How to Structure a Friends and Family Investment Agreement: A Practical Legal Checklist for Startup Founders

Many founders start with a friends & family round. The temptation is to keep it informal: a few texts, a quick Venmo, and an understanding that everyone is “in it together.”

That informality is exactly what creates problems later. Undocumented deals can turn into mismatched expectations, strained relationships, and due diligence red flags when you raise a real seed round. And even when the money comes from people you trust, you’re often still making a securities offering"which means basic compliance matters.

This guide is for early-stage startup founders and small business owners raising capital from friends or relatives (with or without a lawyer) who want a clean, defensible process.

It's a practical checklist: we'll cover the common structures (equity, loans, convertible notes, and SAFEs), the key terms your friends and family investment agreement should include, compliance basics, and how each choice impacts your cap table.

By the end, you'll have a clear action plan to document the round, set expectations, and keep your company fundable.

Understand What a Friends and Family Round Really Is

A friends and family round is an early capital raise from your personal network"before you're ready (or able) to raise from institutional investors. It might be $5,000 checks from a few friends, or a single larger check from a relative who wants to support you.

It's not the same thing as (1) a gift, (2) an informal "loan" with no paperwork, or (3) a formal priced seed/Series A round with a lead investor, negotiated preferred stock terms, and a full diligence process. The documents, expectations, and legal requirements are different in each case"and mixing them is where problems start.

Even if it feels informal, you should treat most friends and family raises as a real offering of securities (or a real debt transaction). That means clear written terms, risk disclosures, and a basic compliance approach (including thinking about exemptions and any required notices/filings).

Example: A founder takes $50k from an uncle based on an email that says "I'll invest now and get equity later." When a VC later diligences the company, the unanswered questions pile up: Is it debt or equity? Is there a valuation cap or discount? Does the uncle have repayment rights? Was it offered in a compliant way? The round can stall while everyone renegotiates and paper-cleans the transaction.

Key takeaway: you are either selling a security or creating a loan. Either way, you need signed agreements and a simple, documented compliance plan from day one.

Choose the Right Structure for Your Friends and Family Investment

The Main Options at a Glance

• Direct equity (common stock): clear ownership now; can clutter the cap table.
• Simple promissory note (loan): repayment-focused; can create pressure if the business can't repay.
• Convertible note: debt that converts in a priced round; familiar, but terms need plain-language explanation.
• SAFE: equity-like right to convert later; simple, but can feel vague to non-startup investors.
• Fastest/cheapest docs: SAFE ‡ simple note
• Most cap-table clarity today: direct equity
• Most future-round alignment: convertible note/SAFE (if modeled and documented)

Direct Equity: Simple but Sticky on the Cap Table

Friends and family buy common stock now. It's often used for small amounts where investors are long-term holders. The upside is it's intuitive ("you own X%"). The downside is administrative: lots of small shareholders can create consent and recordkeeping friction. Example: three friends each invest and receive their own common stock line items on your cap table.

Simple Loan (Promissory Note): Debt First, Maybe Equity Later

A promissory note is debt: principal, interest, maturity, and an obligation to repay. It can be easier for conservative relatives to understand and doesn't immediately dilute founders. But it can be misaligned with startup risk"and adding conversion later should be done carefully with legal review.

Convertible Note: Popular for Early Friends and Family Rounds

A convertible note is a loan that converts into equity when you raise a qualifying equity round. It can keep the cap table cleaner now and defer valuation, but caps/discounts and maturity mechanics must be explained clearly to avoid surprises. See our convertible note agreement guide.

SAFE (Simple Agreement for Future Equity) and Similar Instruments

A SAFE is generally not debt (no interest, no maturity) and converts into equity in a future priced round. It's popular because it's simple and standardized, but it requires candid education: it may never convert if the company fails. Also, don't blindly copy templates"adapt documents to your entity, jurisdiction, and actual deal terms.

