|DoDots Case Study Solution
Question - What are the pros and cons of debt financing for the
DoDots has multiple options to finance the company. One of the
options is to use debt financing. One of the pros to debt financing
is the timing. The timing was not right to have an initial public
offering. DoDots was too late for equity financing, the internet
stocks were not able to obtain the large equity amounts of internet
stocks from the previous year. Investors are not as interested in
IPOs of internet stocks, and that will make it difficult to raise the
true value of the company thru an equity offering. An equity offering
should be kept an option, just not at the current time, the option
should be kept open for the next couple years. History has proved
that it took until 2003 for the IPO market to heat back-up, and it
became very hot in the summer of 2004 with the Google IPO.
Another pro for the debt financing was the founders were able to
keep full ownership of the company. If they were to do a IPO, they
would lose the share of the company that they offer to the public,
diluting their ownership. It is a benefit to the founders to keep full
control of the company when it is in the start-up phase. There are
a lot of directions this company can go, and the founders will be
able to steer this company in the right direction.
One of the cons using debt financing for DoDots is the length of the loans are short. History proved that it was very difficult for internet
companies to become profitable in the short-term, so paying back loans in as short as 36 months may not be possible with out
obtaining more debt. The interest rates are very good for a start-up, DoDots will expect the annual interest rate to be around 10%.
It is also important for DoDots to keep an open line of credit with the bank, or with multiple banks, so they will have excess cash if
needed for growing the company. This proved to be a time of consolidation in the internet sector, and they will need to have cash on
hand in order to obtain companies if the right company is for sale at an extreme discount. They also need to have enough cash on
hand to thwart a buy-out.
The open line of credit is important if the company can not get a second round of financing. If they are able to keep the line of credit
open over several years after the original loan expires, they will be able to obtain financing thru the line of credit. But if the company is
successful, they will be able to obtain an additional loan, and the line of credit will not be necessary.
Another pro of debt financing is if they obtain enough debt financing for 3 years (the estimated amount of time needed for the
technology to reach the market), then they can cash out with an equity offer. This may be the best case scenario for the founders.
The founders would be able to steer the company thru the growth phase, then take the company public and cash out if needed.
However, that depends on if the company is successful.