Law Offices of Michael E. Gross | Chevy Chase Real Estate Lawyer and Business Law Attorney

Business and Finance Law: Financing the Corporation

Introduction

Whether a company is in a start-up phase, needs to implement an aggressive growth strategy involving expansion or acquisitions, is preparing new market-oriented initiatives or product lines, or wants to partner with or become part of another company, it may not have sufficient funds immediately available to pay the up-front expenses involved. In many key transitional phases, a company will need to seek external sources of funding. Working with an experienced corporate and finance law attorney who understands your company's business and its strategic options can save your company valuable time and money and help achieve objectives that maintain your company's value and competitive edge.

Options in Corporate Finance

There are many options open to companies seeking external funding sources. Lines of credit, consumer financing, loans, debt financing or corporate bonds, issuance of stock, venture capital, joint venture agreements and restructurings and reorganizations are among the different ways a company can seek to finance its growth.

Lines of credit may involve subsidiary agreements that take a secured interest in future sales and production. Such agreements can involve banking law and principles of the Uniform Commercial Code. Similarly, a company or a lender may arrange financing for the company's customers or it may directly loan funds to the company. Such indirect or direct loans typically will involve collateral in assets or production of the company or its goods being sold. However, a company's ability to avail itself of lines of credit, customer financing or loan financing may be limited by its current debt levels, its past track record or a recent history of reorganization, or its sheer lack of experience or relatively new presence in the marketplace. The advisability of seeking such forms of financing might also be limited by the company's ability to begin meeting repayment plans on the basis that a lender would require. Many start-up companies, in particular, and companies that are already heavily debt-leveraged may not have access to lines of credit, consumer financing or loans that will be sufficient to meet the needs associated with their growth needs.

Issuing corporate bonds may be another way to finance a company, especially if the company is established, is financing a major expansion or is acquiring another company. In these circumstances, investors may be attracted to such an investment, despite obvious risks, if they are assured of some return on the capital they provide. Bonds issued under such circumstances can be financed by a buy-down fund within the company, or may offer certain options at maturity, including the option for the bondholder to convert the bond into stock. Structuring the terms of such bonds can be especially important, not only for attracting bondholders but also when it comes to existing shareholders. Bondholders will have preferred right to profits realized by the company. These rights must be met before equity shareholders receive a dividend or realize appreciation in their equity interests. And, if the company fails to realize a profit, bondholders will generally have priority rights to the proceeds of the company's assets ahead of the company's stockholders. Whether or not corporate bonds carry a convertibility feature, they are tightly regulated by state and federal laws.

Another common way of financing start-up companies and companies undertaking major expansions is to create equity interests that are given to investors in return for their investment. These can be financial or even, in some cases, in the form of expertise or other services provided to the company. Such equity interests are usually in the form of stock and, like bonds, are tightly regulated by state and federal laws. Unlike bonds, however, such investments may be entirely at risk. In other words, if a company fails in its business launch or is not able to realize a profit through its enterprise, the equity holder may lose most or all of its investment. Equity interests may also involve dividing up control of the company or giving outsiders an interest and voice in how this control is exercised. Planning for the accountability that comes with issuing equity interests in a company is a serious matter requiring legal counsel.

Venture capital is a source of funding much talked about during recent years. Venture capitalists typically finance start-up and young companies and even established companies undergoing major expansions in return for equity stakes that may be expressed not only in terms of number of shares but also in the proportion of equity interest in a company. As a result of their equity positions and also the governance terms they may demand in return for their investment, venture capitalists often will have a voice in the management of the company. They may serve in positions on the board of directors and have shareholder agreements with the company's founders and other investors. It is growing more common to see venture capital investments that are negotiated to afford the venture capital firm a direct say in the choice of management personnel, the organizational structure of the company, and even veto power over certain business decisions. In return for taking a very risky position in a company, which is usually untested by the marketplace, venture capitalists look for ways to obtain often phenomenal returns on their investment. Such arrangements allow them to get in on the ground floor of new ventures that more conservative investors may not be able to support, particularly if they manage funds from institutional or government clients.

Joint venture agreements provide yet another way to access outside funding for a company or particular projects and initiatives. In this manner, a company having little capital, but valuable expertise or intellectual property rights, may partner with a well-financed or well-established company. Franchising and licensing may be involved as well as joint venture agreements and key employee contracts, sometimes affording these employees with equity interest in the profits realized through a joint venture.

Other means of financing a company may involve a buyout of the company, an exchange of stock with an acquiring company or with a company that is being acquired, the restructuring of equity interests in and management of a company, or through reorganization of the company. In any of these scenarios, important consideration may need to be given to protecting the company's managers and shareholders to the extent possible or to devising strategies to legally make decisions in the best interest of the company, which they may resist. The need to respect legally mandated rights of existing shareholders, who may dissent against such plans, and the threat of derivative lawsuits filed by shareholders on behalf of the company are all things that must be considered. Also critical in such situations will be the liability of officers and directors of the company, and the need to identify and avoid potential conflicts of interest.

In any situation involving the financing of a company, it is critical to assess the loyalty of key employees of the company. Non-compete agreements, incentive plans, and employment and consulting contracts may be essential to preserving the value of the company or making it a risk-worthy investment for outsiders. Also important is the protection of the intellectual property of the company, especially where a key invention, familiar trademark, or copyrighted works are critical to the company's ability to meet its business and growth plans.

Conclusion

Companies at different stages of growth may need external financing to ensure or continue their success or to make a transition needed to ensure their survival. There are a number of options that might be available, but choosing the one that is best for your company is a matter not only of having or accessing strong business planning skills but also of finding astute legal counsel. Particularly if your company is a new or start-up company, a small company, or a mature company facing severe adjustments, it may be worthwhile to retain the services of an attorney with practice experience and familiarity with corporate finance laws. Preferably, your attorney will also have a working awareness of the industry in which your company operates or plans to operate.

DISCLAIMER: This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. Seek competent legal counsel for advice on any legal matter.

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