Why do online entrepreneurs need to structure their companies carefully?
Abacus Seychelles Limited
10 June, 2016
Here is John Max, 28, sitting in his makeshift office in downtown Oslo, typing away furiously on his Mac, oblivious of any sound or sight about him. His latest app on how to trade wine collections is almost ready. He will soon put it on Google and Apple App Store. Next will be his website which will not only promote this app, but showcase John's expertise in the area of wine management. And then he will start tying up with wine manufacturers and with the select membership clubs of wine connoisseurs.
Before he knows he will have to sign agreements, contracts and some revenues will start to flow. Soon his brand will start to become well known and there will be increased demand for his services. Soon he will want to acquire a collection of his own, to become one of his own traders. Soon venture capitalists, some of whom are in no way connected with wines, but are experts at funding global e-commerce ventures, will hear of this idea taking shape. And soon some of them will want to invest in what they believe is a unique idea, so far well executed by John.
And then they have a meeting with John. And after a bit of crystal glazing and spirited haggling, they agree on valuation of the venture; and on what part of the venture will the investors own. The deal seems done. John is happy for getting a chance to scale up his dream venture, while still retaining majority control. The investors are thrilled at having picked what they think is a likely winner.
And then the detailed diligence and the documentation starts. The venture capitalists, the investors want the business to be global to justify the promise of the idea of international wine trading. And they want global users to be able to pay for the wine inc's services globally, into a bank and to a company which doesn't restrict global flows. And they themselves want the investee company to be in a neutral jurisdiction which can feed all the global markets, without any overbearing administration or tax hurdles.
Simply because they want the company and correspondingly their returns to be maximized, and to have the freedom to bring in investments from their fund without themselves having to be subjected to the same administrative and tax hurdles.
And what do they discover? That John had incorporated a company, perhaps ill-advised by one of his freshly graduated friends, in a jurisdiction which required a full time administrator to deal with onerous filings and boasted of one of the highest tax rates in the world.
Now, investing in that company would make the venture fund also subject to the excessive tax administration.
The Fund had to re-do their Net Present Value calculations, and realised their break-even for the investment had shifted from likely 3 years to 5 years. And it was no longer an attractive investment option, simply because they had other options - other promising ecommerce entrepreneurs across the globe working overnight to get their ideas converted into products, then business, and then revenues.
The investing fund could still have gone with the deal, but they and eventually John found the process of restructuring the company to be tedious, requiring a very large number of permissions from the regulators, and hence very time consuming.
Sadly the deal didn't go through. And worse, John feared he would face similar issues while facing the next set of investors.
He had become so typical of the new generation of digital entrepreneurs, who are brilliant at developing an idea and taking it to the market, but have no clue on how to effectively structure the corporate side of the business, especially if it is going to be a global business.
John admittedly, made the mistake, but what could he have done differently, if he was advised better.
- Consulted an advisor who understands global businesses and laws of jurisdictions across the world
- As he strongly believed his idea would be successful, he could have looked at his future business and investment needs, recognising that he would need funds and investors eventually to scale up
- Factored the needs of investors who would come aboard in future
- Evaluated and chosen a globally compliant corporate structure, which is flexible in nature, and allows him to administer without encumbrances and allows him the ease of bringing in and exiting the investors
- Made himself aware of several offshore jurisdictions which facilitate global businesses, especially e-commerce businesses like his, by providing flexible and investor-friendly structures
- After due evaluation, chosen an efficient service provider, who would take care of the administrative work of his company, freeing up his mind and time to focus on development of his wine trading business.
- Set up his company in the appropriate global jurisdiction, with the chosen service provider.
Evaluating the structures, jurisdictions and service providers may seem a time consuming exercise and an out-of-death subject to John, who would rather be hosting an online meet of wine connoisseurs.
But he would have realised that making time and that one time effort to understand this critical and essential side of the start-up business, would have led him to take correct structuring decision in the first place.
And very likely, he would not have lost this investment deal with the Venture Fund.
And would be getting on board wine-experts from as far as Chile and Australia on board through his scaled up online trading platform, instead of spending so much time and money on trying to figure how to restructure his business.
And that's why John's recommendation to his entrepreneur friends, and his own adopted motto for his new ventures is 'If you are well structured, you will get funded', provided you have a strong business model, of course.
The lessons learnt from John's scenario are relevant for all ecommerce start-ups which will go global one day.
For more discussion on how to structure for a start-up typical for your industry, just drop me a mail.
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