Capital to finance an innovative new product

    How can a small company find capital to finance an innovative new product? Venture capitalist Kevin Semcken discovered Able Planet, a small startup in Wheat Ridge, Colorado, that produces headphones with an imbedded magnetic coil to enhance sound quality, at a technology conference in Denver, Colorado. Semcken, who suffers from a hearing loss in one ear, was intrigued and tested the small company’s product by listening to Dean Martin’s “You’re Nobody ’Til Somebody Loves You.” “I was instantly a fan,” he says. Semcken invested in Able Planet and soon became the company’s CEO and chairman. Two years later, the company’s unique noise-cancelling Linx headphones won an award for innovation at the Consumer Electronics Show, and orders began pouring in. In no time, the company’s annual revenue reached $2 million. Semcken was pleased with Able Planet’s progress, but he had a bigger vision for the company. Inspired by stents, balloonlike devices used in medical procedures to clear blocked arteries, Semcken came up with the idea of earphones that incorporated an inflatable disk that could conform perfectly to the size and shape of a person’s ear canal. The result would be a set of earphones that fit snugly into the ear canal, stay in place even during strenuous activity, and block out ambient noise. He even had a great name for the product: Sound Fit. Semcken saw the potential for Sound Fit not only to improve substantially the performance of earphones, but also to revolutionize the design of other products, such as Bluetooth headsets and hearing aids. He had lined up 30 potential customers who were interested in learning more about the innovative earphones and had convinced them to sign nondisclosure agreements. What Semcken needed now was financing so that Able Planet could manufacture production-quality prototypes of the Sound Fit earphones and generate orders. Then Able Planet’s banker called with bad news. The bank was changing the terms of Able Planet’s $2.5 million line of credit. Under the new terms, the bank would no longer finance the upfront cost of raw materials and manufacturing. Semcken was stunned because even though Able Planet was not yet cash flow positive, the company had always made its payments to the bank on time for the last 3 years. Without a flexible line of credit, Able Planet would not be able to purchase the materials and manufacture the headphones that its retail customers, including Costco and Walmart, demanded. The credit line restriction came at the worst possible time. Able Planet was gearing up for the late-spring graduation season, its second biggest sales period of the year after Christmas. The company normally cranked up production for the crucial back-to-school and Christmas seasons (which account for 60 percent of its sales) during the summer, but the bank’s new restrictions on its line of credit put its most lucrative sales seasons in jeopardy. Semcken met with Able Planet’s two board members, Rob Cascella and Steve Parker, both of whom are investors in the company. They advised him to put the Sound Fit earphones on hold for the time being and to focus on increasing sales of Linx headphones. Without a way to finance production of the headphones, however, Semcken knew that opening new retail accounts and increasing production would be impossible. He needed $1.5 million to finance current operations for Linx, build the Sound Fit prototypes, and market both products to new and existing customers. Semcken traveled around the country to call on 15 different banks, but none of them was interested in making a loan. A crisis in the financial markets had all but slammed shut the lending window at most commercial banks. Semcken pondered his options. Questions 1. Experts say that entrepreneurs who need between $100,000 and $3 million often face the greatest obstacles when raising capital for their businesses. Why? 2. How should Kevin Semcken raise the $1.5 million in capital that Able Planet needs? Be sure to consider sources of both debt and equity financing. 3. Write a short memo to Kevin Semcken explaining what he should do before he approaches potential lenders and investors to maximize his chances of getting the capital that Able Planet needs