fundingI’ve heard a few people talk about the benefits of issuing IOUs instead of shares when funding a startup. What does this actually look like? Is there a legal structure for doing this? How do IOUs work in the real world?
There aren’t too many basic options in funding, but there are lots of variants. From the perspective of a funder, here are the principal questions:
Who gets my money? It could be an individual, an existing company, or an intermediary en route to one of those (e.g. Kickstarter acts as a trusted intermediary)
What do I get? Leading choices are satisfaction for having helped, my money back (perhaps with interest), the first $X of any income, the right to buy shares in the future at some beneficial rate, voting shares, non-voting shares, the optional right to convert debt to shares
What additional protections do I have? Perhaps if the venture fails, I own whatever’s left
What if it all goes wrong? For instance, a loan to a company disappears if the company ceases; a personal guarantee attached to that loan means that an individual has to make good
I’d usually understand an IOU to be a person-to-person promise to pay back money loaned. So in the above framework, I give you the money; I get that money back from you at some future point; there are no special privileges; and if the venture goes wrong, you still owe me the money.
However, in the startup world sometimes what’s going on with IOU-type paper agreements is a decision to delay making decisions on how shares are going to work and who’s in and who’s out until the venture is underway. That could be a good route for a startup that’s nobody’s day-job, although it could be a problem downstream if by the time you’re ready to formalise, the interests of different parties have gone in different directions.
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