5 PAINFUL mistakes Founders make when Expanding
It’s an entrepreneurial rite of passage to make mistakes. Whether it’s a small mistake – the kind that leads to sleepless nights – or massive mistakes – the kind that crush your business – chances are that you’re not the first entrepreneur to make that mistake. Mistakes often happen when you are unfamiliar with the domain, or it is in a realm you have comparatively less interest in like... corporate structure, tax and labor laws. Especially for SEA entrepreneurs who expand regionally early in their company's life, differences between regulatory regimes can be incredibly painful. So, we’ve (alongside with Hustlefund.vc ) compiled a list of 5 painful mistakes that have plagued entrepreneurs over time.
#1 Mistake: expanding your business “conveniently”
You are running at startup speed – we get it. You want to be first to market, first to earn real revenue, first to be at work in the morning.
But in certain situations, being careful is more important than being first. One example of this: expanding your business. Businesses that expand to new locations without carefully considering the shareholding structure, method of funding the new location, and plan for future transactions will likely face disaster. When expanding your business, it may be tempting to mirror your current structures in each new location. After all, if it’s working at home, why change it? But here’s the reality: each business location will come with unique legal obstacles and different sets of shareholders. Further, the decision on how you’re going to fund that new location is often an afterthought; what will you say when your accountant asks: “Is this transfer to your subsidiary a loan or an investment?” Without careful consideration of how you’re going to expand, you could face serious risks.
Why it’s risky:
- You will not be able to consolidate the value of your companies to get a fair valuationInvestors will question which structure to invest in, and may decide not to invest at all
- The cost of fixing this mistake (consolidating the subsidiaries) at a later stage can be very expensiveFunding your subsidiaries either as equity or loan will generate very different tax costs for your business as a whole
#2 Mistake: cross-funding on a whim
When your company has multiple locations, it’s likely that one branch isn’t performing as strongly as another. A seemingly convenient solution to this problem is to send money from one cash-rich subsidiary to another that needs liquidity. Why it's risky:
- This creates a bunch of intercompany transactions, which raises scrutiny from authorities (look up “transfer pricing” for more information)
-Your CFO will have to monitor these transactions, make regular interest payments and file for withholding taxes in various locations respectively
-Your cap table will be messed up! This could deter larger investors at later stages of capital raising.
#3 Mistake: hiring everywhere
So, your business is growing. And you’ve started to hire a few key team members to take some of the work off your plate. Congrats! But finding talent at an affordable rate is challenging, so it’s likely that you’ve started looking at other cities or countries for affordable talent. As the team grows, you may realise certain talents are concentrated in the same areas... you may even consider renting a small work space for hires in the same vicinity to work together. Since your business is registered somewhere else, you might think that you do not have the same level of corporate governance in that remote location. Why it's risky:
- You are creating taxable presence in these countries inadvertently. Even if the local authorities have not caught on, your investors will be able to identify this risk in their due diligence process.
-Your HR manager may not have the chance to understand local labor laws and your finance manager may not know about withholding part of monthly wages... until you get hit with a penalty.
#4 Mistake: not planning for ESOP
As an entrepreneur, you might not yet have the cash to pay market salaries for talents that you need to build your dream team. Having an Employee Stock Ownership Plan (ESOP) can attract talent and help with employee retention. It’s tempting to do this in the simplest way possible: setting up an ESOP pool by an agreement or inserting it as part of your constitution. But as time goes by, the various terms (cliff, vesting, etc) on ESOP for each employee make it difficult to administer. Why it's risky:
- You have no idea how much ESOP is costing you because you did not ensure your HR team worked with the Finance department to add the cost to the budget
- You do not have a cap table that captures changes as employees exercise their options or leave the company
- You did not set aside enough funds to pay for the shares when ESOPs are exercised
- Potential investors will see an ill-managed live cap table as a risk they don’t want to take on
#5 Mistake: not planning for an exit
You may not care about your tax residence status right now – you are busy building your dream company and your salary is a joke. However, as a founder your tax status can directly affect your company’s tax status. This will become significant as your business becomes successful (see mistake #1 for examples of this). Why it's risky:
- Gains from exiting your business could be significantly diminished if this has not been planned for
- Your company may also be investigated for any unfulfilled statutory obligations – filings, declarations, taxes, etc., which could result in penalties
- When you have a high level of operations, assets, and income in locations where authorities are aggressive, valuation of your business will be heavily discounted by your buyer
These are just a few of the mistakes we've seen startups make as they expand their businesses. Did we miss any? Email hello@CAdvisory.co to share your tips or stories for a chance to be featured in a future email.