Drafting Considerations for Attorneys Blog Series – Complex Capital Structure Takeaways and Suggestions

The fields of law, accounting and valuation are only continuing to become more complex. Given the overlap in these areas of specialty, it is increasingly important for attorneys to have an understanding of the accounting, tax and valuation effects of the legal agreements they draft. Armed with this knowledge, lawyers can produce the intended outcome for their clients and minimize unintentional consequences and compliance burdens. 

Complex Capital Structures – Takeaways and Suggestions

Complex capital structures are becoming more common as private equity and venture capital investments continue to grow. The unique valuation issues that complex capital structures create may not be immediately apparent to certain investors or the company’s accounting team. Therefore, it is important that clear descriptions of the various preferences and the “waterfall” be incorporated into the corporate governance documents and that time is taken to ensure all of the parties involved understand the related financial implications. A few of the key takeaways and suggestions to keep in mind when drafting corporate governance documents that incorporate complex capital structures are:

• Consider the additional valuation complexities that are created when complex capital structures are employed before implementing them
• Remember that the more preferences preferred shareholders are granted, the greater the difference will be between the value of the preferred stock and the common stock
• Be wary of setting common stock option strike prices based on recent per share values from a preferred stock issuance – doing so may require a significant amount of appreciation to be achieved before the options are in the money
• Be aware that just because the common stock has no value under the Current Value Method (which assumes that the company was sold as of the valuation date), it may still have option-like value based on potential increases in the company’s value in the future

Continue reading about the key accounting, tax and valuation considerations of buy-sell agreements in our e-book: Drafting Considerations for Attorneys: Buy-Sell Agreements, Accounting, Tax and Valuation Issues. Have a question about capital structure equity valuation? Contact Sean Saari at [email protected].