Friends-and-family startup money can be structured as a loan, an equity investment, or convertible debt. The right structure depends on what the company and investor need—and each carries different repayment, ownership, and risk consequences. Calling a round “friends and family” does not, by itself, exempt a securities offering from registration or other legal requirements.
How the three funding structures work
The U.S. Securities and Exchange Commission describes friends-and-family funding as common at the pre-seed or seed stage and identifies loans, convertible debt, and equity as possible structures. The choice is not determined by the investors’ relationship to the founder; it is reflected in the actual agreements and the company’s needs. SEC: Early-Stage Investors
Loan
The company borrows money and agrees to repay it under a loan document. Before a friend or relative lends, the agreement should make clear who owes the debt, when principal and interest are due, whether repayment is secured or guaranteed, and what happens if the company defaults. Repayment is a contractual obligation; it is not automatically tied to the company raising another round or becoming profitable.
Equity
The investor receives an ownership interest under the issuance documents. Unlike a loan, equity does not promise repayment on a schedule. The founder should understand how much ownership is issued, what rights attach to it, how the issuance affects the company’s capitalization, and how it may affect later fundraising. The exact rights depend on the security and corporate documents.
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Convertible note
A convertible note begins as debt and may convert into equity when specified contractual events occur. The note should explain what event triggers conversion, how the conversion price is calculated, whether interest accrues, when the note matures, and what happens if the anticipated financing does not occur or another conversion trigger is never met. These terms are contract-specific; a sample document is not a substitute for reviewing the actual agreement.
Compare repayment, ownership, and what happens if plans change
| Question | Loan | Equity | Convertible note |
|---|---|---|---|
| Is it debt at the outset? | Yes. The company undertakes to repay under the loan terms. | No. The investor receives an ownership interest. | Yes. The investor initially holds debt. |
| When does the investor get ownership? | Not through the loan itself. | At issuance, subject to the documents. | If a stated contractual conversion event occurs. |
| What determines payment or conversion? | The repayment schedule, interest, security or guarantees, and default terms in the loan agreement. | The ownership interest and rights specified in the issuance documents. | The conversion triggers and pricing mechanics, plus interest and maturity provisions, in the note. |
| What if the expected financing does not happen? | Repayment remains governed by the loan terms. | The investor remains an owner under the issuance documents; no financing-based repayment is inherent in equity. | The note must state the consequences if conversion does not occur, including how maturity is handled. |
| What should the founder explain to the investor? | Who owes the money, when it is due, and the consequences of default. | The ownership issued, associated rights, and potential dilution from future fundraising. | When conversion can happen, how the price is determined, and what happens if it does not. |
There is no universal best option. A loan makes repayment obligations central; equity makes ownership and rights central; a convertible note defers the ownership outcome while adding debt terms and conversion contingencies. Choose only after both sides can explain the downside if the business fails or the expected financing never arrives.
“Friends and family” is not a securities-law exemption
The SEC says a business generally may not offer or sell securities unless the offering is registered or qualifies for an exemption. Federal securities law does not create a different exemption merely because an offering is called “friends and family,” “angel,” “seed,” or “Series A.” The SEC lists loans, convertible debt, and equity as possible structures, but the label does not settle whether a particular instrument is a security or what rules apply. SEC: Early-Stage Investors
If an issuer relies on Regulation D, SEC staff says the issuer must file Form D under Rule 503. The staff FAQ also explains that federal and state securities-law obligations can both matter: Rule 506(b) and Rule 506(c) offerings are not subject to state registration and review, but state antifraud authority and possible state notice, consent-to-service, and fee requirements remain. The SEC identifies these FAQs as staff guidance with no legal force or effect, not as a statute or rule. SEC: Form D FAQs
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1Repair Windows errors before they cause bigger problems2Fix the driver behind crashes, sound loss and screen glitches3Clear out junk files and repair common Windows errorsThe applicable exemption, filing, state notice, corporate approval, and investor-qualification requirements cannot be determined from the friends-and-family label. They depend on the instrument, how the offer is made, who participates, where the offer and sale occur, and the company’s entity and transaction facts. A startup securities lawyer can assess those facts before funds are accepted or an offer is made.
Low-interest loans can have tax consequences
A zero- or below-market-interest loan may raise federal imputed-interest questions. IRS Publication 550 explains that a below-market demand loan generally has an interest rate below the applicable federal rate; for a term loan, the test compares the amount lent with the present value of payments using that rate. Under Internal Revenue Code Section 7872, forgone interest may be treated as transferred between the parties and can require interest income recognition. The nature of that deemed transfer depends on the relationship between lender and borrower. IRS Publication 550
This does not mean every low-interest startup loan has the same tax result. Publication 550 describes categories, exceptions, and fact-dependent rules. Applicable federal rates are published monthly, so the relevant rate must be checked for the month and terms of the actual loan rather than assumed from an old example. IRS Publication 550
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.Protect the relationship with clear terms and risk disclosure
Personal trust does not remove investment risk or make informal terms safer. The SEC advises founders to explain the risks of an investment and the downsides if the company is unsuccessful, particularly because friends and family investors have close relationships with founders. SEC: Early-Stage Investors
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Quick Recap
- Give the investor the proposed agreement early enough to understand the repayment, ownership, or conversion terms.
- Explain plainly what could happen if the company fails, cannot repay, or does not raise the financing expected to trigger conversion.
- Keep the company’s capitalization records and approvals consistent with the transaction documents.
- Have qualified legal and tax advisers review the actual transaction, especially where securities-law exemptions, state requirements, or below-market interest may apply.
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