However all too common is the enterprise that organizes itself improperly out of the gate by making the wrong choice of entity, issuing the wrong type, class, and amount of stock or member units, seeking equity investments either from the wrong sources or at the wrong time, utilizing the wrong form of debt financing and the list goes on In today’s post I’ll examine some common capital formation mistakes to avoid.
I conducted an informal poll not too long ago with the goal being to try and understand how entrepreneurs choose to organize their companies. The following five questions were posed to a group of bright, successful, and sophisticated entrepreneurs and the answers received ranged from the sublime to the ridiculous, to the very enlightened. The answers displayed below are representative of the most common responses:
1. How did you select your entity structure? “I asked my accountant which form of entity to use and he said that a Sub S would be the best choice for minimizing my tax burden”
2. How did you organize your capital structure? “My attorney just told me to issue 100 shares of common stock.”
3. What was your capital formation plan? “I had a little cash saved up and I figured once I had been in business for a while and established some revenue I’d get a bank loan.”
4. What was your valuation strategy? “I didn’t really have a valuation strategy I thought it would take care of itself at the right time.”
5. What was your exit strategy? “I didn’t really have an exit plan per se, I just thought I’d survey my options when the time was right and see what produced the best return.”
The truth is I’ve seen companies make all the wrong choices in their formative stages and yet still do well. However, these companies that have succeeded in spite of themselves had the luxury of having the time and the money to re-engineer their business at a later date. The sad reality is that most companies don’t have the time or the capital to unwind critical mistakes in their strategic financial plans.
My advice is simple Do not fall into the trap of working with a small “mom and pops” accountant or attorney; rather seek out the highest caliber professional advisors when developing your corporate financial plan. Time spent in the development of a sound strategic financial strategy will help your company secure capital at the best terms, rates, and conditions thereby allowing your company to scale by leveraging the lowest blended cost of capital into the best valuation resulting in the highest return on equity.
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