The Cost of Capital Formation

The Cost of Capital FormationRecently I gave my ten thousandth explanation of why it costs money to form capital. Most entrepreneurs do not understand the process of capital formation. If it is borrowed money or an equity infusion there are a host of costs associated with capital formation. So let’s talk about the costs.

Lawyers Cost Money

The client is always responsible for the costs of capital formation. First is legal. Lawyers cost money. The client will have to have a good general corporate lawyer on hand to read and interpret contracts, loan documentation and various agreements associated with a loan transaction as well as review and assist in the preparation of due diligence documentation. Also if the transaction involves the infusion of equity then the entrepreneur will need a top flight securities attorney. These are a special breed of lawyer. If they are worth their salt they will bring capital resources to the table as well. These lawyers are a bit more expensive than the corporate lawyer. So be prepared for the bill to be larger and more extensive. However if they are good they will be well worth the cost.

Accountants Cost Money

Lenders and investors want the most up to date financial statements and also desire as much disclosure as possible. Enter the accountancy costs. Accountants also charge by the hour. Getting your most up to date financial statements prepared or for that matter a full blown audit will cost you a pretty penny. The fact is the “numbers” as we say will tell the story and are a requirement. Don’t balk at the need for the preparation of financial statements. If you need capital you are required to provide disclosure. This one of the first steps you need to take.

Professional Reports Cost Money

Appraisals, Valuation Reports and Feasibility Studies are a fact of life. Even the Need and Necessity study is now par for the course in required documentation. If it is real estate or asset based financing these reports are a must. They can get quite expensive. Third party opinion reports are now the second set of eyes on almost every transaction. The lender or investor uses them as a touchstone to test their own impressions of value and need. Appraisals are usually accompanied by a Feasibility Study or at the very least a Need and Necessity Study. Equity or convertible debt transactions now require a Valuation Report. There is less reliance on the appraisal then before. That is why you see the Feasibility Report as the second requirement to real estate documentation requests. Hold on to your wallet because these reports are costly and getting the highly experienced and recognizable firms will cost even more.

Professionals Do Not Work For Free

The due diligence process takes not only time but money. Structuring a transaction should be done by the pros. Hiring a corporate finance consultant is a must. Get your own private banker to ply his skills during this phase of the process. A surgeon does not perform surgery on himself. Therefore the entrepreneur should let the professional step in and guide this part of the process. Getting the entrepreneur ready for the dance takes time and money as well. Preparing the documentation in an acceptable format takes time and money. Presenting the deal the entrepreneur seeks costs money. Presenting to the reliable sources takes time and money. Determining the final appropriate source for financing takes time and money. Your accountants, lawyers and corporate finance consultants will all have to pitch in to make the transaction a go for the entrepreneur. Even the final documentation will need all hands on deck for review and final negotiation. This costs money. Professionals do not work for free.

There are a host of other costs such as entitlement expenses, master planning costs, forecasting and budgeting, title searches, litigation and background checks. The list really does go on and on. Suffice to say that if you do not have this money in the bank when you start the process don’t start. No one worth his salt is going to work for free of put it all on the line for the entrepreneur when the entrepreneur can make or break the entire transaction. You need money to form capital. This is not a process where everyone around the entrepreneur is expected to take all the risk when there is little to gain.

Money Begets Money

I always get a kick out of the prospect that says if you charge “upfront fees” I am not interested. First of all BHCL does not charge “upfront fees”. But after I am done explaining to the prospect the aforementioned his tone changes. It’s easy to spot the guys with just an idea looking for a free ride as opposed to the serious entrepreneur who knows what he is facing to reach for the brass ring. In short money begets money. You have to have it to get it. Be prepared. It can be very expensive. But when the end goal is reached and the entrepreneur gets the capital he needs, then he understands it has been worth every penny he has spent.

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George Lovato, Jr. is President and Principal of BH Capital Ltd., Merchant Banker, Consultant, Author and Lecturer. Happily married for over 30 years to his childhood sweetheart Gale, they live nestled in the shadows of the Sandia Mountains in Albuquerque with their six hounds.

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