I’ve known George Von Gehr for more than 30 years. A few weeks ago, I ran into him and learned about his new book, “The Effective Entrepreneur: Fifty-nine rules to Create Value Throughout the Life Cycle of Your Company”. George was kind enough to permit us to reprise some of the highlights here; the book is available on Amazon.com.
George, to quote from his book, “is a proven counselor to entrepreneurs and their advisors. He had front-line experience as an entrepreneur before starting, growing and selling his successful boutique technology investment-banking firm. His background includes degrees in engineering, law and business from Princeton and Stanford, as well as consulting with McKinsey & Company, Inc.
I selected as the first post excerpts from Rule #9 – Keep Capital Structure Simple — because I suspect that capital structures will be a major topic of discussion among investors and entrepreneurs as they struggle to refinance their companies during this economic crisis.
“In an ideal world, young companies would have only common stock and therefore simple capital structures. All shareholders would be treated equally, regardless of whether they contributed cash or “sweat equity.” This approach would require that boards and managements use considerable restraint in granting options, founders’ shares, warrants, or other equity based incentives. As an alternative to policing the issuance of common stock, investors have gravitated toward preferred stock, a class of stock that gives cash investors first right to sale proceeds and various other protective and preferred rights, including special voting privileges.
Complicated capital structures cost money to track and maintain. Thus, each new financing requires a review of all the elements of the complicated capital structure, may delay the process, and often leads new investors to ask for more strength in completing a difficult financing. Multiple classes of stock also cause investor and board tension and possibly confusion over which class receives proceeds in what order and which class has special voting rights. This class vote can, in fact, control some aspects of major decision- making for the company.
Creativity can be wonderful in financing and often is the only way to raise money. Many venture capitalists love to brag about the clever financings they have done. But the more clever the financing, the more damage it may eventually do to the capital structure. Although the cash may arrive at the closing, the impact of the creative part of the financing may be felt for years and may ultimately make subsequent financings more expensive and difficult.”
George’s wisdom is a worthy caution as you consider the most suitable capital structure for your business, whether it’s an initial or follow-on round of financing. Careful planning can protect ALL the stakeholders—those who took the earliest risks, as well as those who’ve invested at the highest valuations. In the best of circumstances, you won’t have to worry about esoteric funding mechanisms. If you do find yourself contemplating these more complicated alternatives, an experienced attorney specializing in early-stage financings is an invaluable asset as you evaluate the impact under various scenarios on founders, employees, and outside investors.
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