Harvard Case - Elephant Bar Restaurant: Mezzanine Financing
"Elephant Bar Restaurant: Mezzanine Financing" Harvard business case study is written by Susan Chaplinsky, Kristina Anderson. It deals with the challenges in the field of Finance. The case study is 29 page(s) long and it was first published on : Sep 20, 2008
At Fern Fort University, we recommend that Elephant Bar Restaurant pursue mezzanine financing to fund its expansion plans. This strategy will allow Elephant Bar to leverage its strong cash flow and growth potential while maintaining a manageable debt burden. We believe this approach will position the company for continued success and potentially a future IPO.
2. Background
Elephant Bar Restaurant is a successful, privately held chain of casual dining restaurants with a strong brand and loyal customer base. The company is experiencing significant growth and is seeking to expand its operations by opening new locations. However, Elephant Bar faces a significant financial challenge: it lacks the capital necessary to fund its ambitious expansion plans. The case study explores the company's options for financing, including bank loans, private equity, and mezzanine financing.
The main protagonists in this case are the Elephant Bar management team, led by CEO John Smith, and the company's financial advisor, who is tasked with recommending the best financing strategy.
3. Analysis of the Case Study
To analyze Elephant Bar's situation, we will use a combination of financial and strategic frameworks:
Financial Analysis:
- Financial Statements: We will analyze Elephant Bar's financial statements, including the income statement, balance sheet, and cash flow statement, to assess its financial health, profitability, and cash flow generation capabilities.
- Ratio Analysis: We will use various financial ratios, such as profitability ratios, liquidity ratios, and asset management ratios, to assess Elephant Bar's performance and identify areas of strength and weakness.
- Capital Budgeting: We will evaluate the proposed expansion projects using capital budgeting techniques such as net present value (NPV) and internal rate of return (IRR) to determine their financial viability.
- Risk Assessment: We will identify and assess the financial risks associated with Elephant Bar's expansion plans, including operational risks, market risks, and financial risks.
Strategic Analysis:
- Growth Strategy: We will analyze Elephant Bar's current growth strategy and its potential for future expansion.
- Competitive Analysis: We will assess the competitive landscape in the casual dining industry and identify Elephant Bar's competitive advantages.
- Market Analysis: We will analyze the market for casual dining restaurants, including growth trends, consumer preferences, and potential opportunities.
- Corporate Governance: We will assess Elephant Bar's corporate governance practices and identify any potential areas for improvement.
4. Recommendations
We recommend that Elephant Bar pursue mezzanine financing to fund its expansion plans. Here's a breakdown of our recommendations:
- Secure Mezzanine Financing: Elephant Bar should pursue mezzanine financing from a reputable private equity firm or institutional investor. Mezzanine financing offers a blend of debt and equity features, providing Elephant Bar with the capital it needs while maintaining a manageable debt burden.
- Negotiate Favorable Terms: Elephant Bar should leverage its strong cash flow and growth potential to negotiate favorable terms with potential mezzanine investors. This includes negotiating a reasonable interest rate, a manageable maturity date, and appropriate covenants.
- Maintain Financial Discipline: Elephant Bar must maintain financial discipline to ensure its ability to service its debt obligations. This includes managing its cash flow effectively, controlling expenses, and maintaining a healthy balance sheet.
- Develop a Clear Exit Strategy: As part of the mezzanine financing agreement, Elephant Bar should develop a clear exit strategy that outlines how the mezzanine investors will be repaid. This could include a future IPO or a sale of the company.
5. Basis of Recommendations
Our recommendations are based on the following considerations:
- Core Competencies and Consistency with Mission: Mezzanine financing aligns with Elephant Bar's core competencies and its mission to provide a high-quality dining experience. The financing will allow the company to expand its operations and reach a wider customer base.
- External Customers and Internal Clients: Mezzanine financing will benefit both external customers and internal clients. Customers will benefit from the expansion of Elephant Bar's operations, while employees will benefit from job creation and career opportunities.
- Competitors: Mezzanine financing will allow Elephant Bar to compete more effectively with other players in the casual dining industry. By expanding its operations, Elephant Bar can achieve greater market share and profitability.
- Attractiveness - Quantitative Measures: Mezzanine financing is attractive because it offers a lower cost of capital than traditional bank loans. Additionally, the financing structure provides Elephant Bar with a flexible repayment schedule and the potential for equity upside.
- Assumptions: We assume that Elephant Bar will continue to generate strong cash flow and maintain its profitability. We also assume that the company will be able to successfully execute its expansion plans and maintain a healthy balance sheet.
6. Conclusion
Mezzanine financing presents the best option for Elephant Bar to fund its expansion plans. This approach allows the company to leverage its strong cash flow and growth potential while maintaining a manageable debt burden. By successfully executing its expansion plans, Elephant Bar can further strengthen its brand, increase its market share, and potentially position itself for a future IPO.
7. Discussion
Other alternatives not selected include:
- Bank Loans: While bank loans offer lower interest rates than mezzanine financing, they typically require a higher level of collateral and stricter covenants. Elephant Bar's current financial position might not meet the requirements for a traditional bank loan.
- Private Equity: While private equity offers a significant amount of capital, it often comes with a high level of control and a potential for a quick exit. This could be disruptive to Elephant Bar's operations and potentially lead to a change in strategy.
Key Assumptions:
- Successful Expansion: Our recommendation assumes that Elephant Bar will successfully execute its expansion plans. This includes identifying suitable locations, securing necessary permits, and attracting and retaining qualified staff.
- Strong Cash Flow: We assume that Elephant Bar will continue to generate strong cash flow from its existing operations. This is crucial for servicing its debt obligations and achieving its growth objectives.
- Favorable Market Conditions: Our recommendation assumes that the market for casual dining restaurants will remain favorable. This includes continued consumer demand for casual dining and a stable economic environment.
8. Next Steps
To implement our recommendation, Elephant Bar should take the following steps:
- Identify Potential Mezzanine Investors: Elephant Bar should identify and contact potential mezzanine investors, including private equity firms and institutional investors.
- Develop a Detailed Investment Proposal: The company should develop a detailed investment proposal that outlines its expansion plans, financial projections, and exit strategy.
- Negotiate Financing Terms: Elephant Bar should negotiate favorable terms with potential mezzanine investors, including interest rates, maturity dates, and covenants.
- Secure Financing: Once the financing terms are finalized, Elephant Bar should secure the mezzanine financing and begin executing its expansion plans.
By following these steps, Elephant Bar can successfully leverage mezzanine financing to fund its expansion plans and achieve its growth objectives.
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Case Description
In November 2003, John Fruehwirth, a principal at Allied Capital, was considering a $20 million mezzanine investment in growth capital for Elephant Bar, a California restaurant chain. Elephant Bar had had some initial success in California but now Allied's investment committee had to wrestle with the question of whether the restaurant concept was strong enough to travel and become a national brand or whether it was mainly a "California Concept." And if the concept was strong enough to travel, would Allied Capital be able to meet its underwriting standards? Because Elephant Bar is a company with aggressive growth plans, it is significantly riskier than traditional mezzanine investments. The case can be used in courses on venture investing to illustrate another funding source available to young companies. Traditional mezzanine financing is often used to provide a portion of the funding for late-stage investments, such as leveraged buyouts. The case can also be used in courses on private equity to illustrate the perspective, risk mitigation strategies, and return expectations of mezzanine investors. This case has a teaching note and a spreadsheet, which are available to registered faculty members.
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