When legal and accounting costs outweigh the business opportunity

By Andrew Roy, business lawyer and founder of Roy Legal in Calgary, Alberta

Before buying, restructuring, or expanding a business, it is worth comparing the full legal and accounting costs with the value the plan is realistically expected to create. The budget needs to cover the initial advice and implementation, the ongoing costs of the arrangement, and enough cash to keep the business operating. Sometimes, those costs exceed the available capital, the purchase price, or even the benefit the owner expects to gain over several years.

I have been noticing a pattern in my practice. Someone has an ambitious idea. By the time we speak, the plan already involves several companies, operations in different countries, regulatory questions, and arrangements for future investors. They may not yet have spoken with an accountant, a business adviser, or someone familiar with financing that kind of venture. They have thought carefully about what they want to build, but have had much less opportunity to understand what it will cost to build and maintain it.

That is understandable, especially for someone who has not worked with lawyers and accountants before. A founder cannot be expected to know every issue in advance. But the cost of dealing with those issues belongs in the business plan.

What costs belong in the budget?

Legal and accounting costs can arise at several stages: assessing whether the plan works, putting the arrangements in place, and maintaining them once the business is operating. Depending on the project, that may involve advice on ownership and tax, reviewing a business being acquired, preparing agreements, addressing regulatory requirements, and ongoing filings and accounting.

BDC distinguishes between one-time and recurring expenses in its guidance on estimating a new business’s financial needs. Professional fees can appear in both. An affordable initial setup does not necessarily mean an affordable arrangement over time.

Consider a hypothetical founder planning to launch a business in Canada and the United States. They want a company in each country and an ownership structure ready for future investors. There is interest from potential customers, but sales are still uncertain and funding is limited. Before committing, the founder needs to understand why each part of the structure is needed, what advice and documents it will require, and what it will cost to maintain.

If setting up the structure absorbs much of the available cash before the first sale, what is left for developing the product, finding customers, and delivering the work? Sometimes, as I encounter in my practice, there is no cash available to fund the initial work at all. And if the continuing costs consume much of the expected profit, how does the business become sustainable?

Does the expected value justify the cost?

A business purchase raises similar questions. The purchase price may look affordable, but the buyer also needs to budget for legal and accounting work, financing, and integration. BDC recommends including integration and financing costs in the preliminary assessment of a business purchase. I would include legal and accounting costs in that budget before signing a letter of intent.

Once those costs are accounted for, the question becomes whether the opportunity still makes sense. Revenue alone will not answer that. A business can generate substantial sales while leaving little after its expenses. Timing matters too. Professional work and setup costs may need to be paid well before customers start paying.

A useful starting point is to put a few things on paper:

• What specific benefit is the purchase, structure, or expansion expected to produce?

• What revenue, profit, or other value could reasonably follow, and over what period?

• What will it cost to assess, implement, and maintain the plan?

• How much cash will remain for the business’s other needs?

• How will the costs be funded if growth takes longer than expected?

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BDC recommends testing cash-flow projections under optimistic, likely, and pessimistic scenarios. This helps an owner see how much depends on everything going to plan and whether the business could manage a slower start.

Can a simpler plan achieve the objective?

With those answers, the scope of the project may change. Perhaps the business can start in one market. A proposed reorganization might wait until a particular commercial milestone. A simpler arrangement might achieve the immediate objective without committing the business to costs it is not ready to carry.

Whether those options work needs to be assessed. Some work is necessary before the business can operate, and delaying it can create problems of its own. The purpose of early advice is to establish what is needed now, what can wait, and what the consequences of waiting would be.

For an initial discussion with advisers, it helps to bring the commercial objective, the proposed steps, any existing agreements or company information, the available budget, and the expected timeline. Even where the plan is still developing, that gives the discussion a practical starting point.

What if the business cannot afford the advice?

Sometimes, after considering simpler or staged options, an owner still wants to proceed but cannot afford all the advice the project warrants. That leaves another cost to consider: the potential consequences of proceeding without that work.

An overlooked obligation, an unsuitable agreement, or a structure that later needs to be unwound could cost considerably more than the advice would have. Legal advice cannot remove every risk, but comparing professional fees with spending nothing leaves out those possible consequences. The owner is accepting uncertainty about issues that have not been properly assessed.

An owner may decide to accept some of that risk. The question is whether they understand it well enough to make that decision, and whether the business could withstand the consequences. Where a legal requirement must be met, limited funds may mean changing or postponing the plan.

High costs can still be justified. A business may need to meet an essential requirement, protect a valuable asset, address a serious risk, or invest in a credible opportunity that will take years to develop. Its current revenue or valuation will not capture all of that. But there should be a reason for the expenditure and a realistic way to fund it.

I like ambitious ideas. I also want the business to have enough money left to pursue them.

Understanding the cost of the plan belongs near the beginning of that conversation.

Planning a business purchase, reorganization, or expansion? Contact Roy Legal to discuss the legal work your plan may require. This article provides general information only and is not legal advice. Reading or relying on it does not create a solicitor-client relationship with Andrew Roy or Roy Legal. Laws and their interpretation may change, and their application depends on the circumstances. Obtain legal advice about your specific situation before acting on this information.

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