Adam Capital Management

Adams Capital Management: Fund IV Joel Adams, founder and general partner of Adams Capital Management (ACM), a $700 million early-stage venture capital firm investing in the information technology, networking infrastructure, and semiconductor industries, glanced up as his fellow general partners trooped into his office on a brisk December morning in 2005 for their annual retrospective and planning meeting. The main topic on the agenda was a new one, ?would 2006 be the right time to launch their fourth fund?
Since late 2000, ACM had been deploying its $420 million third fund, using its “markets first” strategy, an approach that identified and sought to take advantage of discontinuities within the three industry segments it targeted. Having invested in a company exploiting such a change, the general partners then guided the investment through a five-point structured navigation system. In November 2005, ACM Ill sold a portfolio company and made its first distribution to its limited partners (Lips).
The fund’s portfolio also had 18 other operating companies that were showing steady growth, ND two new investments were in the due diligence phase and preparing for final negotiations. “The question as I see it,” said Adams to his partners, “is whether we need to exit more companies and generate additional distributions to our Lips before we start raising ACM Since Scam’s first fund had closed in 1997, the investment environment had gone from robust to hysterical to deflated and now, finally, to what appeared to be a modest recovery. Likewise, Scam’s performance had been whipped about.

Fund I was almost top-quartile, Fund II could return capital with a few breaks, ND Fund Ill, a 2000 vintage fund was “too new to tell, “Adams noted (see Exhibit 1 for performance data). The firm had adopted its strategy in part to differentiate itself for potential Lips. But the partners also believed that the pure opportunistic approach of many venture firms?where each general partner was often given wide leeway in determining which, and how many, markets and business models to invest in?could cause the firm to lose sight of the portfolio as a whole.
Without a “markets first” strategy, through which the entire firm agreed upon the markets of interest before engendering individual companies, the partners felt that firms would invest more on the basis of the fashion of the moment than on business fundamentals or market analysis. In Fund Ill, ACM had taken more significant ownership positions than in the past?typically 35% or more?led every deal, and held a seat on every board. In 85% of the fund’s investments, it was the first institutional money in the company.
Adams believed that this was the only way to respond to the sharply reduced volatility of the venture capital market: “build a collection of really good companies and own enough f them to matter. ” Associate Ann Lemon wrote the original version of this case, “Adams Capital Management: March 2002,” HOBS Case No. 803-143 which is being replaced by this version prepared by Professor Field Harmony and Senior Research Associate Ann Lemon. HOBS 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. Copyright 2006 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call -800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www. Hobs. Harvard. Due. 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 meaner?electronic, mechanical, photocopying, recording, or otherwise?without the permission of Harvard Business School.
This document is authorized for use only in FINDINGS Alternative Asset Classes – SSL/2013 by Jason Zen at University of New South Wales from March 2013 to September 2013. 806-077 ACM knew this strategy was not without its risks. Fund Oil’s portfolio contained some rinsing companies, but, Adams said, “When you own a significant chunk of the company and it doesn’t do well, that hurts the fund. ” Going to market with a good small early fund, a struggling second fund and a yet unproven third fund might not be easy. “The Lips may want to know why we don’t go back to taking smaller positions in more companies,” he noted. L have to be able to give them an answer.
” Venture Investing in 2005 The first half of the 21st century had truly witnessed the Dickens best and worst of times. The final years of the sass had seen an unprecedented run-up in venture activity. Everything had increased?the amounts of capital raised, the management fees paid, the amounts invested, the prices that companies could command, the exit valuations received, and the speed with which investments became liquid. As the century changed, so did the venture environment.
The NASDAQ reached its peak in March 2000 and by 2001, the party had come to a grinding halt. After a decade marked by continuously rising amounts of capital flowing into venture funds, 2001 raised half of sass’s record of $71. 7, and 2002 and 2003 raised barely 10% ($7 billion and $8 billion, respectively). L (See Exhibit 2 for fundraising data). By 2005, the numbers of deals, their price levels, and the size of the rounds had all fallen considerably from their peaks in 1999 and 2000. Since the precipitous drop, though, they had steadied (see Exhibit 3 for trends).
