Invest or Take - Case Study PDF

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Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-05-30
On May 20, 2015, Allen Nance had a tough decision to make on an intriguing investment prospect that his
venture capital (VC) firm had been vetting. Nance was one of five managing partners at Sydney, Australia’s
KTN Capital (KTN), and he held the deciding vote on a tempting but controversial investment decision.
Essentially, Nance had to decide whether KTN would legally take an idea presented by an entrepreneur
who had not properly protected his concept or whether KTN would invest in the entrepreneur’s company.
Nance’s venture capital fund desperately
desperately needed to invest in some high-growth companies, but this
particular opportunity involved several ethical and bus
business considerations that Nance would have to take
into account during his decision-making process.
KTN Capital was established in July 2013 as a venture capital firm with a vision of capturing large returns
from investing in innovative manufacturers in niche areas. The intent was to invest KTN’s AU$60 million1
fund in 10 to 15 companies that had the potential to scale to more than $50 million. KTN was based in
Sydney, Australia, but the firm was willing to invest in companies anywhere in the South Pacific.
Five managing partners controlled KTN, and the compcompany had a support staff of six people. Each of the
managing partners had been a part of three or more successful start-ups in areas relating to high-technology
manufacturing. Although the managing partners had si significant experience with start-ups, none of them
had experience as a general partner in a VC firm. Each of the partners had invested $1 million of their own
capital, but most of the fund’s capital had come from outside investors. KTN had accessed these outside
investors through the general partne
partners’ extensive business networks.
1
All currency amounts are shown in Australian dollars. US$1 = AU$1.08 on July 1, 2013.
This document is authorized for educator review use only by Prathmesh Tawade, Somaiya Vidyavihar until Mar 2024. Copying or posting is an infringement of copyright.
Permissions@hbsp.harvard.edu or 617.783.7860
As of May 2015, KTN had invested in only four companies and had $37 million of its fund left to invest. The
VC partners had not invested most of their capital mainly
inly because it was extremely difficult to find deals that
met KTN’s criteria, and the five managingng partners had been unable to agree on prospective deals. The firm’s
operating agreement laid out five criteria that a venture must meet
eet in order for KTN to invest:
The company has an innovative manufactured product(s) in a niche area.

The company’s product(s) has/have strong
rong intellectual property protection.
The company’s product(s) has/have a product life cycle of over five years.
The company has the potential to scale to a valuation of more than $50 million.
KTN is able to exit the investment in a five- to seven-year time frame.
When the partners developed these investment criteria, they thought it would be easy to identify investments
that met the criteria, mainly because each of the managing ging partners had experience in operating companies
that had been guided by these same conditions. However, the VC partners had failed to take into account
that in their past experiences as investors,
estors, they had been dealing with just one venture at a time. None of
them had tried to put together a portfolio
tfolio of companies at the same time. To exacerbate the problem, the
partners were not working well together. They had known known each other for at least five years, but none of
them had ever worked together. They each had different
different ways of approaching potential investments, and
they could not agree on a common framework to evaluaevaluatete opportunities. This situation caused great conflict
within the group, and by January 2015, the animosity had reached a point where the partners were having
trouble simply being cordial. By that time, the only thingthing all five could agree on was that they needed to
get all the capital in their fund invested soon.
When they started the firm, the partners had intende

intended to have all $60 million invested within 24 months.
By January 2015, however, they were 29 months into th the fund’s life and had not invested even half of it;
their investors were very unhappy about this state of aaffairs. The investors had originally been told that all
of the capital would be invested within a two-year period. Then, the portfolio firms would grow over a
three- to five-year period, at which time the investme
investments would be exited, and the investors would get their
principal back, along with a large retu
return. In order to stay close to that timeline, KTN needed to make some
investments quickly. Also, because this fund marked th the first time that Nance and his four colleagues had
been managing partners in a venture together, they felt extra pressure to succeed and to get the capital
invested in high-growth companies.
At this critical juncture, Nance found a potential inv

