Raising money from Family & Friends? Here’s what you need to know!
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 is 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.
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. Don’t ask your family member or friend how much they think their shareholding is worth.
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
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.
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
It is important to 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. It gets even trickier when you take funding from multiple family members each with a different expectation on their returns and involvement.
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.