Need Funding Fast? Consider Family & Friends
BY Nicole Denholder | June 4, 2020
Category : Early Stage
Need funding fast? Consider family and friends
When you’re starting to develop your business there are a range of funding options to consider. One of the most attractive, particularly at the idea or early stage is family and friends. We’ve all heard of the entrepreneur whose mother, father, brother, sister all put in money to support their idea and often times these funds are provided with very sympathetic return expectations.
A family and friends round typically takes place at the start of your business, perhaps before your idea is fully developed. Even it’s if a small amount or just a loan to get started, as a founder you should treat the round with caution, professionalism and a long-term strategy in mind.
“Family and friends are the first to support your business so it makes sense that they’re often the first funders”, says investment commentator, Amanda Williams. “But keep in mind that they may choose to invest without asking the kind of tough questions posed by seasoned investors. That can often mean that you’re less accountable. Over time, this can change so you have to be prepared”.
Take a formal approach
While your funding may be informal don’t treat your investors like that. Start with detailing each milestone, estimate how much you will need to fund each milestone and then decide how much equity or shareholding in your company you are prepared to attach to each investment. It’s crucial that you make these decisions for yourself. Don’t ask your family member or friend how much they think their shareholding is worth. Every dollar invested is a negotiation so start with what you’re prepared to offer and go from there.
Next step is designing a pitch deck or similar to explain exactly what your plans are in terms of development and milestones and how funding will be used. Having something visual is a critical tool for any investor and it also helps you in refining your pitch process, something you’ll need later if you take on subsequent funding rounds.
Kinds of agreements
Once you’ve been made an offer of funding, the next step is formalizing the agreement. There are different ways of doing this; a term sheet, a share subscription agreement and/or a shareholders agreement. Some are binding – the subscription and shareholders agreements – and some, like the term sheet aren’t. Can you proceed without any agreement at all? Yes, but it’s not recommended. Even if funding is provided in terms of a loan without being attached to any equity, you still have to decide and agree when those monies will be returned and whether or not interest will be charged.
If your family and friends are going to receive a shareholding in exchange for their investment, you’ll need to issue share certificates, which is a proof of ownership in the company. In some markets, the local or national registry needs to be notified of these shareholdings.
There are several things to keep in mind when considering an equity investment. First up, be commercial and strategic when deciding how much equity to give away. If the company requires future funding rounds, investors will be put off if too much equity has been given to family and friends. Remember, a seed round carries with it expectations of around twenty per cent equity. Also keep in mind your board structure. An angel or VC investor may be turned off if you give unqualified family or friends a seat on the board.
What are the pros and cons?
We’ve already seen that family and friends funds are often with very sympathetic return expectations. Another plus is the fact that there are minimal legal or contractual obligations and no due diligence. There’s an inbuilt trust that you’ll pay the money back or at the very least provide a return on the investment. Plus, there’s an assumption or a confidence that you’re skilled enough to see the idea through. And that kind of support is what can keep you going mentally too. When someone you know takes up an investment opportunity in your company, that’s validation of you and your idea.
It’s not all plain sailing
But like every funding option, there are downsides too. First, it’s highly likely that the nature of your relationship with that family member or friend will change. They’ve got skin in the game now so expect regular questions about how the business is going and at a much deeper level than if they hadn’t invested. They are now shareholders in your business and like any investor may want to know exactly how their money is being spent. They might also want to give you advice on how the company is run, which markets to focus on and the best to way to grow the business. It gets even trickier when you take funding from multiple family members each with a different expectation on their returns and involvement.
It’s all about how you start
There’s lot of advice about how to handle these kinds of issues but perhaps the best is this, start as you mean to go on. Before you even take a dime, work out how you plan to keep investors updated on activities. Decide how much information about the business you want or need to share. Be clear about the schedule for updating them and know how you’re going to distribute that information. Is it going to be a document with the latest monthly or quarterly figures listed? Or, are you going to hold a regular investment call to update multiple family and friends, now your shareholders, on your business progress? If so, provide an agenda to all participants. If there are less savvy business investors be careful to avoid corporate speak, industry terminology and acronyms. That might have impressed them before they invested but now that they’ve put in their hard earned dollars they might want it laid out plain and simple. In fact, lay out it simply anyway. Why do we need to call it bottom of the funnel when we can say new customers?
If that family or friend wants to be involved in the business post-funding be clear on their role and responsibilities. Again, we come back to the old adage, start as you mean to go on. At a brand level, that means your mission and vision for the company and how it will be represented – to the day-to-day operational norms, even the way you answer the office phone. If you’re not clear about their duties and the boundaries at the beginning don’t be surprised if friends and family investors start doing it their own way.
Beyond starting well, treat the family or friend investor like you would any other backer. That means patiently answering every question, penning professional correspondence and not shaming them for asking basic questions. It might seem elementary that net income equals revenue minus expenses but that might be a foreign concept to your retired parents.
As a female entrepreneur, be prepared for the fact that you might be asked sexist questions too. The old, “how will you juggle family responsibilities and run a company” is certainly a question more women get asked than men but sexism aside, that might be a legitimate question when it comes from the people who know you best. If expanding your company demands regular travel but your investor sister knows you have limited childcare options, it’s a reasonable inquiry. So, think about the kind of questions you might get asked by this particular group of investors before they ask them.
When things go wrong
There are so many tough things about running a business including the decision to start it in the first place. But there’s also the very real struggle when your plans don’t go to plan. There’s the unforeseen economic downturn, a miscalculation of consumer appetite or being ripped off by a supplier. Having to explain that to investors is hard enough but when those investors are part of your lifelong social circle it’s even tougher. First thing, bury the shame and embarrassment. Business is business and sometimes things go wrong. Communicate to friends and family in the same way you would to any investor. Be clear as to what went wrong and how you’re going to fix it. The more confident you sound, the more confident they’ll feel. If it’s the kind of problem that’s likely to force the business to shut, be upfront about that too. Outline your post-closure plans clearly and concisely if you don’t have a formal agreement in place. If your plan is to reimburse investors, decide how and when you’re going to do it. And try not to take criticism or negative feedback personally, even if those comments run personal. Take the high road, always. Easier said than done but if you think of that person as a suited and booted, high-flying investor and not your dad in his pajamas telling you off over his breakfast cereal then you’re half way there.
Family and friends is an excellent source of funding. It’s often fast, free of legal agreements and due diligence and also has the added benefit of low returns expectations. But, to avoid the pitfalls of this type of investment, remember; the relationship is undoubtedly going to change. Provide a formal funding agreement, be clear about the role and functions of each investor, be professional in your dealings with them and decide from the start how you’re going to keep them informed. When things go wrong, keep that professional hat on. Be clear and concise about next steps and whatever you do, don’t take criticism personally or let the experience ruin your relationship. After all, they’re family. Plus remember, these are your biggest supporters, they want to see you succeed. And they’ll be the ones who’ll sound your trumpet after your big wins too.