BACKGROUND

Honest Tea (HT) is a three year old start up that has taken advantage of a gap in ready to drink beverages market in order to introduce high quality, organic bottled tea and whole-leaf teabags in U.S. The firm has tremendous growth potential and needs additional finance to sustain its operations and fund growth to capture market share by leveraging its competitive advantage.

ISSUE OF WARRANTS

Goldman and Nalebuff were the founders of HT and invested $300,000 at the beginning. Additional fund-raising activity involved offering shares to friends, family and a small group of investors and these issued shares were accompanied by warrants. Exercise of warrants was subject to company’s performance, in the event when projections were not met; then investors would gain additional share of the equity. Warrants held by the founders were exercisable at higher prices than share prices paid by other investors, therefore founders backed their projections by warrants. Warrants eliminated potential valuation disagreements and enabled the founders to obtain finance relatively quickly at attractive prices without the loss of significant equity in the firm. If these warrants were not employed then the finance raised would have been at much higher cost and at loss of significant share of firm’s equity.

PREFERRED INVESTORS FOR CURRENT ROUND

Firm needed an additional $2 million to fund investment on new distribution channels, acquire sales team, purchases marketing and merchandizing materials and finance operating losses before becoming profitable after one more year of operations. A VC firm offered to invest $5 million that would quickly solve financial constraints. This option had the benefit of significant time savings enabling the management to concentrate on expansion and strategic planning. Backing of a renowned VC firm would enable rapid expansion but the deal had significant drawbacks. HT had strong brand image as a socially responsible company and its goals were not aligned well with those of VC’s; HT currently needed $2 million and investment of $5 million would be wasteful and a large portion of equity would be forfeited as a cost of this financing. Loss of control over strategic decision making as a result of significant VC representation on board of directors was also undesirable.

Investors’ Circle (IC) was a group of angel investors who invested in socially responsible start-ups, which made HT ideal for investment. HT’s mission and IC’s investment philosophy would complement each other perfectly. However IC would only provide one quarter of total investment of $2 million needed by HT. However if IC agreed to invest according to the valuations provided by HT then this would enable the firm to raise the desired equity at attractive prices and other investors would be more willing to invest with IC on board. None the less, this option would likely take significant time and effort that has the potential to distract management from day to day operations and decision making.

Overall investment by IC and angel investors is more attractive strategically and finance would be raised at attractive prices without significant loss of equity. A diverse set of investors with a lead investor would also provide representation on board of directors and valuable ..............................

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This case is making Seth Goldman and Barry Nalebuff, founders of Honest Tea. Honest Tea is the launch of ready-to-drink tea market. Goldman and Nalebuff have to work out the expansion and financing strategies. "Hide
by Paul A. Gompers Source: Harvard Business School 29 pages. Publication Date: Mar 08, 2001. Prod. # 201 076-PDF-ENG