Financial Architecture

Observations from our Founder and

Managing Director

Topic: Does the Financial Architecture a Founder Selects

Matter?

People typically engage an architect to review the proposed

function of a building, and then create a design that integrates

practical engineering with the desired aesthetic.

Does a business optimize enterprise valuation based on the

selected financial architecture of the entity? Can the financial

architecture selected penalize the future valuation? These are

important considerations when evaluating both the immediate

and future consequences of a business's financial architecture.

As consultants to new and growing businesses, particularly

those based on the exploitation of proprietary intellectual

property, we frequently find ourselves tasked with “cleaning

up” or restructuring the chosen corporate architecture.

When we use the term “corporate architecture,” we are

referring to the type of entity, and the securities (membership

units, partnerships, etc.) that have been issued, or are yet to be

issued, the compliance completed or to be completed, and the

analysis of what the optimum structure(s) should be for the

intended enterprise operation, both current, and future.

Questions Need to be Asked and Answered

1. What is the best financial architecture for an

enterprise? A company that has legal personhood

has options.

2. What corporate form or combination of forms

should be selected? C-Corp, S-Corp, LLC,

partnership, or professional association?

3. Where should it be domiciled?

4. Does the domicile change over time? Why change?

5. When is a holding company with subsidiaries a wise

strategy?

6. Which structure is best to build equity in the

selected enterprise vertical?

7. Which type of entity should an entrepreneur choose

when the initial and ongoing focus is to “build to

sell” versus “build to keep”?

8. If the enterprise is a multi-state operation, or will be

a multi-state operation, are state- based entities

under a holding company the best option, or should

the entity simply register as a “foreign” company

doing business in each state?

9. Which type of entity more easily qualifies for

commercial credit?

10. Which type of entity provides a founder with

maximum after-tax benefit for current operations?

11. Which type of entity provides the founder with the

maximum after-tax benefit if the entity is sold

whether in one year or five years?

12. How and why can a corporate veil for liability

protection be pierced?

Hint: When the founder or operator chooses to act

as though the entity is merely an extension of the

founder, with a common checkbook, failing to hold

corporate meetings or memorializing board

authorizations, commingling funds, and otherwise

blurring the lines between the corporation and

individual, the corporate veil can be pierced.

The Big Picture

Financial architecture matters.

Maintaining corporate compliance matters.

And, sorting the use of corporate equity as “capital” to reward

others matters.

1. When, if ever, do you provide equity as an

incentive? To whom? For what services?

2. Is there an option that provides the benefit of equity

without actually giving up equity?

3. If you plan to “cash out” some day, are there

prophylactic measures that can be put in place so

the founders remain in control of the timing and

terms for that event?

4. How many shares of stock should you authorize?

Issue?

5. Are there drawbacks to operating like a “penny

stock” company? Fifty million shares of a company

that has no net earnings is not worth more than

1,000 shares of the same company.

6. Is it ever wise to create two classes of stock? Two

classes of debt?

7. Are warrants a wise strategy for a private company?

8. When is it prudent to separate intellectual property

into its own entity?

9. Where should an intellectual property entity be

formed and domiciled?

10. What U.S. and international precedent tax court

rulings should guide management decisions and

financial contracts for the use of intellectual

property?

11. Is there any advantage to selecting differing tax

jurisdictions?

12. What are the direct and ongoing costs of offshoring

the IP?

13. What are the potential benefits of offshoring the IP?

Selecting a corporate structure that checks the most important

boxes is best determined after a careful analysis of the current

and future business’s likely actual operations (as opposed to the

“big dream” possibilities).

Said another way, a simple, low-maintenance, compliant entity

structure is typically best, until opportunity, overall tax

compliance, cost, or potential liability requires greater

complexity.

A Few Words of Caution

1. Issuing equity in your enterprise to third parties, such as

advisory board members, for “potential” future

contributions that may never materialize is seldom a

wise strategy.

2. Issuing equity to employees who may be distracted by

future outside offers is seldom a wise strategy.

3. Memorializing board representation participation or

granting control to a lender or investor over future

actions until the debt is repaid is seldom a wise strategy.

4. Issuing millions and millions of shares without a

requisite necessity is seldom a wise strategy.

5. Paying bills or vendors on behalf of your corporate

entity rather than loaning money to the entity so it can

pay its own bills is seldom a wise strategy.

6. Loaning money to your corporate entity requires actual

documentation of the amount loaned, the term, and the

interest rate to be paid.

7. Selecting a SIC code that is inaccurate for reporting

purposes is seldom a wise strategy.

8. Combining two entities, one with a significant NOL

and one with taxable income in the hope of reducing tax

liability without a specific business benefit will not

shield the entity with taxable income from tax

obligations.

9. Failing to hold required governance meetings for a

corporation or a limited liability company (LLC) is not

a wise strategy.

10. Failing to file required state information returns for

your entity is not a wise strategy.

11. Having the corporate entity pay all your personal bills

is seldom a wise strategy.

In the end, the financial architecture of an enterprise is both the

foundation and the framework upon which its value is built. A

well-structured, compliant, and thoughtfully maintained entity

allows a company to grow, attract capital, and ultimately

achieve a premium valuation when opportunity arises.

Conversely, poor architecture, neglect of compliance, or

careless use of equity can erode value and limit future options.

Sound structure is not an expense. It is an investment in the

enduring worth of the enterprise

-From the Office of the Managing Director.