investment that he was thrilled about. It was a solar-
powered pool filter made by a company called SunCl
SunClean. Nance had met the founder of SunClean, Mike
Levine, at a home and garden tec
technology show in January 2015.
At the time Nance met Levine, SunClean was only a couple of years old, but it had already won several
prestigious awards. When Nance questioned Levine aabout the company, Levine was excited to tell the
company’s story.
While working as an engineer on a large-scale water treatment project in South Asia, Levine came up with
an idea for a solar-powered pool filter. r. He created SunClean in January 2013, with the intention of
commercializing his idea. After building a working prototype, he quit his full-time job and formally started
SunClean in May 2013. Levine had built several prototypes,
otypes, but the one he was commercializing in 2015
was a floating device that measured three feet (91.4 centimetres) in diameter and weighed only 30 pounds
(13.61 kilograms). When exposed to sunlight, the pump moved around the pool on its own and filtered the
water, all but eliminating the need to run a pool’s inline filter pump.
Several independent tests showed that the SunClean filter was just as effective at filtering pool water as
were the traditional pool pumps; in fact, some
me of the tests showed that SunClean was more effective, and it
also reduced the amount of chemicals that a pool needed. The product won several prestigious green
innovation awards, and its retail price in 2015 was $799. The main benefits of the pump were that it saved
the average pool owner $750 a year in electricity costs and it was environmentally friendly. In 2015, the
filter qualified for several government rebates, which, in some cases, amounted to more than $400. In almost
all cases, the government rebates effectively lowered thee price to the end consumer by a couple of hundred
dollars or more.
Levine had originally planned on funding his venture through bootstrapping (i.e., through personal finances
and the operating revenues of the company, rather than through venture capital).2 Levine had $250 thousand
in savings at his disposal, and he expected that SunClean
SunClean would be up and selling within a year, allowing
for reinvestment of the sales proceeds
proceeds into the company’s growth. Things did not go exactly as planned,
however. Levine burned through his savings within 15 months, and, two years into the venture, he had
generated only $150,000 in revenue and was nearly out of cash. LeviLevine was very honest with Nance about
this situation, telling him that he had enough opera
operating capital to keep the company going for only another
45 days. Levine explained that he had been so focufocused on developing and marketing the product, he had
lost track of his burn rate.
In January 2015, Levine had started speaking to ve venture capitalists, and his company was generating a lot
of investment interest. He felt confident about being able to raise the capital, but he was a little worried
about how long it would take. Levine told Nance, “I was little naïve about the venture capital process. I
thought it could be done in a month, but it is looking like it could drag on for months, which could put me
in a really bad spot. I miscalculated how much money I would need and how long it would take to get.”
Nance was so impressed with what he saw in Levine

Levine’s company that, the week after meeting Levine, he
flew to SunClean’s headquarters in Melbourne, AustAustralia. Nance’s first impressions were not good. The
offices and production facilities were a mess, and the thr
three employees were aloof and out of touch with the
company’s mission. Above all, Nance was quite dismayed by Levine’s crass nature. Within the first five
minutes of Nance’s arrival at SunClean’s facility, Le
Levine had screamed at one the production workers for
a minor error. Nance also heard Levine on the phone
phone, insulting a customer who was having an issue with
her filter:
2
Ahmar Bhide, “Bootstrap Finance: The Art of Start-Ups,” Harvard Business Review 70, no. 6 (1991): 109–117. Available
from Ivey Publishing, product no. 92601.
We don’t include instructions on how to put the filters on because it is so stinking easy that a five-
year-old could do it. You must be a real idiot! You’re too stupid to screw in a light bulb, so I am not
even going to try to walk you through this. Have a great day and good luck finding your brain.
Later that day, Levine bragged about what an intelligent and accomplished d engineer he was and complained
about business “idiots” getting in the way of brilliant engineers. Nance thought this comment was
particularly humorous after seeing the brochure that Levine
vine had created. It was unprofessional, sophomoric,
and contained glaring grammatical errors (see Exhibit 1).
In spite of his poor impression of Levine, Nance was still optimistic about SunClean
SunClean’s potential, especially
after going through the company’s financial projections (see Exhibit 2). The projections were grossly
inflated, as Levine had projected that the company wouldd eventually generate more than $1.7 billion in
revenue and would have a future valuation
ion of more than $5 billion. On the
the other hand, the data showed that
SunClean had a lot of potential. After meeting with Levine
vine that day, Nance went back to the hotel and did
a quick pro forma projection of what SunClean’s income could potentially look like within three years (see
Exhibit 3). Even when looking at the numbers conservatively,
conservatively, Nance’s pro forma projections
pr suggested that
SunClean could become a $300 million company. He came up with this figure based on a rudimentary top-
down analysis of capturing 1 per cent of the 10 million po
pools
ols in the world. Nance’s analysis indicated that
the company could generate approximately $80 million in annual revenue from the sale of 100,000 filtration
units a year. In addition, the proprietary filtration cartridges on the device would need to be replaced
annually, and selling these would generate
generate another $7.5 million in revenue.
Based on the expenses that Levine had presented to Nan