The initial decline, termed a “train wreck,” reflected the fact that almost three years of record-breaking venture activity had funded too many companies chasing too few customers in almost all technology customers had cut their capital expense budgets, and on top of that, were suffering from a backlog of earlier technology investments that had not yet been fully implemented. Spending on technology fell off sharply. As a result, portfolio companies significantly underperformed expectations, often forcing their investors to resort to inside rounds for continued financing because all firms were trying to fix their own troubled portfolios.
Thereafter, activity had resumed albeit at a lower level. A further complication for the venture capital (PVC) industry was the longer path to liquidity. The Initial Public Offering (PIP) market dried up in 2001, only to revive?at least to a degree–in 2004 and 2005. The number of venture-backed mergers and acquisitions had stayed reasonably steady in the vicinity of 300 transactions from 000 through 2004 and even looked likely to continue for 2005 based on first-half data, the number of Ipso had plummeted from 264 in 2000 to 41 in 2001 and a mere 24 and 29 in 2002 and 2003.
Although this number had tripled in 2004, to 93, sass’s first half saw an uninspiring 20 Ipso, a number nonetheless close to the total for all of 2002. 2 By mid-2005, though, glimmers of recovery pierced the gloom. PVC fund- raising for 2004, at $1 5 billion, equaled the sum of the previous two years’ total. Firms had triages the worst of their problem companies, by selling them for the intellectual repertory, merging them with other weak companies, or shutting them down.
Technological evolution provided market opportunities for young companies and some older ones, weaned off the easy-money of the bubble, had brought their products to market and were profitable. Disclosed prices for mergers and acquisitions rose to the highest average since 1 Abstracted from data from Private Equity Analyst and Asset Alternatives. 2 Thomson Financial/Venture Economics, Venture Backed M&A Volume Holds Steady,” www. Nava. Org, accessed December 8, 2005. 2 IQ 2002. 3 The door to the PIP market, blown off its hinges in 2004 by PVC-backed
Google’s debut, reopened, with new companies pricing their offerings almost every week. The pace and valuations of deals had risen, and with it, investor confidence. “It’s not that PVC has become hard,” said one veteran venture capitalist. “It’s Just gotten back to normal. ” Adams Capital Management Joel Adams, founder of ACM, grew up in Phelps, New York, a small town between Rochester and Syracuse. “My dad owned a dairy farm,” recalled Adams, “and his and doing chores. ” Adams was 15 when his mother passed away, leaving his father with no choice but to delegate most of his wife’s responsibilities to the three children.
Looking back on those days, Adams said: “At the time the confluence of events was a hell of a wake-up call for a teenager, but I learned invaluable lessons about money and time management. ” After graduating from the University of Buffalo in 1979, Adams Joined nuclear submarine manufacturer General Dynamics, where he became a test engineer, the lead engineer responsible for starting and testing a sub’s nuclear reactor and representing General Dynamics during the Navy’s sea trials of the new boats. In 1984 he moved to Pittsburgh to attend the business school at Carnegie Mellon University (UCM), lured by its strong program in entrepreneurship.
During Adams’ second year at UCM, he worked part-time for Foisting Capital, a small PVC firm that invested on behalf of the Foster’s, a wealthy Pittsburgh family. Adams Joined Foisting after graduation as a Junior partner, with the firm’s new $14 million fund. Shortly thereafter, the firm and Adams became involved with PAP/Foisting l, a Joint venture formed with Patricia ; Co. To manage the $40 million fund that the state of Pennsylvania wanted to invest in PVC.
