Gonzales Food Stores seeks to raise $10 million for expansion through equity financing while retaining company control. They are considering either private stock sales or bonds. Private stock sales would give investors ownership stakes but require giving up some control. Bonds require repaying debt which may not be feasible given the company's high debt-to-equity ratio of 50%. The company is considering offering preferred stock, which provides tax benefits to institutional investors, or classified common stock with different voting rights. Founders shares that vest over time could incentivize long-term commitment from new investors or employees. The optimal approach may be a mix of callable preferred stock and founders shares.

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Case Assignment:
Gonzales Food Stores: Selling A Piece of The Ownership for Expansion Needs
Stacey Troup
Investments & Portfolios/ MBA-623
January 28, 2019
Professor Dr. Ralph Ezelle
Touro University Worldwide

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Abstract
Retail markets struggle to keep alive in this landscape of “instant gratification” with sites
such as Amazon.com taking over the bulk of revenue share for this market. Gonzales Food, for
this example, will seek to raise funds through a private sale of some shares while exploring the
different landscapes in which to do this while they have a high debt to asset ratio and seek to
retain control of their company while raising the capital needed in order to expand.
Keywords: D/E Ratio (high); Expansion; Private Equity; Venture Capital;
Markets to achieve goals

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Retail Expansion Goals – Gonzales Food Stores (Private)
In this exercise, we will explore the options when seeking to expand the operations of
Gonzales Food Stores, a privately held company with a high D/E ratio (50%). The company,
who is cash poor due to their liquidity being held up in the operations and stock of the store,
seeks to raise $10M through an equity push of stock sale to private investors while exploring the
option (and costs) of going public. Throughout this paper, we will approach the subjects of
financing options, stock variations of both publically and privately traded stock, what going
public would mean to our ownership and bottom line as expansion dreams drive our decisions to
give up a piece of our ownership.
Stock Vs. Bond Financing
The decision to allow private stock sale vs. bond financing is one that needs to be
approached from the perspective of cost and ownership retention. When private shares are sold
to investors, the investors own a percentage of the company in exchange for the financing
required to meet the goals (as on “Shark Tank”). These purchased stocks give the investors
voting rights and often, the companies investing through this method will request that at least one
member of their staff join the firm in order to ensure ethical and smooth running operations in
accordance with their Private Placement Memorandum (PPM) (Ingram, N.D.).
Stock isn’t the be all end all answer to financing and is not without its problems either.
With the stock option, the valuation of the stock may be low due to the D/E ratio of the company
and it may take longer for investors to get on board with this financing option. Alternatively, the
equity share given up in exchange for this financing may be hard for owners to swallow when
they are used to running the operations on their own. They would need to adjust to having a
board of advisors guiding each decision and would also give up a pre-determined portion of the

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profits to the underlying private investors. For some, this adjustment may be beyond reach as
they are very set in their ways and emotionally unprepared to take orders from someone new
(AllBusiness Editors, N.D.).
Bonds, on the other side of this equation, provide for privately financed portions of the
needed money to come to fruition but the bonds themselves are attached to interest payments in
addition to a full repayment of the bond value, which may not be able to be met in the time frame
of a bond. While this option provides for retention of the company as a whole, the risk is greater
for the ability to repay is a high-risk maneuver for a firm with a D/E ratio of 50% such as
Gonzales. The bond option is a preferred one for institutional investors as it allows for a
deduction of the interest and dividends to be reduced from the income in the form of a Capital
Gains deduction (Ingram, N.D.). The bond option also does not come with any form of
ownership, Board of Directors privileges, or voting rights and is really just a loan with interest
financed outside of the normal bank method. Finally, with stock sales, there is no new debt
accrued as there is with bond sales for the same purposes.
Through the “PPM” agreement in order to buy private stake in a company which is not
publically listed, the PPM gives guarantees to the underlying investor in the form of repurchase
rights, limitation of the number of shareholders/stockholders allowed, limitation on the dollar
amount able to be raised (in accordance with SEC regulations), and additional coverages under
RegD (SEC) in accordance with the Securities Act of 1933 (Ingram, N.D.).
SEC Rule 701 and Form S8 allow for an exemption of registration for firms and investors
provided that the investment is under $5M in the previous 12 months. As this investment would
be one seeking $10M, Gonzales would be required to deliver additional information and
documentation to investors within a reasonable period of time prior to sale date. Our investment,

