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KEL565

©2011 by the Kellogg School of Management at Northwestern University. This case was developed with support from the December 2009 graduates of the Executive MBA Program (EMP-76). This case was prepared by Matt Bell and Scott T. Whitaker ’97 under the supervision of Professor James B. Shein. Cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. To order copies or request permission to reproduce materials, call 800-545-7685 (or 617-783-7600 outside the United States or Canada) or e-mail [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Kellogg School of Management.

JAMES B. SHEIN

Jonathan Miller: Custom Energy Bar Entrepreneur Pitches Sharks

Jonathan Miller was nervous. A serial entrepreneur, he was no stranger to pitching potential investors, but today, September 13, 2009, was different. Miller had traveled to Los Angeles to raise money to grow Element Bars, his year-old energy bar business.

He had never met the five people in the next room, but he knew them by reputation. They were experienced entrepreneurs and investors who were tough questioners and even tougher negotiators. Miller knew he would need to stay calm and rely on his preparation and previous experience to get the money he needed without giving up too much.

When he got the signal from the assistant he walked through a set of double doors, down a short hallway, and through another set of double doors into the bright lights of the set of the reality television show Shark Tank.

The Birth of Element Bars

Miller created his first company, the textbook discounter GetCheapBooks.com, in 1999 when he was an undergraduate at Northwestern University and sold it in 2009. In 2008, while a student at the Kellogg School of Management at Northwestern University, he founded TrueYardage, a company that manufactured software that enabled golfers to use their GPS-enabled smartphones to accurately measure the distance between them and the pin for which they were aiming. Miller’s entrepreneurial acumen, presentation skills, and ability to defend TrueYardage in the face of judges’ questions earned him first place in the Kellogg Cup, the school-wide business plan competition featuring fifty teams and more than two hundred competitors. His victory earned him $7,000 cash, which he planned to invest in his next start-up, Element Bars.

Element Bars had been born out of Miller’s personal interest in healthy energy bars. He often snacked on energy bars, but was frustrated that they were made from unhealthy ingredients that left him feeling tired a couple of hours after consumption.

Determined to find a healthier solution, in 2005 he began using all-natural and organic ingredients to make his own bars, which he found much more effective at keeping his energy level up.

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

JONATHAN MILLER: ENERGY BAR ENTREPRENEUR KEL565

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At the end of 2007, his wife, Jennie, was completing a fellowship at the University of Chicago Medical School, where she worked with diabetic children. When a co-worker, Maria, heard about Miller’s custom energy bars, she asked Jennie if her husband could create bars specifically designed for diabetic children. In particular, Maria was interested in energy bars that contained raisins. When Miller heard that Maria wanted raisins, his first reaction was that he did not like raisins himself. His next thought—what he later called “the raisin moment”—was, “Make exactly what people want.”1

Miller’s experience had taught him that an entrepreneurial venture needed three things to succeed: personal passion, market need, and a point of differentiation. He was already a passionate consumer of energy bars. Given the rapid growth and eventual sale of natural energy bar and health food companies such as Humm Foods (maker of LaraBar nutrition bars) and Bear Naked Granola (maker of granola cereals and other granola products), he saw a clear and strong market need. Finally, his “raisin moment” convinced Miller there were many people who liked energy bars but preferred to choose their own ingredients, so he decided that product customization was a viable point of differentiation.

Soon after deciding to create his custom energy bar business, Miller heard about You Bar, a company that did exactly what Miller wanted to do. A first-time entrepreneur might have been crushed, but Miller’s entrepreneurial experience had prepared him for such setbacks. He saw the news as confirmation of the idea’s merit and set out to create a better custom energy bar business. In September 2008 Miller, Maria, and a friend of Miller’s launched Element Bars.

Element Bars customers could build their own bars by choosing natural and organic ingredients on the company’s website, starting with the core, then adding fruits, nuts, and sweets, and finally selecting various nutritional boosts (Exhibit 1). Customers could create a unique name for their bars or have the website suggest a name based on the choices they made. A box of twelve bars cost $36 plus $6 for shipping.

For production, Miller found a wedding cake bakery that was not using its ovens a couple of days each week and paid it $1 per bar to produce Element Bars.

Miller promoted Element Bars using ads on Facebook and on Google search result pages. He also took advantage of free media coverage opportunities. On the day the business launched, Miller wrote a short note to TechCrunch, a popular blog about technology-based start-up companies. “I had no idea what to expect,” Miller said, “but I figured, why not aim high?” TechCrunch wrote about Element Bars2 and Miller said that article “brought in a huge amount of traffic almost immediately.”3

1 Jonathan Miller, in interview with the authors, December 8, 2010. 2 Jason Kincaid, “Element Bars: Built-To-Order Nutrition Bars That Don’t Taste Like Chalk,” TechCrunch, September 17, 2008, http://techcrunch.com/2008/09/17/element-bars-built-to-order-nutrition-bars-that-dont-taste-like-chalk. 3 Miller interview.

