पाठशाला Pathshala · धन Dhan, Money · Lesson 04 · Start

Friends, family and the first ₹25 lakh

The first outside money usually comes from people who would lend it to you anyway. Structure it so the relationship survives both outcomes: the company that works and the one that does not.

Pathshala, The Founder Library · 11 October 2026 · 10 min read

The first cheque into most Indian companies is written at a dining table by someone who would have lent the money anyway. It arrives with love and without paperwork, and both are a problem. The love means neither side will ask the hard question. The missing paper means that in three years, when the company is worth something or nothing, nobody can remember what was promised.

This lesson is about getting the paper right while the love is still intact. It covers why this money behaves differently from an investor’s, the four instruments Indian law actually offers for it and the rule that makes each one legal, why ₹25 lakh is the line that matters, how to price shares sold to your mother now that the angel tax is gone, and the conversation to have before any of it. The decision tree in the middle picks the instrument one cheque at a time.

Why this money is different

An angel loses money for a living. A seed fund has a portfolio in which most companies fail and a few pay for the rest. Your uncle has one investment in a startup and it is you, and he has made it for reasons that have nothing to do with portfolio theory. The consequence is that the two outcomes a professional investor plans for are the two outcomes a relative never imagined.

If the company fails, the professional writes it off. The relative has lost ₹10 lakh of retirement money and will see you at every wedding for the rest of your life. If the company succeeds, the professional is pleased. The relative discovers that the ₹10 lakh which was a loan when it felt like a loan has become, in his memory, a stake, and that the stake was surely larger than two per cent. Neither failure is about money. Both are about the gap between what was said and what was written, and the whole method of this lesson is to close that gap before the transfer.

The first question, then, is not how much. It is what the person expects back, asked in exactly those words and answered before anything else is discussed. There are only three honest answers: nothing, the money back, or a share. Each has an instrument, and each instrument has a rule in Indian law that must be met or the directors are personally exposed.

The four instruments, and the rule behind each

A gift is money to you, the founder, which you then put into the company as your own capital. It never touches the company’s books as anyone else’s money. The Income-tax Act exempts gifts from relatives as it defines them in the recipient’s hands; gifts from others above a small annual threshold are taxed as the recipient’s income, which is why a friend’s money is usually better taken as an investment and a parent’s as a gift. The paper is a one-page gift letter saying nothing is owed. Its purpose is not tax. It is to make the sentence “nothing is owed” exist in writing.

A loan is where most family money actually starts and where the Companies Act is least forgiving. A private company that takes money it must repay has taken a deposit unless an exemption applies, and the deposit rules are built for public companies raising from the public. The exemption that matters here is in the Companies (Acceptance of Deposits) Rules: since the September 2015 amendment a private company may take a loan from a director or a relative of a director without it counting as a deposit, provided the lender declares in writing that the money is not itself borrowed and the company discloses the loan in its board’s report. A loan from a friend who is neither director nor relative does not get that exemption, and the honest options are to convert the friend into a shareholder or to use a different instrument.

Priced equity means the person buys shares at an agreed price per share, which means the company has been given a valuation. For a private company the route is private placement under section 42, and since the 2018 amendments the mechanics are strict: an offer to no more than two hundred persons in a financial year, an offer-cum-application letter in Form PAS-4, money only from the subscriber’s own bank account into a separate account, allotment within sixty days and a return of allotment in Form PAS-3 within fifteen days of it. The money may not be used until the return is filed. A late return costs the company, its promoters and its directors ₹1,000 a day up to ₹25 lakh, and a breach of the section can cost the amount raised or ₹2 crore whichever is lower. The shares may be ordinary equity or compulsorily convertible preference shares, the CCPS that professional investors use, and the same form works for an aunt.

A convertible note is the instrument the state built for exactly this situation. Rule 2(1)(c)(xvii) of the deposit rules, inserted in June 2016, excludes from the definition of deposit an amount of ₹25 lakh or more received by a start-up company in a single tranche from one person by way of a convertible note, meaning an instrument that evidences receipt of money initially as debt and either converts into equity or is repaid. The original window was five years; a Ministry of Corporate Affairs amendment of September 2020 extended it to ten. Start-up means DPIIT-recognised: a private company within ten years of incorporation with turnover never above ₹100 crore. A non-resident relative may subscribe under the non-debt instruments rules at the same ₹25 lakh floor. The point of the note is that nobody has to decide today what the company is worth; that argument is deferred to the next priced round, usually with a discount to that round’s price or a cap on the valuation at which the note converts.