In 1994 after nine years with Foisting, Adams, SCOFF Andrea Joseph, longtime secretary Lynn Patterson, and former partner Bill Hulled armed Adams Capital Management, Inc. O handle the Foisting portion of the $60 million PAP/Foisting II, raised in 1992. In 1997, ACM raised its first fund, the $55 million ACM l, with its markets-first investment strategy. Discontinuity-based investing Ever since he had Joined Foisting, Adams had been dissatisfied with what he considered a lack of focus and discipline in the firm’s investment strategy.
“Here’s a nuclear engineer, walking into this industry, with a very small fund in Pittsburgh whose strategy was to be diversified by stage, by industry, and by geography,” Adams recalled. After about a year, I said, ‘This isn’t a strategy at all? you could do anything. He was especially nonplussed by the method of developing deal flow. Rather than learning about markets and then targeting specific deals within them, he said, “The approach at Foisting was to open the mail in the morning” to see what business plans had arrived. Two of Adams’ experiences at Foisting acquainted him with the power of targeted investing.
The first was his involvement with Sharper Corporation, a developer of software applications for engineering product data management. “l understood the issues of engineering data management from my says at General Dynamics,” Adams said. L was a much smarter investor looking at an industry that I knew. ” Not only was he a better investment manager and board member, he realized, 3 Ibid. 3 but he was also a better negotiator.
“Entrepreneurs are passionate and biased about their businesses,” he said. “If the first time I hear about a market is from the entrepreneur, I’m at a big disadvantage. ” His second revelation was even more powerful. Seeking a computer in 1987, Adams happened to learn about a mail-order operation in Texas called PC’s Limited that custom-built personal computers and undercut retail prices.
After speaking with the company’s CEO, Adams invested $750,000 in the future Dell Computer’s first outside venture round. Had the firm held this position, it would have been worth $382 million as of the end of September 2005. Adams realized that Dell had created such an explosion of value by exploiting a discontinuity ? a dramatic and sudden change in a large and established market. In this instance, the discontinuity involved distribution. The rise of direct distribution surprised the large personal computer manufacturers, which had highly entrenched outworks of retail dealers.
These networks, Adams noted, “couldn’t be unwound overnight. ” Dell could build a multi-billion dollar business from scratch because his large and sleepy competitors could not respond to this distribution discontinuity in time. As ACM expanded, Adams resolved that any new partners would be engineers, and thus bring their technical training to bear in thorough examinations of a few promising markets (see Exhibit 4 for partner biographies). Scam’s strategy evolved to focus on investments in markets that the partners already knew well and had already identified as attractive.
A few initial prerequisites had developed over time. The first was that the companies in which ACM invested would sell to businesses, not consumers, and their value propositions would be driven by return on investment (ROI). “That’s ROI for the customers, not us,” said Adams. “Our first question is, ‘If somebody is going to buy this company’s product, what does the Chief Financial Officer’s recommendation look like? ” The second criterion was that the business was fragmentation applied technology,’ or one of the first companies to use a specific technology for a specific application.
Given the partners’ engineering backgrounds, the firm focused on the information technology (IT) and telecommunication/ semiconductor industries, areas that were, in their view, experiencing significant discontinuities. The most important criterion was that, as in the case of Dell, Scam’s portfolio companies would exploit discontinuities in existing markets, shifts that would create opportunities for start-up companies to become market leaders. In the IT industry, the partners anticipated that the need to create virtual enterprises on a global scale would force companies to look for highly adaptable systems.
The telecommunications industry, faced with global expansion in bandwidth requirements for data, seemed to be faced with an entire rethinking of the existing technology and infrastructure, while reaching the limits of current silicon technology appeared likely to revolutionize the semiconductor industry. Within these areas, Scam’s partners sought to identify four primary causes of discontinuities (see Exhibit 5 for more on discontinuities): 1 . Standards. Despite the emergence of a technology technologies in an attempt to preserve their captive customer base.
