As a founder, you invest a lot of time and effort into building your company, often called “sweat equity.” At some point, you may put your own money in to grow or sustain the company, and naturally ask, “Will I get this back?” or “Should this turn into equity?” and so on. In either situation, you will need to document the transaction. This topic is pretty subjective, so take my opinion with a grain of salt, but, in my mind, there are three types of capital that a founder puts into their company: 1) incidental capital, 2) capital that is intended to be paid back, and 3) capital that is an investment.
You’re putting $300 into your company
You won’t get paid back. This small amount of money likely isn’t something you’d document and shouldn’t expect to get paid back. These lower-cost purchases, for a desk here or headphones there, are not unlike the sweat-equity you’ve already contributed. This is why you have founders stock that will be worth a lot when your company takes off. It is not uncommon for founders to often work long hours, take some risks, and have random small expenses. These are some of the characteristics that tend to be associated with the life of a founder.
You’re putting $3,000 into your company
You might get paid back. Let’s say you buy a new computer. Some companies might treat this no differently from a $300 purchase—no documentation, no expectation of being paid back. Other companies might draw up a demand note (also called a non-convertible promissory note). This note would specify that the founder is putting personal funds in the company, and the company has to pay him or her back. Since it’s a demand note, there wouldn’t be language about the note converting into stock. Investors may frown on this sort of demand note, though. Think about this from an investor’s perspective—they’re putting $500,000 into the company. Imagine how they’d feel if $40,000 was going to pay back demand notes for piecemeal expenditures on computers, office rent, etc. They usually want their money to go toward value creation like product development and hiring good people, not paying the founder back.
You’re putting $100,000 into your company
You’re a real investor. At this level, you’re actually contributing meaningful capital to actually grow the business. This is the kind of money that pays to seriously move the business forward, not just cover incidental costs. If you make a capital contribution, you’ll want to document it. One of the most common vehicles for a large founder contribution is a convertible promissory note. Your equity will be recouped in the form of stock when you raise those first institutional dollars.
If you've got a great idea, but not a lot of funding, Fidelity can help.
Sample scenarios are for illustrative purposes only.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.