Based in Sydney, Australia, Foundry is a blog by Rebecca Thao. Her posts explore modern architecture through photos and quotes by influential architects, engineers, and artists.

What Deal Structure Should Be in Place for a Friend and Family Investment of < 20k in Your Startup?

The most important thing for you to do before anything else is to ensure full disclosure and adequate understanding of any terms and conditions with the proper documentation. This means having a business plan to share with your family and friend investors, as well as adequate legal protection - whether you’re using an investment vehicle or a simple unsecured loan.

Encouraging an investment structure is going to look different than a simple loan. Convertible debt notes would generally be inappropriate for smaller investments. Instead, I would urge you to consider taking a look at convertible equity as an alternative to traditional convertible debt notes. Convertible equity vehicles - such as Ressi instruments, Y Combinator’s SAFE agreements, or KISS  securities - simplify these transactions, reduce legal costs and enhance the opportunity for the company’s success.

You can read more about how convertible equity works in another piece I recently wrote. For an investment of < 20k, however, I wouldn’t recommend convertible debt notes since the costs would likely outweigh the benefits of this type of structure. Typically, smaller investments from friends and family are unsecured loans (i.e., there’s no collateral to secure the loan’s repayment). Again, take a look at the convertible equity documents I listed above since they could be more attractive to smaller investors and expand your funding opportunities.

The necessity to clarify the expectations of your family and friend investors prior to accepting funding can’t be overemphasized. Since F/F investors usually don’t demand sophisticated deal structures, you might be expected only to repay the loan. On the other hand, some might expect higher returns, so you should give considerable thought to developing some common key elements. Critical terms might include defining the equity type (e.g., common stock), board seats (e.g., offering seats to leading angels), price (ownership percentage), mechanisms for minimizing dilution, and dissolution preference.

In order to best protect your company and interests, as well as personal relationships, it’s highly recommended that you obtain legal guidance, which can save you substantial money and hard feelings down the road. There is no one-size-fits-all in these situations, so engaging an attorney is actually an investment in your company.

 

What Is a Liquidation Preference?