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What are the pros and cons of friends and family financing for your startup business?
Friends and family financing rounds are one of the most basic and foundational steps for launching a startup business. However, it can be a very controversial source when doing startup fundraising. Some entrepreneurs don’t even want to consider the idea. Others swear by it as the smartest first step in any venture. So, is it for you? Can you really succeed without it? What are the real advantages and disadvantages?
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Even before the Series A, and Seed round of fundraising for startups is the friends and family round.
This is the very first money you’ll get to finance your business idea. Well before going to angel investment groups or VCs or getting on TV shows or being accepted to a startup accelerator program.
What you can’t self-fund, you’ll look for from your personal network of friends and family, and those connections of your cofounders and key team members.
In some cases, they may continue to provide capital at different stages. Though this network is often surpassed by more sophisticated capital as you grow and cross off milestones.
Who Are Your Friends & Family?
This is one of the key components when thinking about pros and cons of friends and family financing. This doesn’t just have to be limited to your immediate family nucleus, or close childhood and student friends.
We all now maintain much larger personal networks than we used to. Partially thanks to social networks like Facebook, Instagram and LinkedIn.
This group can be comprised of lifelong friends, college friends, coworkers, bosses, professors, neighbors, extended family members, and their personal contacts. It also certainly includes any cofounders as well.
What Is Friends & Family Financing?
This can take many shapes and forms. It could be your friends pitching in $10,000 in savings each and using their credit cards to help fund early expenses to start your business. It could be personal loans from mom and dad or your brother in law. It could be capital in exchange for an equity stake from a family friend.
Like many now-famous startups it could be as little as just $1,000. Or it could be hundreds of thousands of dollars.
Taking money from these individuals does not have to make it a family business. They are just helping you get started. It can be directed invested or financed as debt or equity. Or it can be a side agreement separate from the business entity itself.
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Why Raise Money From Family And Friends?
As part of the pros and cons of friends and family financing, keep in mind that even the cheapest to start ecomm businesses and those designed to be small local family businesses need some money to get started.
At a minimum you need domain names, website design, copywriting, to incorporate your business and to fund the opening of a business bank account.
Many businesses need even more money than that. They need a marketing budget, help with financial modeling, dollars to produce prototypes, and begin manufacturing.
You typically aren’t going to find this type of money from banks. Yet, without some type of financial lifeline, you may not make it long enough to give your startup a chance.
Regardless when you are looking for capital even if it is from family, remember that you need to master the story which is what raising money is all about. This is being able to capture the essence of the business in 15 to 20 slides. For a winning deck, 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.
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The Pros Of Friends And Family Financing
There can be many advantages of using friends and family financing first which makes sense outlining as part of the pros and cons of friends and family financing. Those include the following.
It’s The Easiest Money To Raise
Getting your friends and family to loan you a few bucks for a business should be the easiest money you can hope to get. You don’t need an award-winning PowerPoint presentation or a great credit score. There should be a sound business idea and reasonable anticipation of success as you prudently manage their money. Yet, it is mostly about them trusting and believing in you and wanting to help. If you can’t find anyone who fits this bill from your whole life so far, then other professional investors are going to certainly wonder why they should take the leap too.
Get The Best Financing Terms
Hopefully, your friends and family are reasonable and aren’t just loan sharks. Whether it is a debt or equity agreement, you should hope this will be the most attractive funding terms you can get.
Slack When You Need It
When you don’t pay your home mortgage or rent on time, you know your landlord or bank doesn’t care why. They are going to start the eviction or foreclosure process as fast as possible, and stack a lot of crippling fees on top.
Little goes exactly according to plan with a startup business. Hopefully, your friends and family will be the most understanding and lenient when there are periods of struggle or you miss projections. This can make all the difference in order to keep on going to break through to the good times.
Helping Them To Share In The Wins
You plan to have great success in this business. Why wouldn’t you want those you like and love the most to share in those victories? That can be both in terms of having an impact and great financial rewards.
You are doing them a service by enabling them to invest with you.
The Cons Of Friends And Family Financing
Obviously when outlining pros and cons of friends and family financing, there can be many advantages of using friends and family financing first, including the following.
Relationship Risk
Relationships and people are far more important and valuable than any amount of money. Unfortunately, money is one of the top causes of arguments in families and among friends too. If your venture fails or they don’t feel they are getting the rewards they expected, then it can ruin your friendships and family relationships.
Limited Capital
Unless your uncle is Jeff Bezos, then this circle of contacts probably offers access to a limited amount of money. Sooner or later you are going to need to tap other sources of funding.
Future Impact
Every round of financing can have ripple effects on the next. It can help or hurt. If you officially take your company into a lot of debt at high rates with family or give up big chunks of equity so early on, that can hamper future fundraising efforts. Think ahead.
What Else Are You Getting Besides The Money?
Savvy entrepreneurs know that money is the least value you get out of an investor relationship. The resources, support, advice, connections, and brand ambassadorship, and evangelism you get when you bring in an investor is far more important than the money. There may not be a lot of this value in your friends and family circle. Know what you are getting or giving up.
Hopefully, this post provided some light when it comes down to the pros and cons of friends and family financing. Below is also I video where I cover in detail how to raise startup capital.
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