Your assignment is to work on the Hello Alfred deal. The easiest way for you to get up to speed on what they do is to watch the first few minutes of their TechCrunch pitch at https://www.youtube.com/watch?v=xYKt5YgV0pk. Before we get into the nuts and bolts of your assignment, let me summarize what I have learnt about the company so far. The founders priced their subscription service to ensure accessibility. They initially experimented with a tiered pricing model, but ultimately settled on a single price of $99 per month. Later, in May 2014, they introduced a three-tiered pricing scheme, which they subsequently simplified to two weekly price points: a “Basics” offer of one visit (or “run”) per week for $32 or four visits for $128. Both included tidying up the home, delivering and unpacking any goods that had been ordered, and performing special tasks. In addition to charging a subscription, Hello Alfred earns a margin off the difference between the wholesale price vendors charged it and the retail price it charged its customers. As it grew, the company secured volume discounts for services. Profit margins are modest for some goods, like groceries. However, margins on other services are attractive, particularly when multiple vendors bid for Hello Alfred’s business. The company’s core offerings are groceries, dry cleaning and laundry, house cleaning, and dealing with packages. (See Exhibits 1a and 1b for service penetration and spending.) They also facilitate various home improvement tasks, such as wall-mounting a television. However, the company avoids undertaking tasks that are not widely sought by its customer base or for which no wholesale vendors existed, although they occasionally do so as a one-off courtesy. The company relies primarily on word of mouth, referrals, and public relations to gain customers. Existing customers can help build local density by referring neighbors. The company offers incentives, such as a free week’s service, for a successful referral. Alfred initiates service in a new neighborhood within a week if an aspiring consumer secures five other new customers in his or her building. Alfred services are also occasionally bought as gifts, such as a mother paying for an Alfred to ensure a newly employed child had healthy groceries and a clean apartment. It costs Hello Alfred about $100 to take on a customer—for the visit, data entry, etc. It did very limited online advertising through tools like Google AdWords. “Customers who have never heard of Alfred don’t imagine something like it is available,” Sapone noted. “No one searches for a service they were unaware exists.” Hello Alfred’s central dispatch, located near Union Square in New York, aggregates orders from the app. Those aggregated orders are assigned vendors such as Instacart, Dean and Deluca, and Fresh Direct. Instacart, for example, meets “Alfreds” (a.k.a. Alfred Client Managers or ACMs) on their runs to their various customers and delivers groceries to clients’ homes. By investing in technology, Beck noted that they have made scheduling “repeatable,” and that over time, patterns have emerged that allow Hello Alfred to execute much more efficiently. The time an ACM takes to complete each task at each stop (about 20 to 25 minutes) and travel time drives the economics of the business. That hinges on integrating customers’ orders and coordinating with on-demand vendors to ensure timeliness and accuracy. An experienced Alfred serves about a dozen clients in a day. The company estimates its direct costs at $223 per Alfred per day. Hello Alfred wants the client’s relationship to be with the company, not with the individual ACM. ACMs leaves a signed note after every visit that always features the name “Alfred.” There are no “forever ACMs.” Instead, they are rotated every few months. That prevents customers from bonding with specific Alfreds, a relationship that might be disrupted by vacation, maternity leave, or turnover. The firm captures the knowledge about specific client’s preferences, such as where towels go or how cupboards were stocked, to maintain continuity in service. 3 Customers proved to be comfortable once they had undergone their first ACM change. The company assigns less experienced Alfreds to more established routes and experienced ACMs to new buildings or accounts when possible. In 2014, Alfred customers spent roughly $350 per month, or $4,200 a year. In early 2015 customers spent between $320 and $450 per month. (See Exhibit 2.) Alfred projected a revenue opportunity of $36 billion, in the $227 billion market for household services. The potential profits to be made on top of these services varied. Observers estimated margins on grocery delivery to be 10% and margins on dry- cleaning delivery and laundry services, as well as household chores and light construction or contracting work, to be on the order of 50%. Hello Alfred currently operates in Boston and New York and has 2,400 active subscriptions and. Subscriptions are expected to grow at a 15% monthly rate during the next 12 months. Overhead costs currently run at $300,000 per month but the company plans to expand its geographic footprint over the course of the next five years. A new city will likely be staffed by 4 non-ACMs employees ((1) site manager to manage all employees and do B2B