Funding from family and friends is often the quickest and easiest way to raise some capital for a new business venture or start-up. Friends and family investors may be more willing to put money into your business venture on an interest-free basis. In return, they may receive an equity stake or another form of award.
However, even if it is a small amount of money taken from several family members or close friends, it is important a contract is signed to ensure all investors are aware and in agreement with the terms and conditions. In this article, our commercial and corporate partner Andrew Niblock outlines why it is vital to sign a contract with family who are investing in your business.
An investor agreement provides certainty, allowing both parties understand in advance how the money will be used and repaid. Circumstances can change, particularly in families, and so proper legal framework can help prevent future misunderstandings.
There may be more emotion tied to the funds of family and friends, therefore it is advised that an agreement should be drafted or, at the very least, overseen by a qualified independent solicitor. The solicitor will provide an objective professional view of the circumstances and prepare an agreement that’s clear and accounts for all eventualities, reducing the chance of a dispute further down the line.
Key considerations when drawing up an investment agreement
An investment agreement should be clear for all parties involved. It should address:
- If the business is being run by a sole trader, partnership or limited company.
- If the investment is a loan or will the investor be given an equity stake in the business in return for their investment.
- Is it a secure loan? If so, what assets will be used?
- What is the interest rate or return on investment?
- Can the investor claim Enterprise Investment Scheme tax relief?
- What happens if repayments are late – or are not made at all?
- What happens if the investor dies and does any loan become immediately repayable to his or her estate?
A signature to an agreement only needs to be witnessed if the document is signed as a deed, which should be indicated in the agreement just before the signature clause. If a witness is required, it can be anyone who is 18 years old or more and is best for the witness to be independent of the deed.
What happens if the business fails?
In the UK, it has been reported that almost 60% of small businesses fail in their first three years of life. Therefore, it is imperative some form of written agreement is in place before any funds are invested.
If the investor has taken shares in a company in exchange for the investment, they will only be repaid if there’s money left once all the creditors have been paid. If it’s a loan and is secured, for example, by a mortgage on the borrower’s house, then the mortgage can be called in. All parties should be aware of the potential outcomes and how it will impact them if the business fails, before any investment is made.
If an investor asks for their investment back, whether the amount invested must be repaid on demand will depend on the type of investment. If it’s a loan, the loan agreement should state the repayment dates and provided the repayments are met, the investor should not be able to demand the money back immediately. If they’ve taken equity in the company, they are treated like any other shareholder and will have to sell their shares to get their money.
If you are worried about asking family to invest in your business, contact Andrew Niblock.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.