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, orsecurities – simplify these transactions, reduce legal costs and enhance the opportunity for the company’s success.
You can read more about how convertible equity works inI 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.
I invite you to check outfor additional information that can help you make these important decisions about structuring deals for early investments from friends and family. Also please feel free to message me directly if you want an entrepreneurs perspective on raising a seed round from your F&F investors. Hope this is helpful!