Even as customers demented the standard, the existing manufacturers perceived it as a threat to their oligopolies market positions, and were reluctant to adopt it. One such example was FORE Systems, which built communications devices that conformed to the ATM (asynchronous transfer mode) standard for communications in wide-area networks. The big players at the time, AT&T/Lucent and Northern Telecoms, each had proprietary protocols for those communications. These manufacturers clearly had the technical prowess and market muscle to 4 exploit ATM as well, but they were slow to do so for fear of cannibalizing their own racket shares.
In April 1999, FORE was acquired by GEE Pl for $4. 5 billion. 2. Regulation. Unexpected regulatory changes could force market players to adapt quickly to a new market reality. An example of such a dislocation had occurred in the U. S. Cellular market where a host of new opportunities and networks had emerged after the government’s creation of the PC’S spectrum. From a technology point of view, the new spectrum provided a chance for GSM, the cheaper and more easily-deployed base station technology popular in the rest of the world, to gain ground on the unwieldy proprietary technology dominant in the United States.
GSM equipment manufacturers and the upstart carriers who provided their services used their agility in the new regulatory environment to challenge the giants. 3. Technology. A technology-based discontinuity could take two forms. In one, it could appear as a whiz-bang package that took big competitors months or years to duplicate, such as Apple’s Macintosh operating system. Alternatively, it could involve the convergence of technologies that had hitherto been separate, requiring innovation to allow these once-disparate systems to interact.
An example here was the rise of corporate remote access, which forced companies to buy technology that would connect the public carrier telephone networks to the corporations’ internal local area networks. 4. Distribution. Dell Computer in the earlier example provided the ultimate example of a distribution-based discontinuity?the rise of mail-order completely surprised existing personal computer manufacturers, to the great enrichment of Dell and its shareholders. This top-down approach to identifying markets was crucial in helping ACM achieve consensus about and control over where its partners would invest.
Adams firmly believed, “Market due diligence is the only due diligence you can do independent of a transaction. If you present the partners with the industry and market dynamics ahead of time, then we can all talk about each other’s prospective investment. ” Scam’s approach to identifying discontinuities included its Discontinuity Roundtable, a group of advisors that met periodically with the ACM partners to identify and discuss market discontinuities that could lead to fruitful investment theses. The 20-person Roundtable comprised industry experts and observers who attended meetings depending on the topic at hand.
Among their number had been Clayton Christensen of the Harvard Business School known for his research on how innovation affected markets; George Symmetry, inveterate entrepreneur and founder and backer of over 200 companies; Attic Razz, former CEO of MAD, the chip-maker that competed against Intel; and Mike Maples, former COT of Microsoft. The process required partners to write discontinuity white papers that advanced the investment thesis and to present them to a Roundtable of appropriate experts drawn from the pool.
The group would discuss the merits of the thesis under consideration, usually greening to pursue two or three of the eight to ten papers presented in a meeting. The meetings would also identify other avenues for future exploration. Once an investment thesis was thoroughly vetted by the Discontinuities Roundtable, the ACM partners would systematically search for deals in that domain. Sometimes this took the form of identifying pockets of excellence in the appropriate technology and supporting entrepreneurs in forming a company.
In other cases, it was a matter of identifying and sorting through several existing potential investments. This process eve the partners deep knowledge of these companies’ opportunities and therefore made ACM more attractive as an investment partner. 5 Structured Navigation In addition to a systematic approach for identifying markets, ACM also developed a system for managing its investments, called “structured navigation. ” The system was born out of the observation that early-stage technology companies shared many of the same benchmarks and needed many of the same elements to succeed.
Jerry Sullivan, who had Joined the firm from MAC, Tektronix and Phillips, explained: Our investments typically have high development costs coupled with the direct sales Orca characteristic of companies at these stages. The majority of our investments? 90%?are software-based, so resource planning and allocations are well understood by all of our general partners. We feel that our structured navigation strategy applies to all companies within the model. Aspects of the structured navigation included : 1 . Round out the management team.
