Investors who know you best…
After self-funding, the next most common source of cash for startups is friends and family. I say “cash,” as these supporters do not always formalize their investments as formal debt or shares of stock.
No matter whether it is a handshake or formal agreement, investments from friends and family typically take a slightly different form than investments from others. The transaction is far more a trade of “social capital” for financial capital. That is, the real trade is your honor and reputation within the family or between friends, in exchange for the money you need for your startup.
Funding from friends and family is so common in startups that myths have arisen around it. The biggest and most important myth is that the securities laws do not apply to shares sold to your family or to people you know well enough to call friends.
There is no such exception. In the United States, it is against the rules to sell shares of your company to anyone who is not an “accredited” investor. See Chapter 6 for the rules on what makes an investor accredited.
Nor is borrowing money any different. Your friends and family can lend you all the money they want, if you are personally the borrower. However, if the borrower is your company, then that loan is a security, and it falls under the accreditation rules, and possibly some state or local lending rules, too.
Gifts are a different story, with different limitations. Anyone can give or donate money for your company, as long as you don’t then promise them shares in the company or promise to repay the gift.
Do talk to your lawyer before blindly promising ownership of your company to anyone.