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

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Financing Growth

After one year, Element Bars was selling five hundred bars per week and was on track to generate an estimated $100,000 in revenue for the year—not enough to pay Miller a salary, but enough to confirm the business had potential.

Miller’s previous ventures had provided steady income—more than management consulting for less work—but not much growth potential. Intent this time on creating a high-growth venture that he could sell at a multiple of profit, Miller knew that Element Bars needed to grow.

However, Miller was looking for growth financing during a severe recession that significantly reduced the amount of capital available to all companies, but particularly entrepreneurs. Miller first applied for a $40,000 loan from a bank.

Banks looked at two key ratios when considering whether or not to make a business loan: the company’s debt coverage ratio and its debt-to-equity ratio.

The debt coverage ratio was the ratio of cash available for debt servicing, including interest, principal, and lease payments. In general, it was calculated by dividing the firm’s operating income by its total debt service. Debt coverage was a popular benchmark used to measure a company’s ability to generate enough cash to cover its debt, including lease payments. A higher ratio indicated a greater ability to service debt, which made it easier to obtain financing.

The debt-to-equity ratio measured a company’s financial leverage. It was calculated by dividing the company’s total liabilities by its shareholders’ equity. A high ratio generally indicated a higher level of risk.

Miller’s loan application was flatly rejected because Element Bars did not have much in the way of assets or equipment (it did not own its bakery) and because the company had been in business for a relatively short period of time. He needed to look at other options.

Having spent a summer reviewing business plans and observing entrepreneurs’ pitches at a venture capital (VC) firm,4 Miller knew VC firms typically invested in early-stage, high-potential companies that had a novel technology. Venture capital was attractive for new companies that were too small for a public stock offering and did not have enough history or assets to qualify for a bank loan.

In exchange for the high risk that venture capitalists assumed by investing in small, young companies, VC firms usually required significant equity and control over company decisions. When VC firms evaluated potential investments, they typically employed a rigorous approach to evaluating a company’s financial standing and projections, and invested in only a small fraction of the deals presented to them. VC firms usually looked for investments of at least $1 million and were especially interested in technology or biotech companies, which tended to offer the greatest potential for rapid growth and high profit.

4 Ann Meyer, “Energy Bar Maker Carves His Own Path to Growth Capital Through TV Appearance,” Chicago Tribune, September 28, 2009.

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

JONATHAN MILLER: ENERGY BAR ENTREPRENEUR KEL565

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Angel investors were also a potential source of capital for Element Bars. Like VC firms, angel investors looked for opportunities to invest in small businesses with high potential for growth. However, they differed from VC firms in that they typically looked for smaller deals and often considered factors beyond rigorous financial analysis, such as the personal characteristics of the entrepreneur behind the venture—his or her background, track record, and passion. As Miller said, “Angels go much more on gut feel.”5 Many angel investors were successful entrepreneurs themselves and were able to provide business expertise and valuable connections.

The friends or family of the entrepreneur were a potential source of capital that was more easily accessible than that from VC firms or angel investors. However, they were generally not able to provide the entrepreneur with business expertise or connections comparable to those of an angel investor or VC firm. In addition, there were difficulties coordinating board meetings for a group of friends or family members, not to mention the risk to the relationships if the venture did not succeed.

A last option was mezzanine financing. Mezzanine financing was a hybrid form of financing—part equity and part debt—provided by private investors, insurance companies, mutual funds, pension funds, and banks.

Mezzanine financing was typically used to finance the expansion of existing companies. It was structured as a debt with the right to convert to equity if the loan was not paid back in full.6 It was also structured initially as a loan and equity financing, with the entrepreneur borrowing money and at the same time selling stock.

Because mezzanine financing was usually provided to the borrower quickly with little or no requirement for collateral, pricing was aggressive, with the lender seeking a return in the 20 to 30 percent range.7

Mezzanine financing had the advantage of being treated like equity or an unsecured (junior) loan on a company’s balance sheet, which made it easier to obtain additional standard bank financing. To attract mezzanine financing, a company usually had to demonstrate a track record in the industry with an established reputation and product, a history of profitability, and a viable expansion plan.8

Enter the Sharks

During his search for financing, Miller read in a VC industry newsletter that Shark Tank producers were looking for entrepreneurs. Shark Tank was an American reality television show in which an entrepreneur pitched five successful self-made businesspeople (the “sharks”) who would decide whether or not to invest their own money in the entrepreneurs’ business. Part of the show’s appeal was watching the entrepreneurs squirm under pressure from the skeptical and

5 Miller interview. 6 Investopedia.com, Mezzanine Financing, http://www.investopedia.com/terms/m/mezzaninefinancing.asp. 7 Ibid. 8 Ibid.