Like most other PVC firms, ACM was deeply involved in helping its entrepreneurs complete their management teams. “Almost 85% of the management team without capital,” Martin Neat, a former executive vice president with IBM and now ACM general partner, said. People are going to Join a company that has some capital behind it, so we fundamentally believe that if you’ve got a great opportunity that’s well-funded, you’re going to attract a lot of talent. ” ACM devoted significant resources to the creation of its Services Group, which helped its portfolio companies in this area. . Obtain a corporate partner or endorsement. The notion that an early stage company, hoping to exploit a sea change in a large existing market, could forge a partnership (an endorsement, a distribution deal, or an equity investment) with one of the very players from whom it hoped to steal market share mimed entirely contradictory. But the ACM partners believed that this should almost always be possible.
From Scam’s perspective, forging these relationships early would often create other exit opportunities. . Gain early exposure to industry and investment banking analysts. Industry analysts such as Garner, Gaga, and Forrester often created the first wave of market interest in a new technology. This group’s validation could speed the acceptance or application of a new technology. While industry analysts could help create a market for the technology, analysts at investment banking firms could create an exit for the company, and ACM tried to make sure they met the portfolio companies early. First of all, the good analysts really do understand the businesses of these little companies,” N. George Sugars, a general partner in the Silicon Valley office, said. “But the second thing is, [bankers are] in the fee business, and they need to put marriages together. [Introducing the two parties early] is a tactic that will set you up for deals later on. ” 4. Expand the product line. A first-generation applied technology company would be confronted by sigh initial costs of development and sales.
In such a case, Bill Freeze, a general partner in Scam’s Boston office, observed, “The marginal cost of the development for subsequent products or the next sale is much lower. ” Once a new technology product had been developed and a base of customers secured, the costs of leveraging that technology into another, similar product and selling it into a base of existing accounts was comparatively small. But “sometimes the entrepreneur hasn’t thought that out yet,” he noted. Our approach ensures that the companies are adequately focused on this value creation opportunity. 5. Implement best practices. Scam’s partners felt that their entrepreneurs should focus on developing products and selling them to customers, not on structuring stock option packages or compensation 6 plans. After working with dozens of companies with similar structures, the partners felt that they should be able to provide boilerplate versions of plans that worked. ACM used these five “steps” (in no particular order) to manage its investments, complete.
The process, the partners felt, not only made their investments more successful, but also provided the partners in four offices across the U. S. With a molly understood internal barometer of a company’s progress (see Exhibit 6 for offices). “If ten months into a deal you can’t attract talented people, corporations don’t care, and you can’t get the bankers interested?you’re learning something,” observed Sullivan. “And maybe you ought to get out. ” Defending the Strategy Was it really necessary to formulate such a rigorous strategy for investing in early- stage businesses?
Adams admitted that, to a certain extent, the strategy was motivated by the practical necessities faced by a small firm based in Pittsburgh raising a $55 million fund in 1997. We had to get ourselves above the muck, and the way you do that is with a well-defined, market-centric strategy that you execute in a disciplined manner,” he said. It had also given a small partnership, scattered among offices in Pittsburgh, Philadelphia (later Boston), and Austin, Texas (Silicon Valley was added in 1999) a common language and approach that facilitated communication.
Adams balked at the conventional wisdom about PVC and venture capitalists?namely, that PVC was a personality-driven business, and that successful venture capitalists were all genius dealers whose vision turned everything they touched into gold. L just don’t buy the ‘rock star’ model that many venture firms promote,” Adams said. Instead, he wanted to build a venture firm in the same way that most businesses were built ? with a structure in which any of its employees were, in principle, replaceable. “We wanted to develop a system where you could throw anybody out of here and the thing will still cook along,” he said.
