One of the first things I was taught in my corporate law class is that money is never just money. A dollar today is different from a dollar tomorrow. A dollar in your pocket is different from a dollar in your supplier’s pocket. A dollar you can spend however you want is different from a dollar that has been earmarked for school fees.
When dealing with money, a good lawyer should always remember to ask:
- Who does it currently belong to?
- When will it become available?
- What form does it take?
- Are there any restrictions associated with its use?
- What does it cost?
The answers to these questions give different types of funds their unique “flavour”, and it is very important to be able to distinguish and analyse these flavours, as well as alter them through the alchemy of law.
How much money does the business need? And when?
Cash is the lifeblood of business. But you don’t necessarily need every dollar to be available immediately. In other posts we will try out a little bit of cash flow modeling. This is a great way to figure out not just how much cash a business needs to get through a day, week, month or year of operations, but when they need that cash to be available.
In some of our exercises we will look at a simple business with very simple, regular expenses: ingredients, salaries and some upkeep costs. We further assumed that these are pretty much the same from month to month. But add even a little more sophistication to the model, and we need to factor in cash payments for things like annual licenses, replacement parts, periodic maintenance and so on. These obligations do not come due at the same time, or with the same frequency as the other costs.
Why timing is so important, or “Why well-paid lawyers still ask their parents for money”
Why is this so important? Let me try to make it real and relevant with an example that may seem painfully familiar.
Hotshot law graduate Bill Labbalawar signs a contract with XYZ law firm at 10,000 a month and even in his wildest dreams can't imagine spending more than 8,000 a month. Great! That will leave him with 2,000 to save, invest or have fun with. Bill looks forward to his new status as a glamorous, high-earning corporate law badass.
Bill graduates from law school on the 15th, moves out of his dorm and into a temporary accommodation, starts work on the 22nd and has a wonderful week at work while doing a little apartment hunting. He has provided his personal details and bank account information to the XYZ accounts department, and looks forward to the signing bonus and first salary hitting his bank account, (which is as empty as a desert sky, as a lover's promise, or whatever overwrought metaphor you prefer).
On the 29th he finds the perfect apartment: convenient, clean and within budget. There's just the small matter of the deposit which (vastly) exceeds the contents of the aforementioned bank account. Somehow, his earnest protestations of "but I'm a rich lawyer and I can pay you in a week" don't succeed in melting the heart of the broker or the landlord, who need an answer (and a transfer) in 4 nanoseconds, so Bill swallows his pride and makes a call to the “Bank of Mum and Dad”. (Please note - I use parents in this hypothetical example, but the example holds for any benefactor).
On the fundamental importance of mechanics
Here is an example of an absolutely ideal response to a request for emergency funds:
“Sure son! The money will be in your account in a couple of minutes!”
Ah! the sweet sound of a problem solved! But we must never underestimate just how many things have to be in place, in order for this to happen, in addition to your benefactor wanting to help you:
- Your dear benefactor must be solvent
- Benefactor's funds must not be tied up in other obligations
- Benefactor's funds must be in ready cash
- Benefactor's account must be set up for instant digital transfers
- Digital transfer infrastructure must be up and running
- Your account also needs to be set up to receive the funds
And so on...
More complex flavours: beyond timing and mechanics
We’ve just covered two very important flavours, namely timing and mechanics. But there are other flavours that are layered on top of these ones. I think of these as more legal than logistical flavours. Here are three, in increasing order of subtlety:
The first is around usage: Every young person can understand how the sweetness of a promise (“Sure son! The money will be in your account in a couple of minutes!”) can be be soured by the addition of a restriction ("But you better not spend it on going out with your friends!"). But for lawyers, such restrictions are the very stuff of life (and billables). Negotiating what funds can and cannot be used for is a big part of what clients pay you to do. The most likely place you will see restrictions on usage is in debt covenants, but such restrictions also show up in equity agreements and almost every other kind of financing arrangement. As you will increasingly learn, ownership means little without control.
The second is around origin and association: The starkest and most dramatic example of this is probably funds derived from illegal activity. A dollar earned from legitimate business activities is very different from a dollar that has been stolen, extorted or obtained through fraud or as proceeds of a criminal enterprise. But you don't have to go that far to see this in action: gifts, debt, and foreign transactions are all treated in their own special ways, just because of the intent they are imbued with, the purpose they serve, or the nation they were earned in.
The third is around recognition: Most lumps of cash are a store of wealth, but some are special because they are used to keep score, because they enable action, or because they satisfy a regulatory requirement. Through the magic of accounting, a dollar may acquire these and other flavours. For example, the advance payments made to a house painter turn into retained earnings a cent at a time, with each brushstroke. And as they do, the dollars in the deferred income line on the balance sheet trickle through to the income line on the income statement. Whether you are allowed to take a loan against certain dollars or not, whether they justify a particular business valuation, or whether they count towards regulatory capital, might depend on where in the financial statements those dollars "live".
The essence of transactional lawyering
If this list of issues is starting to sound familiar to some of you, it's because as a corporate lawyer it is your job to deal with them every single day. As mentioned in the introduction to this blog, young lawyers are thrown in at the deep end when it comes to business matters. But rest assured, most of what you do as a transactional lawyer relates to the questions I mentioned at the beginning of this post, and the issues that I've just outlined.
So next time you are up to your eyeballs in payment terms, escrow accounts and foreign exchange regulations, just take a breath and try to figure out what is the flavour of the money you are dealing with and what are the unique challenges associated with identifying, laying claim to, and using those funds.
The price of money
To many people, all these flavours and their various implications are interesting but unimportant. What matters is the price of the money. Whether they talk about it as the interest rate on a loan, or the cost of capital for a firm, they believe that price of the funds is the most important thing to think about.
But... hopefully the above discussion helps you understand that the "price" of money isn't just a matter of interest rates. Actually, everything we have talked about contributes to the value of the funds to your client. Your job is to shape, increase and capture that value.