Abduction Productions


  Introduction

Paul McTaggart sat at his desk. Behind him, the computer screen flickered with the home page of his exciting new website: abductee.net. In front of Paul were two folders. One was clearly labeled "Bank", and contained a funding proposal from the Business Development Bank of Canada; the other was marked "Venture Capital", and held a proposal from a possible partner.

Paul knew he had to make a decision: which folder was he was going to go with. He had to make the decision soon if his website was going to be more than just a home page. However, neither of the folders contained the financing package he was looking for. Paul stared at the folders and thought back to the events that had led up to this moment of decision.

The Young Entrepreneur

When Paul McTaggart graduated from university in 1996, two of his instructors predicted he would be a millionaire by the time he turned thirty.

Although Paul's academic record was about the middle of the class, his record as a budding entrepreneur was truly amazing. Paul started his first business when he was in grade nine. By the time he graduated from high school, he had built this venture: Student Lawn and Yard Maintenance to the point where he had four employees. Paul's skill as a salesman and a promoter drove the growth of Student Lawn and Yard Maintenance. However, it was the operating systems Paul created for the business on his personal computer that drove the success of the venture. While other maintenance firms worked on an ad hoc basis, Paul created a complete lawn maintenance operating system. Paul's database tracked the frequency of mowing, the application of fertilizer, the watering schedules and the garden refuse removal. As a result, he was able to increase his customers' satisfaction by giving them a full and specific description of the work his crew had performed; and he was able to increase his profitability by accurately tracking his costs.

Paul's goal, when he entered the University of Victoria in 1992, was to learn about the use of computers in business. In his first year, he fit as many Computer Science courses into his schedule as he could. That summer, he got a job selling computer hardware and software. However, the most important thing Paul discovered that year was the internet. Through the university computer labs, Paul discovered he could send and receive e-mail around the world. More important, he discovered surfing the web using the new program created at the National Center for Supercomputing Applications at the University of Illinois. This program was called Mosaic, and Paul realized it was about to change the way the internet worked.

When Paul entered the UVic Commerce program, he knew his future in business would be tied to the internet. He set out to learn everything he could about networks. During his first coop term, Paul got a job working as a Computer Network Assistant at the university. When Netscape was launched by Marc Andreessen in 1994, Paul knew electronic-commerce was about to be born, and he wanted to be a part of it. Throughout the final two years of his commerce degree, Paul developed his skill as a network specialist and closely followed the development of the internet.

The Opportunity

Paul's business training had taught him the importance of developing a clear competitive strategy before pursuing a new venture. Paul remembered his professors pointing out there are three generic competitive strategies1. The first is cost leadership. In this strategy, the business does everything it can to produce goods or services at a lower cost than their competitors. Paul knew most examples of this strategy were large companies. He didn't think it was likely he could achieve cost leadership in a new, internet-based business venture. The second generic strategy is differentiation. In this strategy, the business creates a product that is perceived by customers to be unique in some way. This was the strategy which allowed Student Lawn and Yard Maintenance to charge a premium price for gardening services. The third generic competitive strategy is focus. In this strategy, the business identifies and serves the needs of a limited customer group or segment. Once the business has identified the group (or market segment) it is targeting, it can choose a cost leadership or a differentiation approach directed to this particular group.

Paul thought about the way commerce was likely to develop on the internet. He believed a focus strategy was probably best suited to this new media. The internet was full of special interest groups. From a business point of view, each of these interest groups was really just a self-selected market segment. Paul felt that if he could find a large interest group on the internet, whose needs were not being met, he would have found a self selected market segment; and a huge business opportunity.

Paul continued surfing the internet. He dropped in on chat groups and followed pointers from all kinds of sites. One day he happened onto a really cool site that had just been set up by NASA. Within the NASA site he found the Search for Extra-Terrestrial Intelligence (SETI) Institute. Paul had always been interested in the possibility of extra-terrestrial life, but had wondered about the scientific accuracy of most of the claims. This site was an eye-opener for Paul. Here was a government agency-supported site looking into the possibility of aliens2. A little more research led Paul to discover that 54% of all North Americans believe in the existence of extra-terrestrials3. Here was a huge untapped market.

Over the next few months, Paul kicked a series of ideas around with two of his friends. Together, the three young men created the outline for a website they thought would capture the interest of people who want to take part in the mystery of extra-terrestrial life.

Personal commitment

In the spring of 1996, Paul graduated from UVic with a Bachelor of Commerce degree in Entrepreneurship. He was offered a job as a marketing assistant with a national stock brokerage firm and accepted the position in spite of his desire to start the internet firm. Paul simply could not turn down the attractive salary, and the promise of interesting work in marketing. When he accepted the job, Paul thought this job might have enough security, prestige and challenge to satisfy him. If the job did not turn out to be satisfying, he would have time to build his business plan and enough money to launch his own business.

