This is often the quickest and easiest way to raise capital for a new business or start-up. Friends and family sometimes invest on an interest-free basis, asking instead that they receive an equity stake or other forms of financial reward for their investment.

Even if the amount of money invested is small, all investors must sign a contract so everyone knows all implications. Circumstances can change, particularly in families, so a legal framework can help prevent confusion.

A solicitor will provide an objective professional view and prepare an agreement that will be clear and explain all eventualities, hopefully alleviating any disputes in the future. 

Considerations that need to be thought about are:

• Is the business run by a sole trader, partnership, or limited company?
• Is the investment a loan, and if so, will the investors receive an equity stake in the business?
• Will the funds be a secure loan, and what assets are available?
• What is the interest rate or return on the loan.
• What happens if repayments are late – or are not made at all?
• What happens if the investor dies? Will any loan become immediately repayable to their estate?

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 that some form of a written agreement is in place before any funds are invested.

Before investing, all parties should know the potential outcomes and how it will impact them if the business fails.

If the investor has taken shares in a company in exchange for the investment they are making, they will only be repaid if any money is left and once all the creditors have been paid. If it’s a loan secured, i.e. a mortgage on the borrower’s house, then the mortgage can be called in. 

If an investor asks for their money back, the loan agreement should state the repayment dates, provided the repayments are being met; and the investor should wait to demand the money back. If the investor has taken equity in the company, they will be treated like any other shareholder and have to sell their shares to get their money.