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Kudler Fine Foods

Virtual Organization Strategy: 'Kudler Fine Foods'

Abstract

Kudler Fine Foods is a privately held company and that it wants to expand its operations. The organization is faced with three options to finance this expansion. It can either go public through an IPO or it can obtain debt from one of the local banks or it can use internal financing such as private savings of the owner or retained earnings from the business. Each option has its own unique strengths and weaknesses. Kathy Kudler will have to look at each strength and weakness and identify which is ideal to her business and situation.

Kudler Fine Foods

An organization is faced with many options in the course of expanding its operations. Each option has unique costs and benefits that affect the organization according to different circumstances it faces. In this paper I will compare and contrast three options that the organisation 'Kudler Fine Foods' can use in order to achieve successful expansion.

One option 'Kudler Fine Foods' can explore, is to go public through an IPO. This requires it to float its shares on a particular stock exchange and sell them to the mass public. In order to take this step, 'Kudler Fine Foods' has to first hire an investment bank who will underwrite the issue. Underwriters like Goldman Saks, Merrill Lynch, Morgan Stanley, etc, are basically middlemen between the company and the investing public. For a handsome fee, they guide the company through the IPO process. Once a deal is negotiated with the investment bank, the company files a registration document with the Securities and Exchange Commission (SEC). If the company has proved to fulfill all the requirements of the SEC, then the company's shares are floated on the exchange.

Another option 'Kudler Fine Foods' can explore is to obtain debt financing. This would require it to contact some of the local banks in order to get a loan. The loan has to be a long-term loan as it will most like take 'Kudler Fine Foods' a long time to pay it back. Since the required amount will be quite large, the banks might be slightly hesitant and might require the company to put up collateral as well as show detailed company histories & other supporting documents to ensure that 'Kudler Fine Foods' will be able to repay the loan with interest.

The last option that 'Kudler Fine Foods' has is to use internal financing. This comprises of using retained profits accumulated over the years or using private funds. If Kathy uses retained earnings of the business then the amount of money available for expansion will depend on the amount of profit from previous years. Kathy Kudler may also be willing to put her savings into the business to expand.

All the options available to Kathy Kudler have their own distinct strengths and weaknesses. If Kathy chooses to 'go public' through an IPO, she will have to pay the substantial fee of an investment bank which is a considerable weakness of this approach. The amount to be paid depends on the type of underwriter hired and the quality of the deal negotiated. For example in a 'best efforts' agreement, the underwriter promises to try to sell the shares of the company to the public but does not guarantee the number of shares sold, whereas in a 'firm commitment' the underwriter guarantees the amount to be raised through the sale of shares. So for a slightly higher fee, Kathy will know exactly how much money she can raise through the IPO. In addition, Kathy will also have to fulfill the strict requirement of the SEC before they will be allowed to list their shares on the stock exchange and become a public company. Public companies are subject to strict rules & regulations and they must report their results every quarter. This means that the company must incur the additional expense of going through the right accounting channels to publish reports quarterly. 'Kudler Fine Foods' will be subject to increased scrutiny by its various stakeholders. In addition, all the stakeholders of the company can access relevant and material information about the company, including investors, shareholders, employees and competitors. Public companies are also subject to takeover as anyone can buy the shares of the company. Even if Kathy Kudler maintains a controlling interest in the company, another person will be able to exercise significant influence if he/she buys a certain percentage of shares through the stock exchange. Despite these disadvantages, 'going public' can also be an extremely good thing. The first strength is that it will allow Kathy to raise a considerable amount of capital. This might be quite useful as Kathy has already opened three stores and might have depleted other sources of funds in financing those. The next strength is related to the prestige and publicity of being listed on a major stock exchange. Only companies with strong fundamentals qualify for an IPO on a major stock exchange and Kathy could gain immense respect from her family, friends if she manages to get listed. Public companies can usually get better rates when they issue debt; this is because they are subject to increased scrutiny as a result of publishing quarterly accounts, abiding by the rules of the SEC and by having experienced accountants check their financial reports and documents. Large Public companies also have the benefit of attracting better talent then private companies. This is because they are usually able to offer their employees better packages and things like employee stock ownership plans. Another strength of this approach is that dividends do not have to be declared by the company. Hence Kathy is not obligated to give shareholders a return on their investment if profits are not up to the mark.

Kathy Kudler can also think about obtaining debt financing from a bank. The strengths of this approach are that she cannot lose control of her company whereas with 'going public' she is subject to this risk. Obtaining debt financing ensures that control stays with the owners of the company which is important as Kathy need not consult any other shareholders before making any major decisions regarding the company. The banks have no voting rights at Annual General Meetings of the company. Another strength of this approach is that loans do not represent permanent liabilities to the business: they will eventually be paid back. Kathy can choose when she wants to repay the loan, whereas shares represent permanent blocks that cannot be bought back without the permission of the shareholder. A weakness of this approach is that interest payments have to be made regularly on time. Kathy cannot decline to make interest payments if profits are low. A bank can also ask a business for collateral, which represents business assets or personal assets that back the borrowed money. These business or personal assets can then be sold by the bank to get back their money in the case of a business declaring bankruptcy. The bank also has the power to place a business into bankruptcy if it defaults on debt interest or repayments or its prospects decline.

Kathy also has the option of using her private savings or using retained profits from previous years in order to fund the expansion. A strength of this approach is that she won't increase the debt of her company nor will she lose control by issuing shares. If she believes her business is doing well and has good prospects, then putting her savings into the company will not be a sacrifice; rather, she will earn good returns on her capital. Although, an obvious weakness of this approach is that Kathy might not have enough private savings or retained profits to plough into the business to fund expansion. This is very likely as she might have used all her savings and retained profits to fund previous expansions and maintain the business in good standing.

Hence, Kathy can choose any of the abovementioned options to fund the expansion. The option she chooses depends on the relative strengths and weaknesses of each. It also depends on her objectives, whether she wants to retain control or whether she's more comfortable in incurring debt. It also depends on the amount needed to fund the expansion; it will be difficult to obtain a large amount to fund expansion from private funds and retained earnings. Kathy also needs to decide how quickly she will need the finance and the length of time of the requirement of finance. For example if she needs the money immediately then private funds and retained earnings will be a better option. In addition, if Kathy deduces that the amount of time for the requirement of finance is longer than any bank allows, she will have to choose to 'go public'. The amount of risk involved in the company expansion will also affect the decision for the type of finance used. External sources of finance (banks) will not provide money for projects which they deem are too risky, it will also be difficult to convince an investment bank to back an IPO if they deem the project to be risky. Therefore, Kathy needs to take all these particulars into account before making an informed decision about the type of finance to obtain.

References

Hall, D. Jones, R., & Raffo, Carlo. Business Studies: Third Edition. UK: Causeway Press LTD.

Investopedia (Ed.). IPO Basics: What is an IPO?. http://www.investopedia.com/university/ipo/ipo.asp. Retrieved

August 19, 2008 from the internet.

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