Nance, a quick calculation showed that SunClean could
produce 100 thousand filtration units and 100 thousand replacement cartridges for a total cost of around
$63 million. Furthermore, Nance was very confidconfident that these expenses could be reduced through
improvements to the manufacturing process, which was in incredibly inefficient. Also, the inputs could be
procured for much less than Levine was paying. In th the end, Nance’s analysis suggested that the company
had the potential to generate an im
impressive
pressive profit of more than $24 million. Similar companies had been
selling in 2015 for multiples of earnings before inter
interest, taxes, depreciation, and amortization (EBITDA)
of 5–10 times, which would mean that, with yearly EBEBITDA of more than $24 million, SunClean would be
worth somewhere between $120 million and $240 million.
Levine knew that SunClean would take about three years to really ramp up, but he was optimistic that the
company’s valuation could exceed $100 million within a three- to five-year period. Even better, Nance
knew of several larger firms that would be very in interested in acquiring SunClean once it hit the growth
phase, so he felt confident that the company could easily be exited with a return on investment of more than
tenfold. Although much more analysis was still needed
needed, Nance was convinced that this company had a lot
of potential and that it met all of KTN’s investment criteria. Furthermore, his analysis was based on
conservative estimates that did not even account for us
using the product to filter decorative ponds. There were
approximately 30 million ponds worldwide that would benefit from SunClean’s solar-powered filtration
product.
After meeting with Levine and lear

learning more about the company, Nance felt strongly that KTN needed to
pursue this investment. He then presented the opportunity to the four other general partners at KTN, and
they all loved it. Independently, each partner came up wwith very similar valuations, and for the first time in
a long time, all five were able to agree on an iinvestment and on the terms of the investment.
In early January 2015, KTN offered Levine $1.5 million for a 25 per cent stake in SunClean. The investment
would be staged in three payments of $500 thousand over two years. Subsequently, Nance presented this
offer to Levine, but Levine was not happy with it, to say the least. Levine said that the KTN partners were
crazy for making such a “lowball” offer. He felt that,, at a minimum, he should be getting $8 million for a
25 per cent stake. Nance politely explained that Levine’s figure was much more than any investor would
possibly dream of paying for a 25 per cent stake. He then went through SunClean’s current situation and
highlighted that SunClean had very little revenue, weak intellectual property protection, and was on the
verge of bankruptcy, but Levine did not want to hear it. He told Nance to “go pound sand,” saying that he
would get the money elsewhere. Nance, of course, was insulted but still wished Levine the best of luck.
Nance assumed that conversation with Levine was the last he would hear of SunClean since the company
had enough cash to stay solvent for only another three weeks. However, two weeks later, Nance received a
phone call from Levine, who was calling to gloat that he had acquired the capital he needed to keep
SunClean going. Nance could not believe that another venture capitalist had invested in SunClean, so, out
of curiosity, he asked where Levine had obtained thee money. Levine proudly told Nance he had taken a
$250 thousand equity line out on his house and that this
this arrangement was much better than working with
“vulture capitalists.” He also told Nance that he was glad to have a chance to tell him to “take your money
and shove it where the sun don’t shine.”
Nance thought he would never hear from Levine again, but, about five months m later, he received another
call, and this time, Levine used a very apologetic tone. He started the conversation by profusely apologizing
for his earlier antics. He said he had lashed out because he had been insulted by what he had thought was a
lowball offer, but he had learned a lot about running a company in the past few months, and he had come
to realize that KTN’s offer was more than fair. He then went on to admit that his company was out of money
again and was within just a few weeks
weeks of insolvency, but he also said that SunClean had made tremendous
progress. For that reason, he was calling to see whether KTN might still be interested in investing in
SunClean.
Levine told Nance that SunClean needed at least $1.5 million, an amount that would allow it to make
tremendous gains. He also told Nance that he had rreceived an offer for $1.5 million for a 45 per cent stake
from another VC firm, so he wanted to see whetwhether KTN would still offer $1.5 million for 25 per cent.
Levine explained that the other VC firm had a larg
larger network of contacts and more experience and would
therefore add much more value to SunClean, but he would still be willing to go with KTN in order to retain
a higher level of equity in his company. Levine was rresolved to keep a controlling interest in his company.
He said, “I am hell bent on keeping controlling interest
interest. I have too much emotionally invested, and I do not
want to ever lose control of my company. Even if someone offered me $20 million for 51 per cent, I would
not take it.”
Nance told Levine that SunClean’s recent developmen

