How To Treat Founder Expenses Prior to Initial Fundraising?

So you’ve been hammering away, putting your life savings into your new startup (plus maxing out your credit cards) and now you have investors willing to put money into your company.

How should the money you contribute before investors be treated? And how do you to get the maximum benefit of the cash you and your team personally put into the startup prior to the fundraising?

It will depend on what your investors say, because some will take the view that such cash is just “sweat equity” and reflected in the value of your founder shares, but you can do a few things to help get paid back the cash and/or get some additional value.

Most importantly, document your expenses and keep receipts.

Any expenses for which the company would be entitled to a tax deduction are fair game for reimbursement. These include all your normal business expenses, such as computers, office supplies, web service fees and travel for work. Investors don’t really push back on legitimate expenses that can be documented.

What about a “loan” to the company?

First, deposit the money into the company’s bank account to officially track it. Then, once you get a material amount (say $10,000 or more), and maybe every three to six months thereafter, document the money going into the company with a simple demand promissory note with the very minimum amount of interest on a short-term note. Investors seldom complain about paying off  notes or converting them into preferred stock. Investors rarely demand conversion, and for as a founder, it would be expensive stock if you wanted to convert, given that you should already have a nice share of the company in common stock paid with your “sweat,”. You are most likely better off having the cash now to pay off any crazy high interest rate on the credit cards you may have maxed out. Investors also may have you delay payment or pay them back over time if the amount is large compared to what was raised, just to make sure that all the new money coming in doesn’t instantly leave the company and that it is used to get to the next milestone.

In short, when it comes to expenses, it all comes down to tracking the funds and acting like a real company. At some point your accountant will ask you for documentation, so it is best to put good procedures in place up front, even if that simply means having a spreadsheet and envelope to track things at first.