Convertible Notes for Friends and Family in NZ

Raising your first $20,000, $50,000 or $150,000 from friends and family can feel simple until someone asks what they are actually getting. A handshake, a bank transfer and a promise to sort the paperwork later can create confusion about whether the money is a loan, shares, a gift or a future right to invest.

Common mistakes include setting a valuation too early, copying overseas templates that do not fit New Zealand law, leaving maturity dates open-ended, and failing to explain the risk that the investor may never get their money back. A well drafted convertible note can keep the round light, but only if the conversion mechanics, repayment rights and investor expectations are clear.

Founders should be able to decide whether a startup convertible note in NZ fits their round, what documents are needed, and which convertible note terms deserve careful thought before accepting money from personal networks.

When a Friends and Family Convertible Note Makes Sense

A convertible note can suit an early friends and family raise where the startup needs funding now, but the founders are not ready to agree on a company valuation. Instead of issuing shares immediately, the investor lends money to the company and the loan may convert into shares at a later funding round or other trigger event.

For a small early round, the appeal is usually speed and simplicity. The company can receive funding to build a prototype, pay contractors, validate demand or cover early operating costs without running a full equity raise. Investors get a written right to conversion, usually with an economic benefit such as a discount or valuation cap.

A convertible note is not the right fit for every friends and family investment agreement. It works best where both sides understand that the investment is high risk, the business may fail, and conversion depends on future events that might never happen.

• Use a convertible note where valuation is genuinely uncertain. Early startups often have little revenue, few assets and no reliable benchmark for a priced share issue.
• Use it where the next round is realistic. If you expect to raise seed or angel capital within a defined period, a note can bridge the company to that round.
• Use it where investors accept startup risk. Friends and family should not treat the note like a savings product or guaranteed repayment plan.
• Avoid it where the company simply needs ordinary debt. If the investor expects fixed repayments from trading income, a plain loan may be clearer.
• Avoid it where the investor wants control rights immediately or detailed investor rights. If they expect voting power, board rights or founder-level involvement from day one, a share issue and shareholders agreement may be more suitable.

A simple example helps. A Wellington software founder raises $75,000 from three relatives to finish a beta product. The business is too early to value sensibly, but the founder expects to raise a seed round in 12 months if pilot customers convert. A convertible note may let the company use the money now while giving those relatives a path to shares later, based on the seed round terms.

The same structure may not suit a cafe owner borrowing from a parent to buy equipment, where there is no plan for a future equity raise. In that case, the legal and relationship issues are usually better handled through a loan agreement with clear repayment terms.

The Documents You Need for a Small Early Round

A friends and family round should still have proper seed funding legal documents in NZ, even if the investors trust the founder. Good paperwork prevents misunderstandings, supports the company records, and helps future investors complete due diligence without finding gaps.

The core document is usually a convertible note subscription agreement or convertible loan note deed. It records the investment amount, when the funds are advanced, interest if any, conversion events, valuation cap, discount, maturity date, repayment rules and investor promises.

Most early rounds also need supporting company approvals. Under the Companies Act 1993, directors must act in the best interests of the company and manage share issues and company obligations properly. Even when the money comes from a sibling or close friend, the company should record the decision to enter into the note, approve the funding round closing pack and issue any future shares in its board minutes or written resolutions.

Founders should usually prepare or check the following documents before money lands in the company bank account:

• Convertible note agreement. This is the main investment contract between the company and each investor, or one agreement signed by all noteholders.
• Board and shareholder approvals. These record authority to raise the funds, sign the note documents and issue shares on conversion if required.
• Updated cap table. This should show current shares, options if any, the note amounts, and likely conversion outcomes under different scenarios.
• Shareholders agreement review. Existing pre-emptive rights, consent rights or issue restrictions may affect whether the company can take the money or issue future shares.
• Company constitution review. If the company has a constitution, it may include rules about issuing shares, different share classes or director approvals.
• Investor information pack. For a small personal network round, this may be a plain English summary of the business, key risks, use of funds and expected next steps.
• IP and confidentiality documents. Investors may receive sensitive pitch materials, product plans, customer information or technical documents that should stay confidential.

Many New Zealand startups also check their basic company profile before raising. The company should be properly registered with the Companies Office, have accurate director and shareholder details, and use its NZBN consistently in commercial records. If the startup relies on brand names, software, designs or content, it should also check whether key intellectual property is owned by the company, not by an individual founder or former contractor. Trade mark strategy may involve IPONZ filings if the brand is central to the pitch.

