For a first-time and young founder, when the founder himself is not too sure of his idea or is in need of money during the early stage of business, it is family and friends(based on ‘trust’ or because they ‘love / like’ the founder), who provide money for the business. For an entrepreneur who has been working, he would have built a small boot-strap capital.
In a F&F round, since the investment is not so much based on business as much as it is ‘like/trust’ on the founder, many a time, the discussion on investment terms is over dinner. The amount of investment is also typically small ('small' here is used as a comparative).
You agree that all businesses are built on trust but then you would have heard “In God we trust; all others bring data.” We could tweak this a bit and say “In God we trust, all others bring evidence” and here's why -
Let us share an experience with you - we have seen a friend investing INR 50 Lakhs towards 25% equity, with the founder verbally agreeing to such a transaction. There was no agreement (not even an email) and no shares allotted for nearly about 11 months. The business started doing very well. The founder treated the money as loan and returned the money to the friend with 6% interest. Within a short period, the founder went on to raise Series A with a little more than INR Rs. 6 Crore valuation.
In another case, it was the reverse. The investor (founder’s College Dean) invested in the start-up. The discussion, it seems, was towards equity. When the startup did not take off, the investor wanted his money back with interest. The startup did not take compliances seriously and had not allotted shares. The founder argued that equity investment is a risk instrument and if the startup does not do well, then the company cannot buy-back shares and therefore the money is lost. However, the investor argued that it was a loan issued to the founder and not equity investment in business. Given that the investor was the founder’s College Dean, the founder took another loan and repaid the investor’s money with interest.
When a founder reads these experiences, clearly the answers are (and it's not rocket science) :
- It is not difficult to be clear on the terms of investment
- To ensure that documentation is in place
- To get compliances, such as share allotments, completed
- Or, if loan, to have the financial statements reflect the same correctly.
Steps to be taken by the founders are rather simple. Please get an uncomplicated agreement which covers the terms of investment. The founder will pay lesser legal fee upfront instead of paying higher fee to clear the mess. It not only helps transparency and clarity, but also the founder could continue going to the same party or wedding that the investor friend is likely to be present at.
Whats your opinion?
Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.