When raising capital from friends and family, structuring the deal appropriately is crucial for long-term success. These early investors often believe in the founder’s vision before there is much (if any) tangible proof of success, which is why clear agreements and well-defined structures help mitigate misunderstandings. One of the most critical terms to define in your agreements is the fee structure that will be paid to the founder or management team.
There is no formal “friends and family” exemption from Securities and Exchange Commission (“SEC”) reporting and compliance regulations, but the term is often used to describe investment financing for small businesses—whether it be the sale of stock, limited liability company interests, and even investment promissory notes (as opposed to commercial loans). Every offer and sale of securities or investments (including for capital raises) must either be registered under the SEC or rely on an available exemption from registration. Exempt investments are not subject to SEC reporting and compliance regulations. The SEC maintains a helpful chart for a quick reference overview of the types of exemption categories and their qualifications.
The entity types most commonly used for friends and family raises are limited liability companies and limited partnerships due to the flexibility and liability protection they offer. The company agreement or limited partnership agreement, as applicable, should contain clear language describing the fee structure that will be paid to the founders (also called sponsors) and/or the management team, including the basis for which the fees will be calculated and when the fees will be payable.
Founders are also typically equity investors in their own companies, putting up capital as co-investors with their friends and family as skin in the game. Founders generally earn the same returns as other equity investors until a certain threshold is reached. Above this point, founders will earn a “promotion.” In other alternative investments, this is commonly known as carried interest. If the capital raised is placed into a pooled investment vehicle managed by the founder or another party, a management fee might be charged. The management fee is often paid on an annual basis and is valued at a percentage of the total capital under management, typically around 1-5%. Sometimes, founders and/or management teams will be paid a success fee contingent on achieving certain milestones, such as raising a specific amount of capital or hitting revenue targets.
Raising funds from friends and family can be a great way to kickstart your business, but it’s important to treat the process with the same professionalism as you would when raising from outside investors. By choosing the right entity structure, offering fair compensation, and promoting the raise effectively, you can build a strong foundation for future growth while maintaining positive personal relationships.
Whether you secure funding from friends and family or another source, RR&A’s skilled corporate team is ready to help navigate you through building a strong foundation for the success of your next business venture.
Miranda is a Senior Associate at R. Reese & Associates and part of the Corporate and Transactions teams. To learn more about Miranda, visit her attorney page.
Disclaimer: The information and material on this website is general information about our practice and firm. This information does not offer specific legal advice and the use of this information does not create an attorney-client relationship with RR&A or any of its attorneys. The information on this website should not be used for legal advice, and persons should not act upon the information on this website without engaging professional legal counsel.
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