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Co-authored by Bryan Springmeyer |
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Structuring Friends and Family Investments
Receiving startup funds from friends and family is a common practice in many entrepreneurial ventures. Even venture scale businesses usually contemplate raising money from friends and family, and then angel investors, before approaching VC firms.
NOTE: For our purposes, when we say “friends and family,” we are talking about unaccredited investors. When we say “angel” we’re talking about Accredited Investors - individuals with a net worth excluding their primary residence of $1 million or more or income over $200,000 per year or $300,000 for a married couple. If you have a friend or family member investor who qualifies as accredited, consider them “angels” to understand the reasoning in this article.
This article will answer some key questions about friends and family investments and we will explain why we like to issue common stock rather than the more typical structuring for these transactions.
Do I need an attorney for friends and family investments?
Investments, no matter how big or small, trigger state and federal securities laws. An attorney can advise how to qualify for various securities exemptions, such as the intrastate exemption or a Regulation D exemption (Rules 504, 505, and 506), and state “limited offering” exemptions. The proposed crowdfunding exemption under Title III of the JOBS Act also provides an exemption for receiving investments from a wider pool of investors in small amounts. In sum, it’s a good idea to check in with an attorney to ensure that you qualify for and file for applicable exemptions to the securities registration requirements. The attorney should be able to keep costs down for friends and family investments by using fairly standard documents.
Can anyone invest in my company at the friends and family stage?
It frankly will make your life easier if all of your investors are Accredited Investors. Bootstrapping until you can get an angel investor is nice, if achievable. However, if you must get contributions from friends and family, there are of course ways to do it. Read on.
Instruments
We often lean toward structuring friends and family investment transactions as straight equity splits, issuing common stock to the investor, with a loan by the investing shareholder to the corporation. This structuring for friends and family investments is best suited to optimize tax treatment and enable compliance with securities laws, avoiding negative business implications down the line.
The most common instruments for early stage investments are Convertible Notes and Preferred Stock. See our article on Angel Investment Structures for more in-depth explanations of these instruments.