We wanted to build a system for executing this business. We’re engineers, we think that way. We’re not rock stars. We have a system for finding areas that are of interest, getting deals, and making them valuable. That’s what we do. ” The Funds Since 1997, the partners felt that strict adherence to strategy, combined with the systematic portfolio management that navigation provided, had served the firm well. They had grown from a $55 million fund to managing $700 million and from one office in Pittsburgh to four in areas in which 68% of all PVC activity in the U.
S. Occurred. Each fund had been invested according to plan, although the results had not been entirely anticipated. ACM I had invested in 15 companies for a total cost basis of $55 million. Information technology accounted for 49% of the portfolio; electrification for 30%, medical devices for 11% and networking infrastructure for 10%. As of September 2005, the fund was fully invested and had exited all but one company, distributing stock valued at $122. 7 million for a net IR to its Lips of 46% Oust below the upper quartile).
The general partners hoped to achieve at least $140 million in total proceeds by the end of Fund Xi’s contractual life. With its smaller size, ACM I had aimed for percentage ownership in the low teens. The firm had held a board seat in 67% of its original 15 companies, and its positions could get diluted if it as 7 unable to participate fully in subsequent rounds. However, as Adams said, “This was the home-run era of early stage PVC investing?significant returns were almost the norm. We had our share, with three acquisitions and three Ipso. That was a good fund. Based on the early success of Fund I and the frenzy around PVC, ACM had closed the $1 50 million ACM II at the end of 1999, followed quickly by the $420 million ACM Ill at the end of 2000 (see Exhibit 7 for fund statistics). In the over-heated environment of 1999 and early 2000, though, the partners found that the game had changed. At first it seemed that home-runs were still possible,” said Adams: … Putting money to work was paramount. Unfortunately, this meant that we had less time to investigate new markets and we therefore had less diversification in the portfolio.
If the big companies were looking for drop-add-multiplex-switches, that was what we backed as all of them were being bought because every big company needed its own drop-add-multiplicities. We ended up with a lot of similar companies. Our goal was to own around 20%, and we usually had enough money to keep our position, which was not always the best thing in retrospect. Fund II had stayed the strategic course. Of the 14 companies in the portfolio, three had been acquired, five written off, and six were still active and showing strong revenue growth.
The firm had moved away from investing in medical devices though. Information technology made up 45% of the portfolio, semiconductors 38%, and telecommunications 17%. Although Fund Sis’s value currently stood at a 40% discount to cost, Adams hoped that, with a few breaks, it could return the Lips’ capital. Fund Oil’s approach of taking larger position had been adopted in response to the changes that the partners noted in the market ??in particular, a reduction in volatility. As Adams explained,: The days of the consistent home-runs are gone.
Reduced volatility meaner that we need to build portfolios that are more balanced and consistent in their performance. We’re not looking for xx returns, although we certainly wouldn’t refuse them. I Just don’t think that’s the norm anymore. Instead, we’re looking to build a solid portfolio that yields xx to xx returns based on operating success?positive cash flow and net income. We look to own enough of each company that every deal is an impact deal, both for us and for the company. And here, because outcome volatility has fallen so substantially, we need to have diversity among our companies.
You might say that beta has fallen so we must increase alpha. We had to assemble an interesting collection of really good companies that addressed significant discontinuities in the market and own enough of them to matter. We’ve done that. We’ve also added value to them through the ACM Services Group, which provides corporate partnering, recruitment and financial management guidance. By September 30, 2005, Fund Ill had called 74% of its committed capital. Information technology accounted for 59% of


Human Capital Management

My decision to pursue the 9-month Master of Science in Management Studies (MSMS) program on offer at MIT Sloan School of Management was largely influenced by Chinese University of Hong Kong (CUHK)’s Faculty of Business Administration invitation as one of the participating schools for this prestigious program. CUHK’s inclusion affords me the opportunity to fulfill my lifelong desire of acquiring a top-notch global business education from a world-class university.