developments were very interesting, but KTN probably would
not be interested in investing based on its past inter
interactions with Levine. However, Nance was desperate to
find a good investment since several of KTN’s major iinvestors were threatening to withdraw their capital
if KTN did not soon invest all of the money in the fund
fund. In fact, just the week before, Nance had talked one
of the investors out of pulling his $10 million investme
investment from the fund. Due to this increased pressure from
investors, and also because of the interesting devedevelopments SunClean had made, Nance told Levine he
would look over the company’s progress, and if it were compelling enough, he might try to get his partners
to reconsider.
Immediately after that conversation, Nance received an email from Levine that contained a summary of
SunClean’s updates and a copy of the investment offer SunClean had received from the other VC firm.
Nance was floored by the progress SunClean had made. It had generated almost a million dollars in revenue,
but, even more impressively, it had secured more than $12 million in contracts for the following year. On
top of that, SunClean had streamlined its production process and significantly reduced its production costs.
Nance ran a couple of quick valuations and determined that the company was worth at least three times
what it had been worth just five months previously. This progress was very impressive, and it revealed that
SunClean was exactly the type of investment nt that KTN wanted—and needed—to make.
Nance was so impressed with what he saw that he was willing to give SunClean another chance. On May
11, 2015, he decided to call a meeting with the other four managing partners of KTN to call a vote on the
SunClean investment opportunity. Given the history of KTN and SunClean, he knew the other partners
might not vote in favour of this opportunity. To his surprise,
surprise, all four were in favour, but only if KTN could
gain controlling interest in SunClean, and only if KTN’s technology consultants felt confident in
SunClean’s product.
Nance immediately informed his partners that Levine Levine would not give up his controlling interest in
SunClean. His partners gave him a lot of pushback on this detail, but in the end,e the group reached the
consensus that if the technology were as good it app appeared
eared to be and if the company had $12 million in
business contracted for the next year, they would be w willing to look past Levine’s earlier antics and invest
in SunClean. While the partners were not keen about the prospect of Levine maintaining a controlling
interest in the company, the opportunity was too good to pass up, especially when KTN still had more than
half of its fund to be invested, and the investors were becoming increasingly anxious.
After the meeting, Nance immediately contacted his patent attorney and a technology consultant to evaluate
SunClean’s core technology, and within two days, he received a reply from both. The patent attorney
informed Nance that SunClean’s three patents on its core technology were not worth the paper they were
printed on; it was evident that Levine had filed these patents without any expert help. The patent attorney
said, “My 12-year-old son could have done a better job filing these.” He then went on to explain that anyone
could easily steal these ideas, and SunClean would ha have no legal recourse. The patent attorney also
informed Nance that these patents could easily be corrected and refiled for less than $50,000. He assured
Nance that the refiled patents would be very strong aand that the refiling could be completed quite quickly.
The technology consultant informed Nance that his ex examination of SunClean’s technology showed it to be
a unique and highly effective product. In addition, he estimated that this filter’s product life cycle would
last more than 10 years since products in the pool industry tended to have a very long product cycle.
However, he indicated that the core technology co could easily be copied. He thought it could be reverse-
engineered and recreated in as little as a few weeks, but he emphasized that a couple of strong patents would
fully protect the product. Nance, in turn, forwarded these expert opinions to the other partners and called
for another meeting on May 20, 2015, to vote on the SunClean investment opportunity, sensing that the
experts’ opinions would clinch the vote.
On May 20, 2015, the partners met for the formal vote on the SunClean investment opportunity. Two of
Nance’s partners opened the meeting by immediately stating
ting that the group would be foolish to invest in
SunClean, suggesting that, instead, they could save a lot of time and effort by simply taking the product
concept and building a company around it. The two emphasized
phasized the fact that SunClean’s patents were
indefensible and that KTN had not signed a non-disclosure
sure agreement. They then laid out a plan for how
they could quickly launch this new company and save hundreds of thousands of dollars in comparison with
the option of investing in SunClean. Even more importantly,
antly, this new plan would get Levine out of the
picture. The two partners went into great depth to emphasize how impetuous Levine was and how his
behaviour had set him up for this scenario. They also made it very clear that the process would be
completely legal and that they knew some talented people whom they could hire to recreate the product and
run the business.
According to their well-crafted plan, these two partners