The friends and family context does not remove financial markets considerations. Offers of shares, options and convertible securities can fall under the Financial Markets Conduct Act 2013. Some early offers may rely on exclusions, such as offers to close relatives, close business associates or wholesale investors, but the position depends on the facts. Founders should avoid treating every personal contact as automatically exempt, especially where acquaintances, customers or social media contacts are invited to invest.

A practical approach is to keep the round narrow, document why each investor is eligible to participate, and avoid public promotion. If a later seed investor asks how the early money was raised, you want a clean answer backed by signed documents, company approvals and clear investor records.

Convertible Note Terms Founders Should Get Right

The main convertible note terms decide how much equity the investor may receive, when conversion happens and what happens if the next round never arrives. Small differences in drafting can change founder dilution and investor expectations significantly.

The terms do not need to be complicated, but they do need to be precise. Friends and family investors may not ask detailed questions at signing, yet disputes often arise later when the company succeeds, struggles or raises money on different terms than expected.

Investment Amount and Drawdown

The agreement should state exactly how much each investor is providing and when the company can use the funds. Some small rounds are funded in one payment. Others use tranches, such as $25,000 on signing and $25,000 after a product milestone.

Tranches can protect investors, but they may also create cash flow uncertainty for founders. If the second tranche depends on a milestone, define the milestone in a way that can be objectively checked.

Interest

Convertible notes are debt instruments, so they often include interest. In friends and family rounds, founders sometimes set interest at zero or a modest rate to keep the arrangement simple. If interest applies, the note should say whether it is paid in cash, accrues until conversion, or converts into shares along with the principal.

Interest can affect the conversion calculation. For example, a $50,000 note with accrued interest may convert on a larger amount than the original investment, increasing the number of shares issued.

Conversion Trigger

The most common trigger is a future qualified financing, such as a seed or angel round where the company issues shares to new investors. The note should describe what kind of financing qualifies and whether a minimum raise amount applies.

Founders should avoid vague wording like next investment round without explaining whether small top-up amounts count. If the company raises $15,000 from another friend six months later, should the earlier notes convert? Often the answer is no, unless the round meets a defined threshold or is approved by noteholders.

Valuation Cap

A valuation cap sets the maximum company valuation used to calculate the noteholders' conversion price. It rewards early investors if the startup grows quickly before the next priced round.

For example, a note has a $3 million valuation cap. A later seed round values the company at $6 million before investment. The noteholders may convert as if the valuation were $3 million, giving them a lower share price than the new seed investors. This means more shares for the noteholders and more dilution for founders.

A cap that is too low can create unexpected dilution. A cap that is too high may not feel like meaningful compensation for early risk. For friends and family, the cap should be explained with simple examples so investors do not assume they are buying a fixed percentage of the company.

Discount

A discount gives noteholders a reduced price compared with the new investors in the next round. If the discount is 20 percent, the noteholders convert at 80 percent of the price paid by the seed investors, unless the valuation cap gives them a better outcome.

Some notes include both a cap and a discount. The agreement should say which applies if both could be used. Usually the investor receives the better of the two, but this should not be left to assumption.

Maturity Date

The maturity date is the date when the note becomes due if it has not already converted. This term matters because early startups often miss fundraising timelines.

At maturity, the agreement might require repayment, automatic conversion, extension by agreement, or noteholder approval for the next step. Repayment may sound fair, but a pre-revenue startup may not have enough cash. Automatic conversion may be efficient, but it requires a formula for pricing the shares if no priced round has occurred.

For a friends and family round, founders should talk through the maturity outcome before signing. A relative who expects their money back after 18 months may react very differently from one who accepts that the most likely outcome is conversion or loss.

Repayment and Early Exit Events

The note should say what happens if the company is sold, liquidated or stops trading before conversion. Investors may receive repayment before ordinary shareholders if there is money available, or they may convert immediately before a sale.

These terms can affect sale negotiations. If a small acquisition offer arrives, founders need to know whether noteholders are repaid, convert into shares, or choose between alternatives.

Investor Rights

Friends and family noteholders do not always receive board seats, voting rights or information rights before conversion. If they will receive updates, inspection rights or consent rights, set these out clearly.

Regular updates can be helpful. A quarterly email under an investor rights agreement covering cash position, product progress, major risks and next fundraising plans can reduce anxiety and keep the relationship healthy without giving every investor operational control.

Legal and Relationship Risks to Manage Early

The biggest risk in a friends and family convertible note round is not only legal uncertainty, but a mismatch between what the founder thinks was offered and what the investor thinks they bought. Clear documents help, but direct conversations matter just as much.