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from the beginning, would have these investors duly notified as they would be included in our
offering documents and clearly laid out as to limit the desired investment to $10M (Ingram,
N.D.). The SEC Commission amended rule 701(e) to “implement the acts mandated to increase
the threshold from $5M to $10M for the aggregate sales of a security in the 12 months prior to
the sale (bearing additional disclosure requirements)” (Securities and Exchange Commission,
N.D.). In addition, disclosure under the 701 ruling are only needed after $10M in sales in a 12
month period (Securities and Exchange Commission, N.D.).
Public Vs. Private Stock
As the store owned by Gonzales is privately funded by the owners, assumed to be family
members, the stock in said store is privately owned. This situation would change to a semi-
private ownership status should the family (owners) decide to privately offer stock options to a
venture capital firm in order to meet expansion needs.
When offering shares of the private company to qualified purchasers (investors) defined
by the IRS and SEC as those with at least $1M in liquidity (Bank, N.D.), it is imperative that we
understand the differences between stocks so that we can offer a classification of stock that
meets both the needs of the investor as well as the needs of the company. Common stock, the
most widely recognized variance of stock options, gives percentage of ownership in a company
and contains voting rights. However, this stock is the last paid in the event of insolvency on the
part of the company and the higher of the risks within stock options but is the preferred stock is
one that is preferred by VC (venture capital) firms because of the ownership rights in the
company (Gora, N.D.).
Preferred stock has a lower degree of ownership and comes with no voting right but
contains a (Federal) tax benefit to institutional investors, not individual investors in the form of a

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“dividend received” deduction allowing for a 70% exclusion of gains through dividends earned
to be taken from their income overall. This benefit is not one available to the public and is
reserved for institutional investors (Drinkard, 2018).
Within the realm of common stock lay the Classified Stock affiliation. Classified stock is
a version of common stock split into classes such as Class A, Class B, etc. which come with
specific voting rights associated with each whereby Class A has greater voting rights (Classified
Stock, N.D.). These rights and benefits are outlined in accordance with the firm’s charter upon
release of stock (Classified Stock, N.D.).
Founders shares (sometimes referred to as a “stock option”) is stock issued with an equity
share ownership in the company, issued at par value (nominal value) which has specific vesting
dates and requirements in order to be redeemed for current trade value in accordance with the
active trade status. Some of the benefits included in Founders Stock can include vesting
provisions, accelerated vesting in the event of a company sale, first right of refusal, co-sale
provisions, lock-up agreements (periods), and superior voting rights. This stock is an internal
one given to employees, owners, principles of firms as a benefit of employment (LINFIELD,
N.D.).
An advantage to issuing the shares as “Founders Shares” is that they are not immediately
callable for higher value until they are fully vested. In most cases, when you do not stay for the
duration of a callable share such as this, you lose your vesting interest in the company.
Sometimes, when these options are given to employees of publically traded firms, and the firm
loses value and gets “delisted” from the exchanges, such as one I used to work for, you lose your
entire value of the stock including any automatic purchases from payroll for same as the stock
has fully lost value to investors. The ability to have this lock-up period could prove useful for

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the company as it requires a stay of duration before these shares can be callable, thus allowing
for the value of the company to rise to the determined face value of the stock issued (LINFIELD,
N.D.).
As for Gonzales food, it is the recommendation of this paper to offer “callable” preferred
stock mixed with “founders” shares (sometimes called treasury stock in financial statements).
This would allow the company to retain a greater share of the company while offering equity
share to those who help drive the company vision of expansion and make it a reality. Callable
preferred stock has a majority of the stock only redeemable at the prospectus price and date, not
before. This lock-up period is key to the success of the valuation of the company as they expand
their offerings/space (Drinkard, 2018).
Options for Offerings – PE Vs. VC Firms
Imperative to our review is the understanding of how to list such privately held shares
and what the expectations are. As Gonzales markets seeks to find the appropriate investor for its
private offering, we need to understand what sets apart private equity (PE) from VC (venture
capital) firms. Private equity firms are made up of qualified investors who invest in established
companies who seek to expand their offerings. However, PE firms often take authoritative
control of the firms through stock/purchase control, streamline the issues at hand, and reap the
rewards of a management/procedural restructure as they become full owners of the distressed
companies they purchase (Investopedia, 2019). While this would normally be a more lucrative
place for us to find our funding, the loss of control is unfavorable to the current owner and the
goals set forth.
Venture Capital firms (VC) typically invest $10M or less in their chosen investments and
have (historically) invested in start-up firms. However, these firms can choose to invest in a