If accepted, enrolling for the MSMS program at MIT will be a kind of a homecoming. This is because of my prior sojourn to the United States for educational and vocational purposes. I had my college education at both Bentley College, Massachusetts and Washington University in St.Louis, Missouri, and I also had a professional stint at the Human Capital Practice unit of Deloitte Consulting which took me to American cities like Houston and Los Angeles.

Afterwards, I had to take a diversion to the CUHK to pursue a full-time MBA program with a concentration in China Business. This was to enable me become well-grounded in modern Chinese business practices and also to catch up on developments leading to the emergence of China as the next global economic superpower.
When I learnt about the CUMBA/MIT MSc in Management Studies Dual Degree Option, it turned out to be an opportunity of a lifetime. I discovered that the program will not only permit me to continue expanding on my knowledge of Chinese business but also empower me to develop a solid background on global best practices in international management.
My academic interests will be focused majorly on issues bordering on work, labor, and employment relations as well as human resource management, labor market issues, and related public policies. I will like to investigate how to retain and motivate employees using incentives other than just pecuniary compensation. In addition, I will also be interested in examining key business topics like supply chains and corporate compliance
Enrolling for the MIT Sloan MSMS program will also enable me to take advantage of MIT Sloan’s impressive research facilities and resources. Of particular interest to me is the Institute for Work & Employment Research (IWER), where I will be conducting a considerable piece of the research towards fulfilling my thesis requirements.
I will be glad to tap into the institute’s over 50 years legacy of research and teaching about the changing world of work and employment and discover how I can apply the acquired know-how in the Chinese business terrain.
Also worth exploring for me in greater depth is the MIT Sloan Management Review, the preeminent quarterly academic journal. I am a huge fan of this reliable source of innovative ideas for the 21st century business leader and would love the opportunity to contribute scholarly articles, or even get my Master’s thesis featured in a future edition of the journal.
MIT Sloan’s intellectually engaging student body, forward-thinking faculty, and extensive alumni network complete the list of key reasons for selecting the management school as my preferred destination for advanced degree study.
I look forward to the prospect of meeting and collaborating with great minds, especially Professor Thomas Kochan, Co-director of IWER and George Maverick Bunker Professor of Management. I would be drawing a lot of inspiration from his thoughts and scholarly works on industrial relations, work and employment.
Restructuring Human Capital Management (HCM) and Corporate Social Responsibility (CSR) in China would probably be a thesis topic I would pursue. Why? Because, often times, in China, the primary focus for company managers are how to reduce overhead cost, make huge profits, and deliver the highest possible returns for shareholders.
For managers that care less about long term, this narrow, profit- oriented approach to business may suffice, but only for a very short period of time. However, for companies that want to stand the test of time and survive the vagaries of modern day business, a more balanced management style is non-negotiable.
Of course, most Chinese companies already have structures in place to cater to Human Capital Management, and Corporate Social Responsibility. The essence of this thesis however, is to suggest ways to reform these structures and make it a little more robust and engaging.


Finance – Cost of Capital for Starbucks Coffee

11308911    Finance – Cost of Capital for Starbucks Coffee
1) Cost of Capital Section Calculate the cost of capital (show calculations) for Starbucks using the following:
a)      Weighted average cost of capital;

b)      Capital-asset pricing model (beta).
 Weighted average cost of capital
Cost of equity: Re = Rf + Beta (Rm-Rf).
Rf= risk free rate
Rm-Rf =equity risk premium
Using the latest date from Yahoo finance:
Risk free rate=5%;
Equity risk premium=4.5%
Re = cost of equity
Rd = cost of debt
E = the market value of the firm’s equity
D = the market value of the firm’s debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = the corporate tax rate
Tc =22%
Capital-asset pricing model (beta)
Kc   = Rf   + beta x (Km – Rf)
Kc is the risk-adjusted discount rate (also known as the Cost of Capital);
Rf is the rate of a “risk-free” investment, i.e. cash;
Km is the return rate of a market benchmark, like the S&P 500.
