“Growth” is everywhere.
We judge economies by GDP and job growth. Companies announce growth targets. Founders track revenue, EBITDA, headcount, customers, and market share.
But growth is not simply more revenue. As a business gets larger, the legal, financial, tax, and operational systems supporting it have to grow with it.
A company can survive a surprising amount of informality when it has five -motivated employees, a handful of customers, and two owners who talk every day. The same practices become increasingly risky at 50 employees, $20 million in revenue, multiple locations, outside investors, or operations in several states or countries.
That is the premise behind our Actual Growth series. Growth creates opportunities, but it also exposes weaknesses. The objective is to identify those weaknesses before they become expensive.
Here are some of the common pain points and remedial actions we will explore.
- Make Sure the Corporate Structure Still Works
As a company grows, its original ownership, legal structure, and lines of business may no longer fit the evolving business plan. That may mean separating valuable assets from higher-risk operations, cleaning up the capitalization table, documenting ownership rights, or addressing buy-sell provisions, transfer restrictions, drag-along rights, and deadlocks.
None of this seems particularly urgent when the owners are aligned. It becomes very urgent when an owner dies, wants out, gets divorced, stops contributing, or disagrees about the future of the company. Those are poor times to discover that the governing documents do not provide an answer.
- Choose Growth Capital Carefully
Growth consumes capital. Companies may fund expansion through operating cash flow, bank debt, private credit, outside equity, or some combination of the four.
The right answer depends on the business, but the terms matter as much as the amount raised. Equity financing can bring board seats, veto rights, liquidation preferences, anti-dilution protection, and restrictions on future transactions.
A large investment may solve an immediate capital need while fundamentally changing who controls the company, how future decisions are made, and how the proceeds of an eventual sale are divided.
- Improve Financial Reporting
A growing company eventually needs more than basic bookkeeping. Management needs reliable information about margins, working capital, customer concentration, cash flow, and the profitability of particular products, customers, and business lines.
Better financial reporting also prepares the company for lenders, investors, and eventual buyers. Weak reporting does the opposite. It can obscure problems from management and make a fundamentally good business much harder to finance, or ultimately sell, because the company cannot reliably demonstrate its earnings.
- Professionalize Employment Practices
Employment practices that work with ten people rarely work with 100. Growth may require standardized offer letters, employee handbooks, invention and confidentiality agreements, compensation policies, standardized performance metrics, and compliance systems. Increasing headcount also triggers additional federal, state, and local employment requirements.
Growing companies also need to think deliberately about retaining key people through bonuses, equity, profits interests, phantom equity, or other incentive arrangements. Informality in these areas can become expensive quickly, whether through an employment claim, an ownership dispute, unexpected tax consequences, or the departure of someone the company could not afford to lose.
- Revisit Commercial Contracts
Smaller companies often accept unfavorable customer and vendor terms because winning the business matters more than negotiating every provision. Growth changes that equation because a company with assets has more to lose.
As bargaining power improves, companies should revisit indemnities, liability caps, warranties, payment terms, intellectual property provisions, termination rights, and other recurring contractual risks.
This is particularly important with forms that are used repeatedly. A questionable provision in one contract may be tolerable. The same provision replicated across 50 customer agreements can create a material enterprise-level exposure.
- Protect Intellectual Property and Data
As a company grows, more of its value may reside in software, trade secrets, customer information, processes, brands, and other intangible assets.
Employees and contractors should clearly assign relevant intellectual property to the company. Confidential information should be protected. Trademark and data policies should mature with the business.
Artificial intelligence adds another dimension. AI can materially improve productivity, but companies need sensible rules governing confidential information, customer data, intellectual property, and appropriate use of artificial intelligence. Few things are more frustrating than spending years creating a valuable asset only to discover during diligence that the company cannot clearly establish that it owns or has adequately protected it.
- Plan Taxes Before the Decision Is Made
Tax planning is most effective before a transaction occurs. Growth should prompt periodic review of entity structure, state and local tax exposure, compensation arrangements, R&D incentives, international operations, and potential eligibility for benefits such as Qualified Small Business Stock treatment.
Timing matters. Once an investment has closed, an acquisition has been structured, compensation has been paid, or a sale agreement is on the table, many of the best planning opportunities have already disappeared.
- Use Acquisitions Deliberately
Growth does not have to be organic. Acquiring a competitor, product line, distributor, or complementary business can add customers, capabilities, employees, or geography much faster than building them internally. A strategic acquiror shouldn’t merely identify and acquire a company that is undervalued. Instead, a growing corporation should ensure that acquisitions are used to build out a corporate development strategy.
- Structure New Sales Channels
Growth frequently means expanding beyond direct sales into distributors, independent representatives, resellers, licensing arrangements, strategic alliances, or joint ventures.
Those relationships require careful treatment of territory, exclusivity, commissions, pricing, termination rights, customer ownership, and intellectual property. International expansion adds tax and regulatory issues, as well as cultural sensitivities.
The agreement that helps a company enter a new market can also prevent it from changing direction later. Poorly drafted exclusivity, territory, or customer-ownership provisions can turn yesterday’s growth partner into tomorrow’s obstacle.
- Build Ahead of Growth
Growth inevitably creates complexity. The legal and tax function should not slow that growth down. Done correctly, it should allow the company to take on more customers, more employees, more capital, and more opportunity without taking on unnecessary risk along with it.
Over the coming installments of Actual Growth, we will take these issues one at a time and look at the practical legal, tax, financial, and operational decisions that arise as a business moves from one stage to the next.
Doug McCullough is a partner at McCullough Huddleston and Woo, advising middle-market business owners, corporate executives, and private investors on domestic and cross-border mergers, tax structuring, and corporate governance.