rs proposed that KTN could recreate the product and
build up a new company for less than $1.2 million. Thee pair indicated that this new company could be
exited within three to five years—and that KTN that would own 100 per cent of the new company and
would not have to deal with Levine. The increased ownership stake would greatly increase the potential
return on investment. The two partners estimated that, within three years, the new firm could be worth more
than $100 million, and within five years, it could be worth more than $200 million. If they could start a new
company and exit within three years for $100 million, KTN’s return could be more than 75 times their
original investment. In comparison, if they invested in Levine’s company, they would need to pour an
additional $300 thousand into the project
ect and would own just 25 per cent of SunClean. Under that scenario,
if they were able to get a valuation of $100 million, their potential return would be only around 17 times
their original investment.
The arguments the two partners laid out were compelling: Not only would their approach save KTN
hundreds of thousands of dollars but it would create a much stronger company, the potential return was
several times greater, and there would be nothing illeg
illegal about it. However, two of the other managing
partners protested that this approach was unethical—tha
unethical—that they would, in fact, be stealing from Levine. They
argued vehemently that although ta taking
king Levine’s product was not illegal, it was morally wrong. They
emphasized how small the VC world was and how wo word would get around that KTN had stolen ideas from
a potential investment company, a situation that would surely hurt their reputation and make it more difficult
to find investments. In addition, the two detractor
detractors emphasized how other venture capitalists would view
the KTN partners as unethical and, as a result, would not want to syndicate with them on future investments.
The two partners who were in favour of taking Levine’s idea countered this argument by saying that because
Levine had such a bad reputation in the VC and start-up world, people would know that it was his own fault
that someone took his idea. The two sides jostled back and forth for a couple of hours, with the “take the
idea and run” pair arguing that Levine’s business mistakes and boorish personality left him deservedly
vulnerable to this kind of situation, and that in the fiercely competitive world of business, these things
happened all the time. The two moralis
moralists stuck to the argument that even though taking Levine’s product
would not be illegal, it still constitu
constituted stealing, and stealing the idea would tarnish KTN’s reputation. All
the while, Nance saw the merits of both arguments.
The one thing that everyone agreed on was that they needed to move quickly on this opportunity. The five
partners were desperate to find an investment, and th
the situation had reached the point that three of KTN’s
main investors were getting ready to pull their money out of the fund unless KTN made a “great” investment
within 60 days. The partners were convinced that the solar-powered pool filtration technology was an
impressive technology that would appeal to KTN’s investors.
After a lengthy discussion, one of the partners called for a vote. KTN would either invest $1.5 million in
SunClean for a 25 per cent stake, or take the idea and
nd invest $1.2 million in a new company that KTN itself
would control. According to KTN’s operating agreement, ent, all major investment decisions required a
majority vote, and with the other partners split evenly, the final decision rested with Nance.
Unfortunately, Nance truly saw the merits of both alternatives. On the one hand, he felt that Levine had set
himself up to be taken over because of his carelessness in failing to acquire a legitimate patent, and Levine’s
crass personality made the idea of working with him quite ite difficult to accept. On the other hand, Levine
had created this product, and even though KTN could legally take it, doing so could easily be seen as
stealing, an action that would surely have profound ramifications for KTN’s reputation in the start-up
community.
Nance also considered abstaining, which would effectively

tively force KTN to pass on the opportunity altogether.
However, with all the pressure that Nance and his partners
partners were under to find good investments, even
though the option in front of them was less than ideal, it was the only option they had at the moment.
Nance asked for a day to evaluate his choices. The other partners granted his request, but they made it clear
that one day was all they would give him. Nance needed to make his decision.
Source: Created by the author.
Sale of filtration units
$1,598,000,000
(2 million units × $799 per unit)
Sale of filter cartridge replacements
$150,000,000
(2 million units × $75 cartridge unit)
Direct production cost of filter units

$700,000,000
(2 million units × $350 per unit)
Direct production cost of filter
$80,000,000
(2 million cartridges × $40 per unit)
General and administrative costs $20,000,000
Sale of filtration units

$79,900,000
(100,000 units × $799 per unit)
Sale of filter cartridge replacements
$7,500,000
(100,000 units × $75 per unit)
Direct production cost of unit

$35,000,000
(100,000 × $350 per unit)
Direct production cost of filter cartridges
$4,000,000
(100,000 cartridges × $40 per unit)
General and administrative costs $24,000,000

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Jon Carrick wrote this case solely to provide material for class

ass discussion. The author does not intend to illustrate either ef

This publication may not be transmitted, photocopied,

Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-05-30

The company has an innovative manufactured product(s) in a niche area.

When they started the firm, the partners had intende

At this critical juncture, Nance found a potential inv

Nance was so impressed with what he saw in Levine

Based on the expenses that Levine had presented to Nan

After meeting with Levine and lear

Nance told Levine that SunClean’s recent developmen

According to their well-crafted plan, these two partners

Nance also considered abstaining, which would effectively

Direct production cost of filter units

Source: Created by the author.

Sale of filtration units

Direct production cost of unit

Source: Created by the author.

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