What we're talking about
Though most founders bootstrap their businesses, there often comes a time when an injection of cash is needed. One option is to reach out to the people who know you best. Fundraising through friends and family typically comes very early on, before you reach out to external investors and carry out seed rounds (the first official equity-funding stage). You might not yet have a fully formed product or anything on the market – people are investing in you as much as your idea.
In return for cash, you might offer people equity (shares in the company), to pay them back via a loan (with or without interest). Or, in very rare cases, it might simply be a gift (albeit a formalized one). The amount raised using this route typically ranges from $10,000 to $150,000.
Why it's important
First, this route can be quick and relatively easy compared with other financing options – and plenty of businesses depend on it. One study found that 22% of business owners relied on capital from friends and family when starting out; a separate survey showed that 86% of business owners obtained all the money they asked for from their loved ones. Compared with the rigorous process and subsequent demands external institutions will have, the terms you'll manage to secure with people you know should, in theory, be a lot more accommodating. It also gives you the chance to build up a proactive community of people to rally behind your idea.
But convincing people your business is worth funding is just the beginning – the most critical part is what happens afterwards, where complications can easily arise. That could be down to the influence investors might seek to have on your strategy, or simply the risks to your personal relationships when money is on the line – and there's no guarantee you'll be able to pay them back. Investor education is sometimes required, as not everyone is aware that investing capital carries risks.
Things to note
It's much harder for some than others. It obviously isn't a given whether you can raise money from friends and family. Disparity in early access to capital is one of the major factors that makes entrepreneurship an unequal space. For example, 75% of founders have a degree and are, therefore, likely to come from advantaged socio-economic backgrounds. But efforts are being made to institutionalize the friends-and-family round. If you don't think you'll be able to get what you need from your network, you can organize your pre-seed round differently. Joining a business accelerator – particularly one that aims to widen access to funding, like YSYS – is one option. Another is grant funding or working with an angel investor.
Do what you can with what you've got. Before you think about raising capital from others, it's essential to get your business into the best possible shape independently. This could be without spending at all, funding the business yourself or taking out a personal loan. Bootstrapping proves value and that your business model is sustainable.
Don't dilute. On the other side of the spectrum, there's a risk that a family-and-friends round will bring offers of too much money from too many people. It sounds like a nice problem to have, but multiple loans can result in serious complications paying it back. Plus, giving out too much equity is a major problem – it might make your business less attractive to investors further down the line. That's why it's important to establish a cap on the amount of ownership you're willing to give up – remember, you may well carry out future fundraising rounds. Here's a helpful thread on how much to offer.
Be clear, communicative and professional. Although it might feel natural to keep things informal, close connections are at stake and you don't want to build resentment. While some aspects can be more chilled out, you definitely need to work with a lawyer on the correct term sheets and repayment terms – even if it's a gift. Conversations with your investors don't stop there, though. You should provide regular updates, ideally via a monthly newsletter, and keep them informed about key wins, key metrics and any potential problems. Your early investors are a super useful tool – don't underestimate the network you might be able to tap into to tackle issues.
How to approach raising money from friends and family
1. Decide how much you need. Establish what you need to take the business to the next level in the next 12 months. A finance professional can help you here, and you need to do your homework. Get the relevant quotes or estimates for your costs (whether for new hires, workspace, product development or anything else) or decide whether it's about supporting your cash flow.
2. Confirm the type of financing that's right for your business. There are two main types of friends and family financing: equity funding and a loan. Equity funding, when you offer up a portion of your business, might work if you're looking to scale quickly and need the expertise and influence of particularly business-savvy people. A loan might be suitable if you'll soon be generating revenue but need some cash to get started. Decide whether you want to get large sums from a few people, or small sums from several.
3. Construct your pitch. This doesn't need to be as polished as it would be for venture capitalists, but you should have something to present for the sake of clarity and credibility and to show you’re serious. Three documents are useful: a high-level executive summary to open up the conversation; a pitch to discuss the opportunity; and a follow-up PDF with a specific capital amount and a call to action. Sending samples or prototypes can also make a big difference.
4. Create a wide pool. It's likely that you'll need to cast your net pretty wide – it's worth remembering that even if individuals aren't interested in investing themselves, they might be able to introduce you to people who might be. Think about how you can tailor your pitch to the different people you contact. Some people will be content to read through a document; others will react better to being taken out for a meal. Some might want to go through your finances closely; others might want to see an interest in social impact.
5. Make contact. When everything's prepared, get in touch. You can be direct in your approach, or simply get a sense of their interest by asking for feedback and taking them on your journey with you – a ‘no’ now doesn't mean ‘no’ forever, and they might also become customers. Always ask if they know anyone else who might be interested.
6. Keep track. Make sure you have a place where you track how all your conversations are going – it can be as simple as an Excel spreadsheet.
7. Have some honest conversations. Following your pitch, you'll probably have a fair few reservations and questions to answer. Try to address these face to face, backed up with evidence. Reiterate the challenges, risks and opportunities, and reassure them that your relationship comes first. Now's the time to also reassess the suitability of each candidate. How comfortable do you feel borrowing money from them? Can they afford to take the financial hit?
8. Negotiate. You may well need to find an agreement with whoever is interested in investing their cash. Due to the nature of your relationship, it can help to have a third party support you here – whether that's a small business lawyer or even a mutual friend – so that emotions don't cloud your judgment.
9. Formalize everything. If both parties are happy, make sure that everyone agrees on what the following years will entail and that you tick any necessary legal boxes by involving some professional help. This is where you get clear on details like repayment terms, allocation of shares and input and how the money will be provided.
10. Keep in touch. Devise and stick to a regular communications plan, offering updates at least quarterly. If someone's decided to invest in your business, it's essential that they're taken on the journey with you.
• Though at first glance it seems an easier route than many other fundraising options, you'll need to decide if your personal relationships can withstand the potential risks involved.
• The main options available include taking out loans, offering up equity in your business or gifts. Your business model and personal preferences will dictate what's right for you.
• Aspects of a friends-and-family round can be informal, but maintaining professionalism is key. Get everything down in writing and communicate frequently to mitigate any serious problems – and make the most of their guidance and broader network.
Perspective. Speaking for a US audience, but with plenty of general pointers, lawyer Yev Muchnik gives an overview of how to comply with the law in your friends-and-family round.
Example. Via developer publication Hackernoon, Lauren Sturdivant (CEO of Case Status, a messaging app for lawyers) talks through how she went about her friends-and-family round. For business development service Virgin Startup, Prashant Lagisetti (founder of social network Localoids) and James Royall (founder of electric cycle brand Propellor Bikes) explain how they did it.
Tool. Check out the templates on presentation design website Pitch if you want your pitch deck to look slick.
A version of this article was published in the Courier Workshop newsletter. For more deep dives into essential business concepts, sign up here.