There is a fifth form that sits between the last two. The iSAFE, published by the Mumbai seed fund 100X.VC, takes the legal form of CCPS so that it needs no ₹25 lakh floor and no DPIIT certificate, carries a cap or a discount or both, and converts at the earlier of a liquidity event or three years. It gives a small cheque the economics of a convertible note on the paperwork of a priced round, and because the documents are public it is a reasonable starting draft for your own lawyer to work from.

Why ₹25 lakh is the line

The number in the title is not a round size. It is the threshold at which the simplest instrument becomes available. Below ₹25 lakh from any one person, the choices are a gift, a director’s or relative’s loan, or priced shares with all the private placement machinery. At ₹25 lakh and above, from a company that holds its DPIIT certificate, the convertible note appears, and with it the ability to take meaningful money from someone close without either of you pretending to know the company’s value. A family round of ₹25 lakh is therefore often best built as one convertible note from the one person who can write that cheque, with the smaller amounts taken as a loan from a director’s relative or not taken at all.

Pricing shares for people who love you

For a decade the hardest part of a priced family round was section 56(2)(viib), the angel tax, under which a closely held company that issued shares above the fair market value an assessing officer accepted was taxed on the excess as income. The Finance (No. 2) Act 2024 sunset the clause: it does not apply from assessment year 2025–26, for all classes of investor. A high price no longer invites that inquiry.

A low price still can. If shares are issued to a friend for less than their fair market value, the difference can be taxed in the friend’s hands under section 56(2)(x) as income from other sources, and the sentimental instinct to give family a generous price is exactly what triggers it. The method that avoids both problems is dull: get a valuation report from a registered valuer, price at that number, give everyone in the round the same price, and keep the round small enough that the valuation is a formality rather than a negotiation. A company with no revenue and a product in beta is worth, to a valuer, something in the low crores; a ₹15 lakh cheque at a ₹3 crore pre-money buys 4.8 per cent, and that is a number a relative can understand and remember.

Family money fails in the gap between what was said and what was written. The whole method is to close that gap before the transfer, not after the outcome.

The conversation, and the paper that follows it

Before any money moves, say four things aloud to each person, in a conversation that is only about this. This can go to zero, and most companies like it do; please only put in what you would be fine never seeing again. Here is exactly what you get: a loan repaid by this date at this interest, or this many shares at this price, or a note that converts at the next round. Here is how and when you might get money back: not at your request, only at a round, a sale or a dividend, and possibly never. Here is what the company will tell you and how often: a short written update on the first of every month, the same one every investor gets. Then put all four in the document they sign.

Three terms to refuse, however they are asked. No board seat and no veto, because a company cannot be run by committee at a wedding. No right to be repaid on demand, because a loan callable at a family argument is not capital. And no promise of a job for anyone, in writing or in spirit. The relative who understands why these are refused is the one whose money you should take.

A worked example

Two founders in Pune have a DPIIT certificate, a product in trial with six small businesses and no revenue. Three people want to help. Her father offers ₹10 lakh and wants it back one day. His college friend, now an engineer in Hyderabad, offers ₹7.5 lakh and wants a share. Her aunt in Toronto offers ₹25 lakh and does not mind which.

The father is made a director’s relative by the obvious route, since she is a director; the ₹10 lakh is a loan at eight per cent with a repayment date in thirty-six months, his declaration that the money is not borrowed, and a line in the board’s report. The friend buys 2.4 per cent by private placement at a ₹3 crore pre-money off a valuer’s report, with the PAS-4 letter, the separate account and PAS-3 filed on day nine. The aunt subscribes to a ₹25 lakh convertible note from Canada at a twenty per cent discount to the next round’s price, converting or repaying within the ten years the rules allow. Eighteen months later a seed fund puts ₹3 crore in at ₹15 crore pre-money. The note converts at an effective ₹12 crore, into roughly two per cent before the new money comes in; the friend’s 2.4 per cent dilutes to about two per cent, worth around ₹36 lakh on paper; the father is repaid from the round, exactly as the letter said he would be. Three relationships, three instruments, no surprises.

What to check, and the monthly ritual

Before the transfer: every person has answered the first question in their own words; the instrument matches the answer; the DPIIT certificate is in hand if a note is used; the valuer’s report exists if shares are priced; the lender’s declaration is signed if a loan is taken; the company secretary has the PAS-3 date in the diary. After the transfer: a register of who gave what, on which paper, with which dates, kept where both founders can find it. And on the first working day of every month, one email to everyone on that register, five lines long, with the number that matters and the thing that went wrong. The founders who send that email for three years are the ones whose relatives come to the next round; the ones who stop sending it in month four are the ones who stop going home for Diwali.

Nothing here is legal, tax or investment advice. The deposit rules, section 42 and the tax treatment of shares change by notification; the sources below are the ones checked for this lesson, and a company secretary who has done a private placement is the cheapest part of the process.