Key Terms to Include in a Friends and Family Investment Agreement

Core Terms That Apply to Any Structure

• Amount invested and when it's due.
• Clear label: is this a gift, a loan, or an investment?
• Risk disclosure: investor can lose 100%.
• Use of proceeds: broad but honest (e.g., product, hiring, runway).
• Illiquidity: no easy resale and long time horizon.
• Governance/updates: any voting rights? any information rights?

Get everything in writing and signed by all parties"including any side letters.

If You're Selling Equity (Common Stock)

Your stock purchase/subscription agreement should cover share price, number of shares, class of stock (usually common), payment mechanics, and transfer restrictions (often including a right of first refusal). Some companies also include repurchase rights or founder reverse vesting. If you don't have enough authorized shares, see how many shares to authorize and increasing authorized shares.

If You're Using a Convertible Note

Define principal, interest (commonly 4–8% in many startup contexts, but it varies), maturity, cap, discount, what counts as a qualified financing, exit treatment, and what happens at maturity (repayment vs conversion vs extension). Example: a $25k note with a 20% discount and $5M cap converting in a later $10M priced round converts at the better of the discounted price or capped price"so it can convert into more shares than investors who come later.

If You're Using a SAFE (or Similar Agreement)

Include the purchase amount, cap and/or discount, what equity is issued on conversion (e.g., preferred or a simplified equivalent), and how dissolution or a sale is handled before a priced round. SAFEs are standardized, but they still need to fit your entity, jurisdiction, and actual deal terms"don't rely on a template without tailoring.

See the Cap Table Impact of Your Friends and Family Round

Friends & family money affects dilution and future fundraising even if it's "small." Future investors will model how today's shares, SAFEs, and notes convert into ownership"and messy or untracked instruments can slow diligence.

Plain-language process: if you sell stock, you issue new shares now (immediate dilution). If you use a convertible (note/SAFE), you add a future claim that converts into shares later (deferred dilution), often at a cap or discount that can increase the investor's percentage in the next round.

Simple Cap Table Worked Example

Setup: Founder owns 8,000,000 common shares (100%). Company has 10,000,000 authorized shares.

Scenario A (direct equity): Friends & family invest $100,000 at a $1,000,000 pre-money valuation. Price per share = $1,000,000 / 10,000,000 = $0.10. They receive 1,000,000 new shares. Post-money shares outstanding = 9,000,000.
Ownership: founder 8,000,000/9,000,000 ≈ 88.9%; friends & family 1,000,000/9,000,000 ≈ 11.1%.

Scenario B (convertible notes): Friends & family invest $100,000 in notes with a $3M cap and 20% discount. In a later $6M priced round, those notes typically convert at the better of the capped price or discounted price"so they may convert as if the company were valued closer to $3M, resulting in more shares (and more dilution) than founders expect if they only look at the $6M headline valuation.

If you're close to the authorized share limit (or need to increase it for financing/option pool planning), see how many shares to authorize and increasing authorized shares.

Don’t Ignore Securities Law: Compliance Checklist for Friends and Family Rounds

Even if your investors are friends or relatives, selling stock, convertible notes, SAFEs, or similar instruments is typically a securities offering. Most startups don't register these offerings with the SEC"they rely on exemptions (often under Regulation D) and keep the process clean and documented.

Accredited vs Non-Accredited Investors

An accredited investor is generally someone who meets certain income or net worth thresholds (or qualifies under other SEC categories). This matters because it affects which exemption you can rely on, what disclosures are prudent, and whether you can "verify" status. Many friends & family investors are non-accredited, which makes your approach more sensitive.

Common Federal Exemptions Used in Early Rounds

• Rule 506(b): private offering (no general solicitation); can include a limited number of non-accredited investors if adequate information is provided.
• Rule 506(c): general solicitation allowed, but all investors must be accredited and their status must be verified.

Operationally, friends & family rounds usually avoid public advertising and stay within a true private network. For deeper detail, see our Reg D/506 resources.

State Blue Sky Laws and Filings

States also regulate securities. Even when federal law provides an exemption, you may still need state notices/fees where investors reside. Requirements vary; counsel can usually handle filings efficiently.