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business such as Gonzales as they may have a stronghold in their marketplace and a unique
offering that is favorable to the public that they serve (such as a specialty market) (Investopedia,
2019) (EduPristine, 2017) (Gupta, N.D.).
The VC model of investment opportunity is exactly aligned with the suggestions listed
previously in terms of type of stock to issue, reasons for same, and how to retain key employees
after an investment. The VC firm may have an issue investing the full $10M in the beginning
due to the high D/E ratio of the firm (50%), however, they will take a full picture value of the
company from a perspective of market share, historical profits, time in business, etc. as they may
recognize that a specialty market in a neighborhood could grow into a true force to withstand the
Amazon.com competition through their offerings and service (Gupta, N.D.).
The convertible stock is often requested by such VC firms as are the founders shares as a
way to ensure the “roots” of the company they are investing in are stable and that the key
employees are locked in through vested stock options (Larcker, 2018). These safeguards give
reassurance to the investor that the market share currently contained will remain or grow given
the retention of these employees (Harroch, 2018). As previously discussed, VC firms will often
require appointments of their staff to the Board of Directors as well as specific authoritative
directives in terms of the business operations (EduPristine, 2017).
While Gonzales may not like this form of investment, they can choose to offer a median
stock version which allows for a buyback or retain greater than 51% of the stock in order to
remain in control (authoritative) of the company.
Going Public
After the private shares are offered to the VC firm, the firm (or the Board of Directors
directing such investments) may decide to expend the near $1M to “go public”. The term “going

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public” refers to offering for sale shares of stock on a major market such as NYSE or NASDAQ
for a set price (in accordance with the IPO price and subsequent sales) to the not only brokers but
investment firms and the public (day traders). The decision to go public is one not to be taken
lightly as the initial fees for the lawyers and listings can reach or exceed the $1M mark and may
be out of reach for a firm of this size. The secondary markets may be where this company finds
its comfort, share retention, and desired outcome.
While the advantages of having this firm go public are things such as an increased stock
price for the issued shares which may drive profits beyond the needed $10M investment while
retaining control of the company through Founders Shares issued to principles, employees, and
owners. Alternatively, the firm could use all of its valuation if the market does not reply
favorably to the offering, which would drive the price of the stock downward and could cause
dream of expansion further away (Larcker, 2018).
When a company decides to “go public” they are “listing” their stock on an exchange to
gain a greater access to investors on many levels, beyond those of just “qualified purchasers”.
The listing times for a stock to go public (after the review of legal documents, which can take up
to 30 days) is approximately 7 days from the point of issue (i.e. the finalization of legal review
and authorization to offer shares on the market). The average settlement to arrive on the
exchanges is 30-37 days depending on if the stock has an ask price which is variable or a set
price (which makes the settlement slightly longer) (N.A., IPO, N.D.). Prior to the release on the
public markets, the stock would be (or could be) exchanged on secondary markets through the
VC firms to their underlying investors.

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Conclusion
While Gonzales seeks to expand their operation through a $10M investment from outside
investors while maintaining control, the dream may be a bit far-reaching. The company will be
able to retain majority control in the company with an influx of investment from a VC firm but
will have to answer to a Board of Advisors determined by the underlying investor who will drive
major decisions for the firm. This can be both positive and negative depending on the
disposition of the owners and their willingness to give up a little day to day control in exchange
for retaining the company through majority share retention (and possible stock buyback).
By understanding the differences between VC and PE firms, we are able to better make
decisions that are in line with our goals of company retention as well as growth through a $10M
expansion, so as to give us greater liquidity while offering greater benefit to our key employees.
It is for this reason, we suggest an offering through the VC firms at a 49% (not to exceed the
$10M needed) stock offering based on the overall value of the firm following a formal company
evaluation of the firm by the underlying investor. While this stock price is based on the value of
the company, we are unable to determine the true value of the company without an overview of
the specific financial documents but will assume that the company is valued at a price that would
warrant an investment of $10M at a valuation to be determined after review of financials.

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