As much as he enjoyed the buzz of working in the securities industry, Paul could not stop dreaming about his internet business idea. In October of 1997, Paul quit his job to work full-time on the start-up of Abduction Productions.

While Paul was working as a stock broker, two of his friends had started up a web-design company: AtomicCrayon. Paul got together with Dale Campbell and Ryan Cawker and worked out a proposal for the development of his web site. The web site would be a simulation of an alien space platform. The web-surfer travels through the platform and is led to a room that offers a full line of products with an alien theme such as tee shirts, polo shirts, ball caps, wool hats, jewelry, models, posters and books. The three friends were excited about the potential of the site: Paul as a business venture and the two web designers as an artistic creation. All that was left was to raise the money to go ahead.

Developing a Business Plan

Paul had written several business plans as school projects, so sitting down to the task of writing out his ideas was not a big problem. Of course, Paul turned to the internet for help. On the net, he found a couple of free interactive business planning tools: the interactive business planner at the Canada/BC Business Service Centre and the Big Idea at the Royal Bank site. He also discovered that CIBC sold "Business Focus" a business plan writing software package at about one third the price of other business plan writing software packages such as PlanMaker, Business Plan Pro, and Biz Plan.

Paul began by outlining his vision. What Paul saw was the creation of a brand name "AbducteeTM " associated with extra-terrestrial products, entertainment and research. "AbducteeTM " will be to believers in extra-terrestrial life what Nike is to sports"4 The "AbducteeTM " logo would stand for mystery and quality. Paul envisioned a full line with the "AbducteeTM " logo.

Next, Paul outlined the overview of the company. The key to worldwide distribution of this line of products would be a powerful internet site and the use of international courier service. The beauty of e-commerce, Paul realized, was that he could build a virtual corporation: Abduction Productions. This global company could be operated out of the basement of his home. Paul saw his job was to act as the coordinator of a team made up of marketers, web designers, manufacturers, order fulfillment personnel, and support staff.

As Paul developed the marketing plan, he analyzed the industry and potential competitors. He developed a profile of his target market: individuals aged 18-45, with post-secondary education and family income over $40,000. He inferred that these consumers would be motivated to buy "AbducteeTM " products because they needed and wanted to be a part of something bigger than themselves5. Paul analyzed the strengths and weaknesses of his competitors' products, and concluded that "AbducteeTM " products had two decided advantages: a strong brand name and superior quality.

Finally, Paul laid out the next steps for the implementation of "Abduction Productions". Based on his strategic plan, he had to build the website, formalize his production processes and then publicize the "AbducteeTM " brand name like mad. First, he had to get the money to do all of that.

Paul sat down and worked out a set of pro-forma financial statements. The results can be seen in the Appendices.

Raising Capital

The pro-forma statements indicated Paul would need $85,000.00 to comfortably finance the new venture. He already had $20,000.00 in savings, so he knew he had to raise $65,000.00.

Debt

Paul remembered some of the basic ideas about borrowing money from his Business School classes; but to borrow that kind of money, he needed to talk to someone who really knew the way bankers worked. Paul contacted Chris, one of his classmates from UVic, who had taken a job as a manager-in-training at one of Canada's major chartered banks and invited him out for lunch. They met at one of Paul's favorite restaurants.

Paul felt comfortable asking Chris how he should approach the banks. "The thing you have to realize is that banks are not very keen on start-ups," Chris explained to Paul6. "Banks are low risk lenders, and they see start-ups as being inherently risky." He continued: "All bankers are restricted by the Bank Act, and by Lending Guidelines issued by the bank's credit departments...so you have to fit into their criteria."

"So how do I find out what the bank's loan criteria is?" asked Paul.

"In your case, Paul," said Chris, "the most important factor in getting a loan is going to be your personal creditworthiness. You have to rely on your past credit record, your personality and the strength of your proposal to the bank."

"But how do I know what my credit record looks like?" asked Paul.

"Most banks use the services of Equifax for credit reports. Equifax is huge: it has almost 1,500 employees across Canada." Chris explained. "They will send you a copy of your personal credit file if you write to them and enclose copies of two pieces of identification. I've got their address right here..." Chris said, and pulled out a rumpled business card. It read:

Equifax

Equifax Canada Inc.
Consumer Relations Department
Box 190 Jean Talon Station
Montreal, Quebec, H1S 2Z2
Fax: (514) 355-8502
Phone: 1 800 465-7166

"The big thing in banking today is credit scoring." Chris was getting heated up talking about the banks. Paul looked confused and asked, "What is credit scoring?"

