Case Study Analysis: UndergroundHipHop.com, Financing, Growth, and the Future
I recently read a case study for a small and growing business called UndergroundHipHop.com I obtained from Ivey Publishing.
UndergroundHipHop.com is a company started by a college undergrad student in his dorm room. The company started out as a project of passion that lead to a large online community that all had interests in underground hip hop music. Adam Walder, the owner, decided to capitalize on his user base by selling CD’s from his website. He later branched out into having a retail outlet to sell his merchandise, although it only accounted for 12% of annual revenues. Walder faces a critical juncture because his company had primarily used internal funding for projects, it was debt free, but this had a limiting effect on the growth of the company.
Walder started with a website where he shared his passion with the world. Once he realized he could do better than the companies that were in the underground hip hop scene, he realized he could serve the community and turn a profit at the same time. As the company matured by having an online store with 36,000 visitors a day, a popular retail outlet and many other opportunities that it could take Walter’s business to the next level, he decided that he didn’t want to run an online warehouse the rest of his life (Wesley, 13).
Walder’s passion is to spread the genre of underground hip hop to those that love it. He explored many expansion possibilities that encompass his vision: digital downloading of music and starting an undergroundhiphop.com magazine.
Walder obviously has passion for his job and enjoy’s being his own boss as many entrepreneurs do. Unfortunately, this caused some possible problems in his business. One glaring problem is that he resisted adding programmers to develop the code that ran his website (Wesley, 9). This limited the amount of features and bug-fixes the website could have, which may have stunted his unique daily views. This also kept his ideas “inbred” by not having outside technology enthusiasts bring new and innovative ideas to the table. The time that he spent programming also meant that he was not pursuing other opportunities such as the satellite radio station or an UndergroundHipHop.com magazine.
Even though Walder did not come from a business background, he did a very good job bootstrapping his organization by running a “warehouse” out of his dorm room, using free services to host his website initially, and by programming the site himself (Wesley, 5). He used his personal finances at first to pay for hosting and content, and slowly he was able to use the company’s positive cash flow as a source of investment capital. He kept the company debt free (no long-term liabilities) which makes businesses more attractive to investors, and he had a track record of success.
He chose to keep investors out of the business primarily because he was scared to give out an equity stake in the company, and because he didn’t want to be burdened with debt obligations. Walder had chances to get capital infusions from various sources including a wealthy family friend and he turned them down (Wesley, 13). Walder wanted to know that the capital he received from an outside source would not incur losses. Being risk adverse can be a good thing, but not when it paralyzes you into a state of non-action.
A financial analysis is essential when reviewing a company’s financial statements in order to objectively analyze the company and to gain insights that figure comparisons can’t provide. Here are some financial ratios followed by their analysis:
- Current Ratio: 7.4
- Quick Ratio: The company has more in inventory than it does total current assets, this would normally be a bad thing, but depending on inventory turnover and considering this company as a going concern are things that must be considered
- Average Collection Period: 0
- Accounts Receivable Turnover: 0
- Inventory Turnover: 2.2
- Asset Turnover: 2.95
- Debt Ratio: .37
- Debt to Equity Ratio: .42
- Profit Margin: .44
- Return on Assets: 2.95
- Return on Equity: 4.7
It’s hard to tell too much about the company and how well it’s doing without comparing the numbers to the industry averages. We are able to infer a few facts about the company’s business model/operations from these numbers though. They are holding more than enough assets to cover their liabilities if they all came due as of the date on the balance sheet. This ratio is so high, they can probably take on more debt to grow more aggressively (hire programmers, web designers, pay for exclusive content, ect) and still be solvent. They hold a respectable profit margin on sales as well. Forty-four cents on the dollar is profit. Again, to tell is this is a good or bad number, we will need to compare it to the industry average. They have no collections on their balance sheet because they don’t have any accounts receivable. This is normal in a retail market that sells to consumers directly. If they sold to distributors, they would then generally offer terms such as Net 30 which means the net of the balance is due in 30 days.
There’s something that is completely inexcusable to me which is the amount of cash-on-hand they have. According to their Balance Sheet, they have a negative cash balance, and I don’t see any other area where they might have cash stored. This means that they might buy their items net 30, and expect to sell other items within that 30 day period to pay off the newer items. This makes me very uncomfortable (a business model similar to this was created by Charles Ponzi, and perfected by Bernie Madoff, et al.), although they seem to make it work having $1.1M in sales, and $500k in profit.
Adam Walder’s passion is spread the genre of underground hip hop to as many people that want it as possible. There are two ways that he can spread the word about the genre without accepting too much risk into the organization: adding the capabilities to sell music digitally, and through licensing the content to start a broadcast station in partnership with a satellite radio station. He already has relationships with the copyright holders of the music and they trust and respect him (which is a bonus because you like to do business with those you like and trust), so extending his business into these outlets will lower the cost to consumers, increase margins, increase mindshare of the genre and of UndergroundHipHop.com, and provide more exposure to Walder’s talent.
Wesley, David. “UndergroundHipHop.com”. London, Ontario, Canada: Ivey Management Services, 2007.