How to navigate a friends and family funding round? Did you know that 40% of startup funding comes from funding rounds with friends, family, and coworkers?
Before a viable product even hits the market, it needs a considerable amount of startup capital. The majority of capital may come from investment capital firms and angel investors outside of your immediate circle.
But, many startups rely on family and friends funding rounds to get started. Some may even rely on using up their personal savings and taking out personal loans.
Startups often need anywhere between $10,000-$150,000 in early funding to get through those stressful first few months of operations.
Also known as pre-seed funding, it gets used to hire staff, renting or purchasing office space, and other resources needed to be entirely operational.
What makes friends and family fundraising rounds different is that the capital doesn’t come from accredited investors but your own personal connections.
Just because this round of funding is coming from your nearest and dearest doesn’t mean you shouldn’t be as professional as possible. Treat them as the investors that are in your company.
The Ultimate Guide To Pitch Decks
Pitching to Personal Connections
Even if you are desperate for funding, it is important to avoid hard selling to everyone you know, no matter how tempted you are.
These spontaneous decisions can backfire, and you might appear overzealous. Especially, if you carry that over to pitch to big venture capital firms of experienced angel investors.
Or you have a reputation for bouncing from idea to idea and asking them for more money.
Another downside is that some may have unsolicited advice on the best way to run the company. They may run after you looking for reimbursement of their investment before you are capable of paying them out.
Lastly, if you fail, there will be a strain on your personal relationships.
When selecting the right people who are in your immediate circle to invest in your startup, choose those who understand how your business plan works and have financial smarts about how startups work.
Draft a business plan and work on your pitch. Take the same steps with your friends and family as you would other investors.
Spend time talking to the people around you so they anticipate the request for funding, and both you and they are prepared.
Providing them with updates will also let them know how serious you are about the project, and that you are committed to its success. Learn the nuances of how to navigate a friends and family funding round.
Keep in mind that in fundraising, storytelling is everything. In this regard for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
Always walk into the room prepared, whether it is friends or family or an investment firm. Have the number in mind you want, because asking for too little will keep your startup from taking off.
A bigger number may need to be broken down into multiple rounds and milestones. Discuss with family and friends what they want in return.
Also, ask about the time frame for when they will seek the return on their investment. Is there a contingency plan for if you can’t pay them back?
If you plan on what you will do should there be no money when they want, it will also lessen their investment fears. Paint the best and worst-case scenarios.
How can you add value to their investment? Will you be offering ownership shares, free services, or discounts? Coming to the table with incentives is another method of enticing them to invest.
Come prepared with all the answers they could potentially ask and show them what you can do for them, including what your company can do for their financial future.
Ensure you have a record of all the investments and financial interactions with your family and friends. Make copies of the documents, so they have a record of them to protect all of you.
If possible, pay your family and friends first. Don’t let their investments get in the way of your personal relationships.
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Protect Your Loved Ones and Yourself
You might not think this is necessary at first because you trust the people around you. But before you fall into a professional relationship with your friends and family, you should foster a healthy relationship by:
- Putting together term sheets: Outline the terms and conditions of the investment with a documented agreement. Include the type of investment, the interest rates, and the startup valuation that you have both agreed upon.
- Get your finances in order: You are an excellent business leader, so show them all the financial reports and policies based on the stage of the startup and their potential investment amount. Have them ask all the questions they want and use it to learn before future meetings.
- Hire a lawyer: It is essential to consult with a financial advisor and attorney before signing on the dotted line. Not only will it ensure your new investors understand their role in the startup, but it can protect you from potential disputes.
Investments from friends and family must be the same as an angel round and follow the same rules while giving them fair economics because of the risks. Make sure to know how to navigate a friends and family round before tapping into this source of funding.
Types of Family and Friends Funding
Friends and family funding can be informal, so it is essential to keep it as professional as possible.
Knowing how much to give them is a difficult process because it is still the early stages of funding. And you may still have to sell more stakes in your company to future investors.
There are two common types of funding from friends and family. These include business loans and equity funding. This means you will either pay back the money with interest or offer them an equity stake in your business.
Getting your startup off the ground is commonly done by small business loans from loved ones in the pre-seed funding stages.