"Credit scoring began with a company called Fair Isaac," Chris said pedantically. "A couple of former Stanford Research Institute researchers, Bill Fair and Earl Isaac, set up shop in 1956 with the idea of using computers to make credit risk decisions. Fair and Isaac used statistical analysis to determine what factors accurately predicted loan failure. They then built credit applications that tested for these factors, and applied their theories to the lending practices of several California financial institutions. The success of credit scoring has increased its accuracy. As more and more financial institutions take on Fair Isaac credit scoring, the size of the data sample gets larger and larger. A larger sample means increased accuracy."

Their meeting was drawing to a close but Chris hadn't finished yet. "I was reading a memo the other day about a study that talked about the three things most likely to cause a loan to be turned down. They were: not being a manufacturing firm, not doing personal banking where the business banking is being done and having experienced financial difficulty within the previous three years7." Paul thought about that and realized that at least he had two out of the three things going for him.

Preferred Lending

Paul went home from his meeting with Chris with a new vision of how he was going to raise the money to start Abduction Productions. If he matched his $20,000 of equity with a bank loan, he would still be short $40,000 from his target. The problem with raising equity is that he would have to share the profits of the company. The middle ground, he realized, was to find a source of funds that would allow him higher leverage.

Paul searched the web and found a couple of great sites that offered funding for technology firms, but Abduction Productions lacked the "product" focus to qualify for these grants and loans. However, in the process of searching, Paul came across a very unique resource: Canadian Youth Business Foundation. CYBF is a private foundation, sponsored by the Royal Bank and CIBC, which offers low interest loans of up to $15,000 to young (age 18-29) entrepreneurs. To qualify, candidates must have a sound business plan and agree to work with a mentor. From the web-site, Paul found the University of Victoria was providing the coordination of CYBF's loan program in the Victoria area and made an appointment to submit his application.

Paul brought two copies of his business plan, an unbound executive summary of his business plan and a letter outlining his proposal to the meeting. With the coordinator, he filled out a simple one-page application, and was told that the Loan Approval Team would review his case within the next week. CYBF applications are reviewed by a committee, which consists of volunteers from the local business community.

Two weeks later, two members of the Loan Approval Team met with Paul to review his application. One was a lawyer with a practice specializing in corporate law, the other was a local businesswoman. They went over Paul's business plan with him and pointed out several weaknesses. In particular, they suggested that Paul create best, worst and most-likely case scenarios of his cash flow projections.

A week after the meeting with the Loan Approval Team members, Paul received a phone call from the CYBF coordinator telling him that his loan had been approved. That afternoon, Paul met with the coordinator to fill out the necessary forms. Together, they worked through a list of prospective mentors and found a local businessman who had done a lot of work with internet companies. The coordinator arranged for an introductory meeting.

Paul now had $35,000 of the $85,000 he needed to start Abduction Productions. More important, he had an approved loan in his pocket. Now it was time to go to the bank.

Obtaining a Bank Loan

Paul followed the advice his friend Chris had given him. He phoned the main branch of one of the chartered banks and asked to speak to their technology specialist. He was connected to a Loans Officer named Jan, and made an appointment to meet with her the next day.

Paul prepared for the meeting by carefully packing his briefcase. He packed his laptop, which had a mock-up of the site loaded. He also packed a resume, personal financial statements, last year's tax statements, and a fresh copy of his business plan. Paul also took along his letter of acceptance from CYBF and a financing proposal. In this proposal, he asked for a term loan of $15,000 and line of credit of $20,000.

Paul felt that the meeting went well. He demonstrated his web site, filled in a loan application and agreed to a credit check. The experience with CYBF had helped prepare Paul for this meeting. The loans officer said that she would get back to him after she had reviewed the loan with the Manager of Commercial Lending.

Four days later, Paul still had not heard back from Jan, so he called to ask about the status of his loan application. He was surprised when she told him that his term loan had been turned down. However, the bank was prepared to issue Paul a personal credit line for his business. This loan was in the form of a special purpose card that had a $25,000 limit. The preferred credit line was at an attractive rate for new business loans: prime + 2%. (Prime is the rate that banks give to their very best big business customers.)

Paul was disappointed but accepted the offer. He now had $60,000 of his targeted $85,000.00. All that was left was to raise the last $25,000. He decided on a two pronged attack on this last amount. First, he would approach the Business Development Bank of Canada (BDC), and second, he would try to find a private investor.

Paul had discovered the BDC Young Entrepreneur Financing Program at the BDC web-site. Paul phoned and made an appointment with a loans officer at the local branch. Paul also made an appointment to visit Vancouver Island Advanced Technology Centre (ViaTec). ViaTech is a Victoria based high technology support organization which matches entrepreneurs to local investors (or angels, as they are referred to in the Venture Capital industry).

Paul's meeting with BDC did not go quite the way he had planned. Paul made the same presentation he had made to the chartered bank, and was surprised when the BDC loans officer requested an up-front service fee of $250 before evaluating Paul's loan request. Reluctantly, Paul agreed to pay the fee and was told the bank would have an answer to him by the next week.