sales, (2) trainer/supervisor for the Alfreds, (3) coordinator with dispatch in NYC, and (4) jack-of-all trades to help with B2B sales and vendor relations). We don’t have much information on wages for non-ACMs but the standard assumption for this industry is that the annual fully-loaded cost of an employee is $150,000. The founders are concerned that Hello Alfred will require time to assemble service vendors in new locations, risking service breakdowns during that process. A similar concern is that it will take time to recruit and train new Alfreds. To mitigate those risks, Hello Alfred would beef up its team with in the areas of logistics, purchasing, and human resources. The all-in cost of the additions to the top management team would be $2 million and it would need to be put in place right away in order to gear up for expansion in a year’s time. Their financing history is easy to summarize. After Sapone’s initial attempts to attract VC funding were unsuccessful, she focused his efforts on angel investors. In October 2014, Hello Alfred completed a $315,000 seed round, selling 140,000 shares of common stock at $2.25 a share to a group of local investors. The seed round represented 7.8% of Hello Alfred’s equity. See Exhibit 3 for the pre–Series A capitalization table. Less than a year later, Hello Alfred was beginning to run low on funds and Sapone was forced to search again for funding. With funds growing short and negotiations still under way, we agreed in September of 2015 to offer Hello Alfred a $350,000 bridge loan until the terms of the Series A round could be finalized. The bridge loan, however, came at a steep price—it required repayment of $700,000 upon completion of a Series A round within six months.1 After a series of back-and-forths, in November 2015, we offered a term sheet for a Series A round to purchase $5.0 million in convertible preferred stock at $4.00 per share (Exhibit 4). The assumption is that bridge loan of $700,000 would convert into Series A shares at $4.00 a share rather than being repaid. Question #1 (20 Points) What is the expected annual value of a customer? 1 Bridge loans were a form of financing known as “convertible debt,” or loans that were initially debt that later converted into equity at the time of the next financing. If no financing materialized, the loan would not convert, but would still be senior to equity in the case of a sale or bankruptcy. Because the investment was in the form of debt, a valuation was not placed on the firm when it was used. Typically, bridge loans were not extended unless the venture capitalist was reasonably confident that a Series A round would be completed. In most cases, the investor was awarded extra compensation for providing the interim financing. The compensation could take the form of a discount (i.e., the loan converted at a discount to the new money raised in the round) or an investor could receive warrants with the right to purchase additional shares at a predeterminedprice. 4 Question #2 (20 Points) Project monthly cash flows during the next 12 months.If they were cover all their funding needs for the next 12 months with one round of VC, how much would then need to raise? Assume that WC and PPE are negligible. Question #3 (20 Points) What is the DCF value of Hello Alfred? Please make the following assumptions: 1. During the next 60 months, Hello Alfred isin a somewhat vulnerable competitive position, i.e. on each month, it has a 3.0% probability of falling prey to the likes of Amazon. 2. The monthly growth rate stays constant at 15% during the next 60 months by expanding into 25 new cities.At the end of year 5, Hello Alfred is likely to be sold to a strategic for 10 times LTM operating profit. 3. Returns are likely to be quite volatile (the annual standard deviation of rA is 60%). 4. The risk‐free rate is 2%, the market risk premium is 5%, and the CAPMβE≈2. 5. Trump does not get his tax plan approved (i.e. the corporate tax rate still is 35%). Question #4 (20 Points) Does the term sheet for the Series A round generally favor the Hello Alfred or us? Please cite specific terms and features of the contract to support your opinion. Question #5 (20 Points) Factoring in the 248,000 options not yet granted (see Exhibit 3), what is the pre‐and post‐money value if the offer is accepted as proposed?As a reminder, our most recent Wharton intern forgot to include the bridge loan in his calculations when working on a similar deal. He is no longer with us. 5 Question #6 (20 Points) What are the implications for us if another investor offers to provide Hello Alfred an additional $7.8 million in equity after the Series A round at a price of $3.00 a share?What’s the new post‐money value? Question #7 (20 Points) Ignoring dividends, what are the implications for us of having participating versus conventional liquidation preference if Hello Alfred issold for $15 million in three years?What are the implicationsif we have a participating liquidation preference and Hello Alfred is sold in an IPO for $50 million in three years? Question #8 (20 Points) Turn to the term sheet in Exhibit 4.Given your valuation work, is the preferred security priced fairly? Question #9 (20 Points) What adjustment in the conversion rate should we be prepared to concede if we insist on a 2X Liquidation Preference?