Practical Compliance Checklist

• Decide which exemption you're relying on before you accept money.
• Limit offers to people you actually know (for a private 506(b)-style approach).
• Track who you approached, who invested, and where they're located.
• Keep signed agreements and risk disclosures in one place.
• Calendar any Form D and state notice deadlines if applicable.

Run a Clean Process: From Conversation to Signed Friends and Family Agreements

A clean friends & family round is basically a mini-financing: consistent terms, documented risk disclosures, clean signatures, and a cap table that updates in real time.

Step 1 – Clarify Your Offer Before Talking Numbers

Pick the structure (equity, note, or SAFE), set a target amount, and define a tight range for valuation (or cap/discount) so you're not negotiating a different deal with every relative. Also consider whether investors are likely accredited or non-accredited.

Step 2 – Communicate Risk and Expectations Up Front

Be explicit: this is high-risk capital and they should only invest what they can afford to lose. Use written acknowledgments and avoid promising returns. For example, with a parent: "This is support for the business, but you may never get the money back."

Step 3 – Prepare and Circulate Draft Agreements

Use a standard set of documents: stock purchase/subscription (equity) or note/SAFE, plus board/manager consents and any required shareholder approvals. Consider an investor questionnaire to track accredited status.

Step 4 – Handle Signatures, Funds Flow, and Closings Carefully

Collect signed agreements first, then confirm wiring/payment instructions (ideally to a company account). If helpful, set a minimum round size before treating it as closed. Update your cap table or convertible tracker immediately.

Step 5 – Follow Through on Filings and Ongoing Communication

File any required federal/state notices, and set expectations for periodic updates (e.g., semi-annual emails). Simple, consistent communication preserves relationships"especially if the company hits bumps.

Common Friends and Family Investment Pitfalls (and How to Avoid Them)

Most friends & family problems don't come from bad intent"they come from informality, inconsistent terms, and missing documentation. Here are the pitfalls that most often create relationship stress and future diligence delays.

Undocumented “Loans” and Side Promises

Handshake deals and vague IOUs are a magnet for confusion. A friend might believe they bought equity while you treat it as a loan. That mismatch can explode during an acquisition, shutdown, or next financing. Fix: put it in writing: gift vs loan vs investment, with clear repayment or conversion mechanics and signatures.

Over-Promising Returns or Timelines

Even casual statements ("You'll get paid back in a year") can harden into expectations. Fix: use risk-forward language: "This is high-risk and illiquid; there's no guaranteed return, and it may take years""and confirm in writing.

Too Many Tiny Investors Cluttering the Cap Table

Dozens of small shareholders increase admin burden and can create voting/consent friction later. Fix: set minimum check sizes, standardize terms, and consider pooling investors into a single vehicle when appropriate.

Ignoring Compliance Because “It’s Just Family”

There's no blanket family-and-friends exception to securities laws. Fix: use proper offering documents, track investors, and handle any notices/filings so later VC diligence is smooth.

Reusing Templates Without Adaptation

Copying a random SAFE/note template can create misfit terms for your entity, jurisdiction, or investor profile. Fix: get at least a limited legal review before taking real money.

Actionable Next Steps

• Classify the money: decide whether each contribution is a gift, a loan, a convertible instrument (note/SAFE), or a direct equity purchase.
• Pick one structure and standardize terms: match it to your goals (amount, investor sophistication, and whether you're planning a VC round) and write down high-level terms (valuation or cap/discount; maturity/interest if applicable).
• Plan compliance: list who you'll approach, where they live, and which exemption path you expect to rely on"then note any likely federal/state filings.
• Draft the documents: use agreements that include risk disclosures and clear repayment/conversion mechanics (avoid "expectations by text message").
• Update your tracker immediately: keep your cap table and convertible instrument log current after every signature and payment.
• Get a short legal review before taking funds: have counsel sanity-check structure, terms, and filings"especially if you have non-accredited investors or investors in multiple states.

If you want help structuring or reviewing your friends & family investment agreements (and aligning them with future fundraising), contact Promise Legal for a focused review and a clean closing plan.