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Start Ups and Emerging Companies – 101: Loans

January 14, 2013

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A loan is "debt", not equity.  This means that the beneficiary of a loan (the lender) is not an owner of the company, but instead, has a contractual right to receive a return of the borrowed amount from the company (principal amount) plus a fixed return on his/her investment (interest).  On liquidation, debt is typically paid before equity, so loans tend to be less risky for the investor than a Private Equity investment.

Less risk, however, has its trade offs.  The rate of return under a loan is typically less than what can be earned in a Private Equity investment.  With few exceptions, the maximum rate of return on a personal hard money loan (under California usury laws) is 10% (or 5% over the amount charged by the Federal Reserve Bank of San Francisco, if greater).  Because start ups are more likely to fail than a proven company, most investors will seek to make Private Equity investments in the start up to boost the rate of return.  However, Friends and Family may be more willing to lend money, than invest in equity.

Loans should be documented in the form a Promissory Note.  The Promissory Note may be secured or unsecured, or coupled with a third party guaranty.  Loans may also be structured as convertible debt, meaning that the debt may be converted to equity upon the occurrence of future events.

With the exception of convertible debt, because loans are not equity investments, loans do not require compliance with Securities Laws.

 

For more information, please contact:

Derek Ridgway

925-746-8484 Direct Phone
925-746-8493 Fax

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