Equity

Paul's meeting at ViaTec went much better. Here was a group that spoke the language of technology, so Paul could describe in some detail the complexities of the web-site he was building. At the end of the meeting, the ViaTec representative made a phone call to a prospective investor, and set up a meeting for Paul.

Two days later, Paul found himself in a Starbucks coffee shop going over his business plan with Jerry: a cool, forty-something veteran of several high tech start-ups. It was evident to Paul that Jerry really knew his stuff when it came to technology. He was well connected and was very interested in Paul's new venture. From the sleek BMW Z3 roadster that Jerry drove, it was evident to Paul that Jerry had done well for himself. Jerry explained that he started out in computers when mainframes were the only game around. His first real break came when he realized the dramatic change PCs would make to business. He and a group of friends built a software program for managing hotels and resorts. When the company went public ten years ago, Jerry put a cool million dollars in his pocket. Since then he had kept himself busy by finding and investing in high-tech start-ups. After an hour of conversation, Jerry turned to Paul and said: "Look Paul, I like what I see. I know the internet is going to revolutionize the way retailing is done. You're exactly the kind of young person who is going to make it big in this new field. I've got the resources, the connections and the business experience that I think you need to really make it work. Here's my proposal: I'll put up the remaining $25,000 for half the equity. If you're interested, I'll put my offer in writing."

Paul was surprised at the amount of equity Jerry was asking for in exchange for $25,000. He answered Jerry: "I've still got the BDC financing proposal out there. Why don't you write up your offer, and I'll give you an answer next Friday."

Debt or Equity

Now it was Thursday. In front of Paul were two folders. One was clearly labeled "Bank", and contained a funding proposal from the BDC. The other was marked "Venture Capital" and held Jerry's proposal. Paul stared at the folders. He had to make his decision tonight.

Paul opened the "Bank" folder, and re-read the funding proposal. The terms were steep: the loan was over 5 years at 5% above prime rate. In addition, Paul had to agree to purchase $3500 in consulting services, and pay a monthly service charge of $50. On the other hand, he would own all of the stock in Abduction Productions and so would make all of the profits if the venture was a success. Paul wondered if he really wanted to straddle his new company with a lot of debt and payments in excess of $1,000 per month?

Next, Paul opened the "Venture Capital" folder and re-read Jerry's offer. Half the company for $25,000 in equity. Jerry's money would be in the form of a shareholder's loan which had to be paid back before Paul could re-coup his own investment. And there was a buy-sell arrangement which laid out the conditions under which either shareholder could buy out the other. Paul knew that this offer would strengthen his financial picture…but did he really want a partner?

It was going to be a long night.

 

Paul McTaggart

Paul McTaggart


 

MULTIMEDIA AIDS
Abduction Productions

Abduction Productions

Canadian Youth Business Foundation

Canadian Youth Business Foundation

BDC

BDC

Chartered Banks

CIBC
Royal Bank
Scotia Bank
TD Bank

Chartered Banks

Venture Capital Firms

Western Technology Seed Investment Fund
Working Opportunity Fund

Venture Capital Firms


BIBLIOGRAPHY:

    Anthony, R. N. (1993). A Review of Essentials of Accounting. (5th ed.). Reading, Mass: Addison-Wesley Publishing Company.

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APPENDICES
( Download )

Appendix A

Application and Sources of Funds

Appendix B

Opening Balance Sheet

Appendix C

Cash Flow Projections

Appendix D

Pro-Forma Income Statement

Appendix E

Balance Sheet at End of Year

 

Footnotes
1 Hill & Jones 1995.
2 SETI was the inspiration for the movie: Contact. Based on the best-selling book by the late Carl Sagan, Contact presented audiences with a startling view of what contact with an intelligent extraterrestrial culture might be like. U.S. Congress eliminated SETI funding when Senator Richard Bryan of Nevada amended the NASA appropriation bill of 1994 to kill SETI. The SETI Institute continues in existence using private funding. The amendment saved one tenth of one percent of NASA's budget. NASA's budget is about 5% of what the U.S. spends on defense.
3 Globe and Mail, Truth is Out There, July 1, 1997.
4 Abductee Business Plan Copy #1, January 1998.
5 ibid
6 This material is taken from interviews with Bank officials who wished to remain anonymous
7 Riding, A., & Haines, G. H. (1994). The Canadian Small Business-Bank Interface: A Recursive Model. Entrepreneurship: Theory and Practice, 18(4), 5-25

This case was prepared by Brian McKenzie of University of Victoria for the Acadia Institute of Case Studies as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective management. Some elements of this case have been disguised.

Copyright 1999, the Acadia Institute of Case Studies, Acadia University. Reproduction of this case is allowed without permission for educational purposes, but all such reproductions must acknowledge the copyright. This permission does not include publication.