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

KEL565 JONATHAN MILLER: ENERGY BAR ENTREPRENEUR

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aggressive sharks when they would say things like, “You know my job is to squeeze your head like a teenage pimple.”9

When Miller read the notice he thought, “Why not?” and sent a note to the show’s contact. A week later he was invited to appear on the program.

Miller knew that during the show he would need to convince at least one of the sharks to invest the full amount he was requesting or he would get nothing. But he had to make sure he did not give up too much of the company in order to get it.

Preparing the Pitch

Miller was painstaking in his preparation for Shark Tank.

First, he needed to decide how much money he needed to grow the business. Miller and his partners had identified several possible areas of spending that could help grow the business (Exhibit 2).

Deciding how much the business was worth was another key point; he did not want to give up any more ownership than necessary. He realized he would likely have to raise more capital at some point and wanted to maintain a controlling interest in the company. Miller was able to find information on two comparable companies, Humm Foods and Bear Naked (Exhibit 3).

He also did as much quantitative analysis as possible, attempting to quantify the size and growth of the market and more (Exhibits 4 and 5).

“You have got to do as much research as possible so you are informed and can argue your position,” Miller said. “You are not going to think of all the different factors involved in the business, but by putting pen to paper, it’s going to force you to think through things you might not think of otherwise.”10

Not only did he arm himself with information, he had his mother, wife, and business partners sit around a table and fire questions at him as if they were potential investors, which helped him prepare a lengthy list of questions he needed to be ready to answer. Miller hoped his preparation would be enough to enable him to withstand the pressure and bright lights of the shark tank and get what he needed to grow Element Bars.

9 Meyer, “Energy Bar Maker Carves His Own Path.” 10 Miller interview.

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

JONATHAN MILLER: ENERGY BAR ENTREPRENEUR KEL565

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Exhibit 1: Screen Shots of Element Bars’ Website

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

KEL565 JONATHAN MILLER: ENERGY BAR ENTREPRENEUR

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Exhibit 1 (cont’d)

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

JONATHAN MILLER: ENERGY BAR ENTREPRENEUR KEL565

8 KELLOGG SCHOOL OF MANAGEMENT

Exhibit 1 (cont’d)

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

KEL565 JONATHAN MILLER: ENERGY BAR ENTREPRENEUR

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Exhibit 1 (cont’d)

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

JONATHAN MILLER: ENERGY BAR ENTREPRENEUR KEL565

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Exhibit 2: Planned Spending and Projected Benefits Planned Spending Amount Projected Benefits Salesperson $75,000 Increase sales $150,000 Production automation equipment $10,000 Decrease production costs 15% Advertising $100,000 Improve visibility, increase sales Office space $12,000 Better environment Trade show expenses $30,000 Possibly get deal with distributors

Exhibit 3: Comparable Company Information

Humm Foods

2003 Sales $400,000 2006 Sales $20 million 2006 Sold to Small Planet Foods, a subsidiary of General Mills, for $56 million

Bear Naked

2002 Founded 2004 Sales $2.2 million 2007 Sales $65 million 2007 Sold to the Kellogg Company for approximately $60 million

Element Bars

2009 Estimated earnings $500,000

Exhibit 4: Growth and Penetration of U.S. Organic Food vs. Total Food Sales, 2005–2009 Category 2005 2006 2007 2008 2009 Organic food ($ in millions) 14,223 17,221 20,410 23,607 24,803 Growth 18.5% 21.1% 18.5% 15.7% 5.1% Total food ($ in millions) 566,141 598,136 628,219 659,012 669,556 Growth 4.2% 5.5% 5.0% 4.9% 1.6% Organic food as % of total 2.5% 2.9% 3.2% 3.6% 3.7%

Source: Organic Trade Association’s 2010 Organic Industry Survey conducted from 1/21/2010 to 3/3/2010.

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.

KEL565 JONATHAN MILLER: ENERGY BAR ENTREPRENEUR

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Wellness 42%

$442M

Athletic 19%

$205M

Diet 39%

$412M

2009 Market $1.06 Billion

Exhibit 5: Nutrition Bar Market

4 Percent Compound Annual Growth Rate Leading to $1.25 Billion Market by 2013

 Wellness is fastest growing segment

 29 percent price increase in Wellness

 Future volume gains from Athletic category

Market Trends

 Emphasis on organic, natural, and minimally processed items

 Room to grow—100 percent awareness, but only 14 percent consume energy bars

 Focus on ingredient content as consumers become more savvy

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This document is authorized for use only by Yawen Luo in Entrepreneurial Finance - FIN 335 Spring taught by Raymond Liguori, Drexel University from Apr 2020 to Jun 2020.