Business owners often wait a long time before planning their exit. For example, they might wait until they get to a certain amount of profits before looking at an exit strategy. The reality is, planning an exit should happen before you incorporate.
The moment you incorporate, you set a number of things in stone. Coming back later to change these things can be extremely difficult and extremely expensive. Sometimes it can cause major damage to your business.
Why should you plan your exit before you incorporate?
==> The State It’s In Matters
Generally speaking, if you want to form a company that’s designed to be venture backed or later acquired by a large company, you want to use a Delaware C-Corp.
The state you choose to incorporate in depends largely on your exit strategy. If you plan to run a business for cash flow or if you’re trying to minimize up-front investment, you might incorporate in a state like Nevada.
On the other hand, if you’re planning to exit big, you definitely want to use a state that has friendly laws towards investors.
==> Knowing Your Exit Allows You to Plan Equity
Knowing what your exit strategy is at an early stage allows you to plan your equity and equity distribution strategies early on.
For example, if you’re running a business for cash flow, it really doesn’t make sense to issue stock options. Those stock options will never be worth anything, as the equity won’t really be worth anything – unless you also have a cash flow sharing agreement.
On the other hand, if you do plan on having a big exit, having an equity agreement early on is crucial. You need to know exactly what happens to equity if a partner leaves, how shares vest, what rights preferred shares have and so on.
==> Poor Early Choices Will Lose You Investors
If you don’t plan your exit strategy before you incorporate, there’s a good chance that you’ll miss out on investment opportunities.
Let’s say you find an investor who’s interested in investing in your company. However, because you didn’t form an exit strategy early, you incorporated as an LLC, an S-Corp or a General Partnership.
The investor can’t possibly invest in your company now, as it’s either illegal for them to do so, or they can’t get paid off in the event of an exit. In other words, your company is just plain uninvestable because of your corporate structure.
Don’t think that you can just come back and change it later either. While this is possible to do, the process can easily cost you $50,000 to $100,000 once your business is entrenched.
To make a long story short, plan your exit strategy early and incorporate your business according to that plan. Don’t wait until it’s too late.