Return available on an appropriate market benchmark investment (like the S&P 500):20%
Return available on a risk-free investment (cash, or government bond): 7.5%
Beta (relative to the market benchmark above): 0.557
Kc   = 7.5%+. 557*(20%-7.5%)
Kc   = 14.46%
Cost of capital for Starbucks calculated by weighted average methods equals to 15.9% and the cost of capital calculated by the capital-asset pricing model method equals to 14.46%
2) Discuss the relative strengths and weaknesses of the methods above as to the appropriate discount rate for the firm.
The usage of weighted average cost of capital method may look more complex because it requires a lot of calculations and data that has to be available to make exact calculations. Still it seems to be more reliable by many economists because it gives the most approximated value of the discount rate.
  The usage of capital-asset pricing model seems to be an easier one, because it doesn’t require that many data set for the calculations, but just return of “risk-free” investment, beta and return rate of market benchmark.
You may also be interested in “Starbucks pricing strategy”
Still the results of the both methods may be different if different people calculate them. It depends on the objectivism of risk factors calculations that depend upon different financial indexes and conditions.
In the case with weighted average cost of capital method it may appear tricky to calculate cost of equity that doesn’t really exist in a difference to the cost of debt.
The cost of equity is primary based on what it really costs the company to achieve a share price that will theoretically satisfy the investors. Moreover it’s rather complicated and difficult to make an exact calculation of the tax rate. It adds additional risks of under or over estimating tax liabilities for the businesses.
 3) Describe why these two methodologies may produce different results.
Because two methodologies use different techniques in calculation methods of capital costs, the results can differ to some extend. WACC is calculated on the base of data set that gives information about company’s debt and its equity in the capital structure. As it was mentioned about it’s not easy to calculate the cost of the equity because this cost is not fixated, but still the formulas used give a clear approximation.
Another method- capital-asset pricing model is primary based on calculation of more abstract values as risks. Because the risks are calculated on the base of statistical facts there can always be errors in the finals calculations that mostly depend on the amount of the initial data available. If the set of data is not big enough the errors will be quite considerable.
4) Identify specific reasons why the cost of capital may differ among the selected companies. What does this say about their past financial performances and future prospects?
There are many reasons for difference of the capital cost for companies who work in the same business. These reasons include the financial situation of the company, the amount of its debt, the amounts of profits, etc. Because every company his its own financial, marketing and other policies, the risks that should been taken into the consideration will differ.
And as the planning of the capital costs is a very important aspect in business planning their strategies for capital costs are made individually by each company to make equilibrium between the possibilities and risks in business.
 Capital costs are model on the experience of previous indexes and experiences so that the development of the company will look stable and will not give any background to possible anxiety about its reliability.
 Fort example a company with big debt will not make a small capital cost because it will look suspicious to the investors, who will possible start to returning stocks when they find out that there financial issues with that business.
5) How would you recommend that the firm lower its cost of capital?
 The modeling of the capital costs for businesses gives quite objective costs of capital, but nowadays the role of the information and the role of informational influence on the investors is suggested to be a good tool to make the capital costs lower. It’s well known that risks that are taken into consideration when modeling and calculating the capital costs mostly include the processes of the stock market that depend on different factors, but the human factor is not always included. If to include and manipulate the human factor that it would be possible a better way for the capital regulations.
It means that if the stock owners will be better informed about the strategies of the company, its policy for future and its priorities of the development there will be a smaller risk that they’ll start to sell the stocks, and that will reduce the possible risks of human factor. It means that traders who are better informed about the stocks are more likely to hold them, that will result in the increases of price and as the result the capital costs will fall.
So as it’s proposed by modern economists, the availability of private information about accounting and marketing strategies to the investors can teach the companies how to manage with informative functions of the company to regulate its financial climate.