Many startups use their family and friends funding as a potential bailout option if there are financial difficulties initially. The family and friends business loan has an agreed-upon interest rate.
In many instances, it is common for family and friends to give the loan without interest because they want you and your company to succeed. Get the loan in writing, so everyone is clear on the loan terms.
This offers equity to family and friends in exchange for funds for your startup. Giving equity funds to your loved ones or acquaintances means you are giving up shares to your company.
Speak to a lawyer and ensure you are careful about what you are giving and the value you have placed on it. Selling equity is a necessity when you seek large amounts of funding from investors down the road, so be mindful of how much you give away initially.
Equity investments are great options because what you owe the investors will depend on the startup’s future value and performance.
Repayment Terms and Contracts
Having repayment terms and contracts is a critical part of receiving funding for a friend and family investment.
You might trust them entirely, but protecting both parties will keep you out of trouble in the future. It is a safeguard and lays out the right course of action to take should things not go well.
These are common problems that you could face when doing business with friends and family:
- You can’t follow through with the repayments you promised
- When you make more profit than anticipated, they might demand more than their share
- Friends and family might want to get involved in business decisions
- They might put pressure on you to hire their family members
- There may be an informal culture regarding their investments, and it can cause your non-related employees to feel insecure about their place within the company
Be mindful that when you receive investments from friends and family, there will be some issues down the road that can damage your relationships. So be professional, and ready for any situation you run into.
The best thing to do for your relationships is to stay on schedule with your repayments and be clear about what they will be getting back. That’s one of the most critical facets of how to navigate a friends and family funding round.
Reaching out to people in your inner circle is only one of the sources of funding. You will need to know how to raise startup capital for your business. Check out this video I have put together with valuable tips to guide you in the right direction.
How to Ask Friends and Family for an Investment
You might be one of those people who are uncomfortable asking the people in your inner circle for money. Asking that initial “do you want to invest?” question is daunting.
You might feel that you are putting people in an awkward position if they say no. It is absolutely normal to experience these feelings, but it can be necessary for the early-seed money.
When approaching your inner circle with your startup, be confident in your delivery and show them how much of an opportunity it is. Let them know that you are not soliciting for charity.
You need investment to get your hard-earned business off the ground. You must not take it personally if they say no. Not everyone has the same vision as you, and they might not want to be involved at all.
Mixing business with family is sometimes an impossible situation, and other times it is the best thing that could happen to you. You should do everything possible to make this seamless for you and them.
Most importantly, you should know how to navigate a friends and family funding round. Here are some tips when asking loved ones for investments:
- Take it seriously: Get yourself an attorney and protect your relationship by drawing up legal documents of their investments. Everyone needs to know what their involvement will be and the repayment terms to protect you both. Legal mistakes could potentially harm the future of your business and potential investments because they don’t want to deal with messy family drama.
- Everyone is equal: Treat your friends and family as you would outside investors. They know you well, your passion for the business, and have taken on many risks. When approaching your family and friends, put together a killer pitch deck, put on your dress shoes, and show them you mean business. When they see you – they must see a businessperson ready to take their investment and make the company grow. They will also feel equal to other investors because they are treated fairly.
- Invest your own money: Nothing screams “I care about your money” more than investing your own money alongside theirs. If you are willing to risk your savings, they will feel more comfortable investing theirs. Owners of new startups take out second mortgages, bank loans, deplete their savings to make their dreams come true. While it is not recommended to put everything on the line and have a safety net, show your friends and family that you’re also willing to take the risk.
The Bottom Line
Understanding how to navigate a friends and family funding round is complicated, but it can be a wonderful experience when it gets done correctly.
Be prepared to give this company everything you’ve got with or without family and friend investments.
Speak to a lawyer and draw up legal documents to protect yourself and your inner circle. You will be thankful should things not go according to plan.
Define the terms of the investment. Will you be giving them equity or taking a business loan with or without interest? Make sure they know where they stand in the company and set clear boundaries.
They are there to support you and want to see you succeed, or they wouldn’t be investing in the first place. Though being professional is key to making this work and preserving your personal relationships.
Remember, there are other alternatives out there for you too. Consider accelerator programs and crowdfunding platforms for more early-seed funding for your startup.
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