank.com/business/services/credit_line.html
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(ViaTec)29. ViaTech is a Victoria based high technology support organization which
matches entrepreneurs to local investors (or angels, as they are referred to in the
Venture Capital industry).
Paul's meeting with BDC did not go quite the way he had planned. Paul made the same
presentation he had made to the chartered bank, and was surprised when the BDC
loans officer requested an up-front service fee of $250 before evaluating Paul's loan
request. Reluctantly, Paul agreed to pay the fee and was told the bank would have an
answer to him by the next week.
Equity
Paul's meeting at ViaTec went much better. Here was a group that spoke the language
of technology, so Paul could describe in some detail the complexities of the web-site he
was building. At the end of the meeting, the ViaTec representative made a phone call to
a prospective investor, and set up a meeting for Paul.
Two days later, Paul found himself in a Starbucks coffee shop going over his business
plan with Jerry: a cool, forty-something veteran of several high tech start-ups. It was
evident to Paul that Jerry really knew his stuff when it came to technology. He was well
connected and was very interested in Paul's new venture. From the sleek BMW Z3
roadster that Jerry drove, it was evident to Paul that Jerry had done well for himself.
Jerry explained that he started out in computers when mainframes were the only game
around. His first real break came when he realized the dramatic change PCs would
make to business. He and a group of friends built a software program for managing
hotels and resorts. When the company went public ten years ago, Jerry put a cool
28
http://www.bdc.ca/
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million dollars in his pocket. Since then he had kept himself busy by finding and
investing in high-tech start-ups. After an hour of conversation, Jerry turned to Paul and
said: "Look Paul, I like what I see. I know the internet is going to revolutionize the way
retailing is done. You're exactly the kind of young person who is going to make it big in
this new field. I've got the resources, the connections and the business experience that I
think you need to really make it work. Here's my proposal: I'll put up the remaining
$25,000 for half the equity. If you're interested, I'll put my offer in writing."
Paul was surprised at the amount of equity Jerry was asking for in exchange for
$25,000. He answered Jerry: "I've still got the BDC financing proposal out there. Why
don't you write up your offer, and I'll give you an answer next Friday."
Debt or Equity
Now it was Thursday. In front of Paul were two folders. One was clearly labeled "Bank",
and contained a funding proposal from the BDC. The other was marked "Venture
Capital" and held Jerry's proposal. Paul stared at the folders. He had to make his
decision tonight.
Paul opened the "Bank" folder, and re-read the funding proposal. The terms were steep:
the loan was over 5 years at 5% above prime rate. In addition, Paul had to agree to
purchase $3500 in consulting services, and pay a monthly service charge of $50. On
the other hand, he would own all of the stock in Abduction Productions and so would
make all of the profits if the venture was a success. Paul wondered if he really wanted
to straddle his new company with a lot of debt and payments in excess of $1,000 per
month?
29
http://vvv.com/viatec/
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Next, Paul opened the "Venture Capital" folder and re-read Jerry's offer. Half the
company for $25,000 in equity. Jerry's money would be in the form of a shareholder's
loan which had to be paid back before Paul could re-coup his own investment. And
there was a buy-sell arrangement which laid out the conditions under which either
shareholder could buy out the other. Paul knew that this offer would strengthen his
financial picture…but did he really want a partner?
It was going to be a long night.
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MULTIMEDIA AIDS
Abduction Productions
http://www.abductee.net
Canadian Youth Business Foundation
http://www.cybf.ca
BDC
http://www.bdc.ca/site/index.html
Chartered Banks
http://www.cibc.com/index.html
http://www.royalbank.com/english/kbi/indexhtml
http://www.scotiabank.com/
http://www.tdbank.ca/tdbank/indexjava.html
Venture Capital Firms
http://www.ventureswest.com/vw/
http://www.westernseed.com
http://www.wofund.com/wof/
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BIBLIOGRAPHY:
Anthony, R. N. (1993). A Review of Essentials of Accounting. (5th ed.). Reading,
Mass: Addison-Wesley Publishing Company.
Balderson, D. W. (1998). Canadian Entrepreneurship and Small Business
Management. (Third ed.). Toronto: McGraw-Hill Ryerson Limited.
Beckman, M. D., Kurtz, D. L., & Boone, L. E. (1992). Foundations of Marketing.
(Fifth Canadian ed.). Toronto: Dryden Canada.
Bellan, S. (1995). Small Business and the Big Banks. Toronto: J. Lorimer.
Eckert, L. A., Ryan, J. D., Ray, R. J., & Knowles, R. A. (1995). Canadian Small
Business: an Entrepreneurs Plan. (Second ed.). Toronto: Harcourt Brace & Company.
Fisher, R., & Brown, S. (1988). Getting Together Building Relationships as We
Negotiate. New York: Penguin books.
Fisher, R., & Ury, W. (1991). Getting to Yes Negotiating Agreement Without
Giving In. (Second Edition ed.). New York: Penguin Books.
Gallander, B. (1988). The Canadian Small Business Survival Guide. Willowdale:
Hounslow Press.
Gray, D. A., & Gray, D. L. (1998). The Complete Canadian Small Business
Guide. (Second ed.). Toronto: McGraw-Hill Ryerson.
Hill, C. W. L., & Jones, G. R. (1995). Strategic Management: An Integrated
Approach. (Third ed.). Boston: Houghton Mifflin Company.
Manley, J., & Martin, P. (1994). Growing Small Businesses. Ottawa: Industry
Canada.
McCarthy, E. J., Shapiro, S. J., & Perreault, W. D. (1992). Basic Marketing. (Sixth
Canadian ed.). Boston: Irwin.
McGuckin, F. R. (1997). Business for Beginners. Toronto: Productive
Publications.
McMullan, W. E., & Long, W. A. (1990). Developing New Ventures The
Entrepreneurial Option. Orlando: Harcourt Brace Jovanovich.
Riding, A., & Haines, G. H. (1994). The Canadian Small Business-Bank
Interface: A Recursive Model. Entrepreneurship: Theory and Practice, 18(4), 5-25.
Stanley, T. J., & Danko, W. D. (1996). The Millionaire Next Door: The Surprising
Secrets of America's Wealthy. Atlanta: Longstreet Press.
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Ury, W. (1993). Getting Past No Negotiation Your Way from Confrontation to
Cooperation. New York: Bantam Books.
Vesper, K. H. (1996). New Venture Experience. (Revised ed.). Seattle, Wa.:
Vector Books.
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APPENDICES
Appendix A
Application and Sources of Funds
Appendix B
Opening Balance Sheet
Appendix C
Cash Flow Projections
Appendix D
Pro-Forma Income Statement
Appendix E
Balance Sheet at End of Year
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