Start with the investor's expectation. Some friends and family investors think they are backing the founder personally. Others think they are receiving a guaranteed return. Some believe they will own shares immediately. A founder should correct those assumptions before accepting funds.

Plain English explanations should cover:

• The investment may be lost. Startup failure is possible, and the company may have no funds to repay noteholders.
• Shares may not be issued immediately. The investor usually holds a contractual right under the note until conversion.
• The final ownership percentage is uncertain. It depends on the next financing, cap, discount, interest and other share issues.
• Future investors may require changes. A seed investor may ask to amend note terms, tidy company documents or convert notes before investing.
• The founder is not personally guaranteeing repayment unless the document says so. Personal guarantees are a major commitment and should not be implied casually.

Another risk is taking money before the company is ready. If the startup has not incorporated, the founder may end up contracting personally. For most venture-style fundraising, the company should be incorporated first, with the correct legal name, bank account and Companies Office details. Founders should also check that all founders have assigned relevant IP to the company, especially software code, designs, brand assets and pitch materials.

Founders also need to manage director duties. Directors should consider whether taking on debt is in the company's interests and whether the company can meet its obligations as they fall due. A convertible note is not free money. Even if repayment is unlikely, it is still a company obligation and should be treated seriously in cash flow planning.

Cap table surprises are another common issue. A founder may raise $100,000 on a note with a low valuation cap, grant an adviser equity arrangement, and then raise a seed round on a lower valuation than expected. The combined dilution can be much higher than the founder pictured at the start.

A simple scenario can show the issue. Two founders own 50 percent each. They raise $100,000 on a note with a $1 million cap and a 20 percent discount. Six months later, they create an option pool and raise seed money. Depending on the seed valuation and whether the note converts before or after the option pool, the founders may give up more equity than expected. A modelled cap table lets founders see the impact before they sign.

Privacy and confidentiality can also arise. Investors may receive customer lists, revenue data, staff details or user metrics. If the startup handles personal information, the Privacy Act 2020 may apply to how that information is shared and protected. Investor updates should avoid unnecessary personal information and should be stored and sent securely.

Marketing the raise needs care. The Fair Trading Act 1986 prohibits misleading or deceptive conduct in trade, and fundraising statements should be accurate. Even in a private friends and family round, founders should avoid exaggerating traction, signed contracts, revenue, IP ownership or exit prospects. Optimism is normal in a pitch. Unsupported claims are a problem.

Founders should also think about what happens after conversion. Once noteholders become shareholders, they may be bound by a shareholders agreement, constitution, share subscription agreement or investor rights deed. The convertible note should require investors to sign those documents on conversion, so the company does not end up with shareholders who are outside the agreed governance framework.

FAQs

Is a Convertible Note the Same as Selling Shares?

No. A convertible note usually starts as a loan to the company, with a right or obligation to convert into shares later. The investor generally does not become a shareholder until conversion occurs.

Can I Use One Friends and Family Investment Agreement for Everyone?

Often, yes. Many small rounds use one form of convertible note agreement with each investor signing separate acceptance pages or counterpart documents. The amounts, payment dates or special rights should still be recorded clearly for each investor.

What Happens if We Never Raise a Seed Round?

The maturity clause should answer this. The note may become repayable, convert using a fallback valuation, extend by agreement, or require noteholder approval for the next step. Do not leave this unresolved.

Do Friends and Family Investors Need Detailed Risk Warnings?

They should receive a clear explanation of the key risks in plain English. Personal relationships do not remove the need to explain that the business may fail, conversion may not happen, and returns are not guaranteed.

Will Future Investors Care About My Early Convertible Notes?

Yes. Seed and angel investors usually review all notes, side letters, shareholder approvals and cap table effects. Clean documents can make the next raise much smoother.

Key Takeaways

• A convertible note can work well for a small New Zealand friends and family round where valuation is uncertain and a future seed raise is realistic.
• The key documents usually include a convertible note agreement, company approvals, an updated cap table, and checks against the constitution and shareholders agreement.
• Valuation caps, discounts, maturity dates, interest and conversion triggers can materially affect founder dilution and investor outcomes.
• Friends and family investors need clear expectations about risk, repayment, conversion and whether they receive any control or information rights.
• New Zealand companies should consider Companies Act, Financial Markets Conduct Act, Privacy Act and Fair Trading Act issues when raising and sharing investor materials.

If you are preparing a friends and family raise, Sprintlaw New Zealand can help with your convertible note agreement, cap table wording, shareholder approvals and investor risk summary. Contact us on 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.