How can I formalise investment from a friend?

What are the key things to consider when raising money from friends and acquaintances?

I am starting a business and a friend is willing to invest some money but is not going to give up his day job – how do I formalise this legally and what are the issues I need to think about?

Danvers Baillieu writes:

The first thing to consider is whether the investment is coming in the form of a loan or whether the investor is taking a stake of your business. If the “investment” is to be made as a loan you’ll need to agree the interest rate.

An unsecured loan can be made fairly simply in a loan agreement but if your investor wants security (perhaps over your home) it’s more complicated and risky. For example, if you personally secure a business loan you could lose your home if you are unable to repay it.

If an investor is taking a share in your business, one easy way to achieve this is to incorporate a limited company and issue shares. You’ll need to agree with your investor how your relationship as co-owners of a business will be governed. Your investor may want veto rights on certain decisions and a say in others.

You will also need to agree if and how you can sell your shares and if you do, at what price and to whom. Consider too how much you get paid and what benefits you receive for your work. 

The flip side will be the question of how much of your time is spent on the business and whether you are allowed to spend time on other business interests. If your business is creative or you’re likely to generate intellectual property then it’s important to agree whether this is yours or if it belongs to the company. Most investors will want to make sure it belongs to the business.

Equally, you should agree up front what should happen if either of you want to quit the company. If you want out at some point, will you be allowed to set up a similar business without your investor being involved and if your investor wants his money back, what’s a fair mechanism for achieving that?

To formalise your relationship you may need a shareholders’ agreement and new Articles of Association, which will cover the issues described here. It’s sensible to seek advice from a solicitor on these documents whether the money goes in as a loan or in exchange for a stake. The upfront cost of doing this is likely to be much smaller than the costs and time involved in sorting out a problem later.

Danvers Baillieu is an associate solicitor at Winston & Strawn

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