Melodies on the Web Case Study
Since her childhood, Sarah Jackson had passion for music and wanted to be an entrepreneur helping
young, talented youth get exposure to potential audience. During 2013, she felt that her professional career was stable enough and decided to launch her own venture, ‘Melodies on the Web’(MOW), without quitting per permanent job. The concept was to have her own radio station on the ‘Patreon1’, web portal. ‘Patreon2’, was launched in the same year and was becoming very popular, hence was her preferred media.
On the ‘Patreon’ portal, Sarah, would lease her own bandwidth and have her own radio station. She would identify talented youth and invite them to perform musical activities like singing, playing instruments etc. She would also focus on digital marketing so that a growing number of listeners would continue to tune in to her radio station. Once they listened to the new talent, their interest in them would grow. They would then be given an option to move on to a second, subscription-based channel providing enhanced content, where they can join for a subscription and continue to enjoy the music of their favourite artist.
Since the business idea was new, Sarah was unable to find business partners or investors. She decided to invest her own savings of $60 000. Most of this amount was allocated towards digital marketing channels. The business model was a service based one, hence there was no necessity to invest in fixed assets. Sarah began bootstrapping her business towards end of 2013. She did not draw any salaries and focussed on growing her business instead.
Fast forward to 2018. Sarah’s vision yielded strong results. At the of December 2018, her operating statistics were as follows:
• Combined subscriber base (both paid and unpaid): 40 000
• Subscriber base – paid: 8 000
• 2018 revenue: $ 800 000
• Year over year subscriber growth: 24%
• Subscriber conversion from unpaid to paid: 20%
• Number of artists on the platform: 120
• Growth rate of artist acquisition: 15%
During Christmas break, Sarah was preparing her Operating Plan for the period 2019-2022. She realized that to implement her plan several strategic issues needed to be addressed and decided to seek help from Conestoga Consulting Group.
You are the consultant from Conestoga Consulting Group and allocated to work with Sarah. You have just held your first meeting with her. You are reviewing your meeting notes and see the following:
• To maintain the growth momentum, MOW can no longer be a bootstrapped venture and it needs to change its structure from Sole Proprietorship. The question is to decide between converting MOW to either a Partnership or a Private Corporation. Sarah would like to know the features of both these forms and like you to make a recommendation that is a good fit with her business.
• She has not prepared any financial statements since starting her venture and inquired as tom why they were necessary? You explained to her the concepts of external and internal users of financial statements and what each user would need the financial statements for? Following the entity change, as proposed above, she would like you to prepare a list of both internal and external users and what their potential interest would be in Financial Statements of MOW.
• Sarah feels that she may need to raise capital soon. Her options are to borrow funds as a loan from BDC (Business Development Corporation)3, or issue shares and raise equity capital. You explained to her about ratio analysis and trend analysis, which caught her attention. Specifically, she would like to know the ratios which the lender (BDC) would be interested in and the ratios a potential shareholder would look at before considering
investing in MOW?
Your next meeting with Sarah is in two weeks. Prepare a memo, addressed to Sarah, with your analysis of the above discussion points.
Memo to Sarah
TO: Sarah
FROM: Conestoga Consulting Group
DATE:
SUBJECT: Addressing Melodies on the Web Strategic Issues (MOW)
Selecting the appropriate Form of Business
From the previous week’s meeting, I noticed that MOW had performed well in the past years, and is expected to continue earning more revenues if the current rate of growth is maintained. However, its growth has reached a point where it cannot continue operating as a sole proprietorship; it can be either Partnership or Private Corporation. Before deciding which form of business to adopt, it is essential to understand the features of each.
Partnership
- It is a co-owned business comprising of two or more partners.
- The partners in the business share profit and loss based on the capital contribution ratio.
- Partnership business is based on the contractual agreement and the parties to the contract must be competent and capable. The agreement could be implied, written or oral.
- It is a form of business that involves agency relationships; that is, a partner is an agent of the business as well as other partners.
- The business lacks separate legal entity, and as such, it does not have perpetual life since incapacitation, bankruptcy or death of one of the partners leads to its termination.
- Since partnership lacks a separate legal entity, partnership faces unlimited liability whereby when the business assets are not sufficient to meet the obligations, the partners’ properties are used.
Private Corporation
- A private corporation or company can raise capital by issuing shares.
- The company’s shares are not traded on public exchange markets.
- The law restricts the number of shareholders for a private company to fifty.
- Members of the private company enjoy limited liability, meaning their personal property cannot be used to pay up business debts.
- It is a legal entity business, meaning it is separate from its shareholders and owners, and it is recognized by law as an artificial person.
- Private company enjoys perpetual succession, meaning that the death of the member does not affect its continuity.
Having compared the features of the two business forms above, a private corporation will be the most appropriate for your case. Although a private company will require more capital than the partnership business, the profit will be high. The private corporation also enjoys perpetual succession, limited liability and it is a separate legal entity.Financial Statements Preparation and Users
From further analysis of your business, I noticed that you do not prepare financial statements. Financial statements are essential in highlighting the financial position, financial performance and the liquidity of the business. Now, having suggested Private Corporation as the appropriate venture for your business case, it is crucial to prepare financial statements for both internal and external users. They both use financial statements information to make decisions.
Internal Users
- Managers use the financial statement to make decisions such as borrowing or investment.
- Employees would like to gauge their performance against the company’s financial results.
- The owners of the business would like to know whether management has executed its duties appropriately.
External Users
- Investors use financial reports to decide whether to invest in a particular company.
- Creditors and lenders use the financial statement to assess whether a business entity qualifies for a loan.
- Government units such as Tax Authorities use financial statements to ascertain the tax payable.
- External auditors use financial statements to arrive at an audit opinion.
- The general public, including economic analysts, journalists, academics and other individuals use annual reports information to assess the positive impact of the company on the society.
Raising Capital: Borrowing versus Share Capital
Finally, I noticed that you want to raise capital either by borrowing from Business Development Corporation (BDC) or through the issuance of shares. If you decide to borrow, BDC will be interested with the following ratios from the financial statements:
- Debt-to-Equity Ratio for comparing business assets with its debt.
- Operating margin to determine the company’s profit when compared to total sales.
- Current ratio to measure the liquidity of the company.
- Leverage ratio to assess the ability of the company to repay a loan.
- Free cash flow to sale ratio to evaluate the ability of the company to make loan repayments.
Potential shareholders will consider the ratios presented below:
- Net profit margin to know how much profit the company makes.
- Price-to-earnings ratio to measure the company’s share price compared to its earnings per share.
- Price-to-book value ratio to compare the business’s market price to its book value.
- Price/Earnings growth ratio to find the correlation between stock price, earnings per share and the business’s growth.
- Return on equity ratio to know overall earnings and what shareholders will gain from the investment.
- Dividend yield ratio to establish earnings from the investment.