How the Friends and Family Funding Round Works
Is it ever okay to ask friends for money? What about family?
If you’re an entrepreneur, there may come a time when you need support from the people who love and believe in you the most, but as the fundraising numbers you need get bigger, it can become harder to do.
Read our Startup Compensation Guide for more information on funding your startup.
For some startup founders, it makes sense to turn to their closest friends and family for capital as an alternative to seeking a loan, opening a new line of credit, or asking accredited investors. When these funding sources aren’t willing to risk their money on early-stage ideas, the people who are closest to you are more likely to take the chance with good faith – but there’s still risk involved.
As an entrepreneur, the worst thing in the world would be for me to profit from a startup before my friends and family could get repaid in full if things don’t work out with the business. As a moral personal value, I always recommend that founders offer shares to friends and family at a 1x liquidation preference, which ensures these investors get their money back before the founder gets their share.
If you’re curious about the ins and outs of the family and friends funding round and how it may benefit your business, here’s what to know:
What Is a Friends and Family Funding Round?
A friends and family funding round is when a start-up company raises money from their personal networks, as opposed to professional investors. This type of funding is usually less formal than other types of rounds, and the terms are often more flexible.
This type of funding can be a good option for companies that are just getting started and may not have a lot of credibility with professional investors. Friends and family members are often more likely to invest in a company and founder they know and believe in, even if the potential return on investment is lower.
What are the Benefits of Doing A Friends & Family Investment Round?
There are several benefits of starting with a friends and family investment round:
- You can get money quickly without the traditional investment and due diligence process.
- You can avoid giving up too much equity in your company so you have greater control as you scale.
- You can build relationships with potential investors who may be interested in investing later on.
- It ensures a strong network of support as you get started.
- It’s an opportunity to raise funds in the earliest stages of a startup when other investment sources aren’t willing to provide capital.
What Makes for a Successful Friends & Family Funding Round?
To have a successful friends and family funding round, keep these tips in mind as you approach it:
- Don’t only consider friends and family. You can also consider friends-of-friends and more. Don’t be afraid to talk to people. I got funding by asking for advice – not money. Remember that.
- Make sure you have a clear pitch that showcases your company and what you’re trying to achieve.
- Screen potential investors carefully and make sure they believe in your company.
- Have a solid business plan that shows how you will use the funds to grow your company.
- Be clear about the risk involved in investing in your company at such an early stage.
- Be prepared to offer a reasonable return on investment to your investors if they ask.
- Don’t let them feel pressured into investing. If they do invest, you want it to be of their own volition and not because they think they have to. Tell them you would appreciate their support in any way, whether financial or otherwise.
- Carefully document each investment, even though it may be tempting to forego these steps due to the intimacy of the relationship.
- Keep in touch with your investors and let them know how your company is doing.
- Thank them for their support! If they feel valued for their investment then they are more likely to invest again in the future.
Getting Started With a Friends and Family Round
For many startup founders, a friends and family round is their first real fundraising effort. Beyond using money from their own accounts, friends and family capital can be the additional funding needed to make initial progress and attract later investors.
How the Process Works
If you’re considering raising money from friends and family, here’s an overview of how the process typically works:
- Figure out the kind of deal you’re seeking. Do you want to give up equity in your company? Are you looking for a loan? A gift? What are the terms?
- Create a detailed business plan. This will help you communicate your vision to potential investors and make them feel confident in your ability to execute. Include information about your company, target market, competitive landscape, business model, and how you plan to use the funds raised.
- Make a list of friends and family who may potentially want to invest. Be realistic. You don’t want to put undue pressure on relationships by asking for money from someone who’s not in the right financial place to do so.
- Reach out to a select group of people and gauge their interest in investing.
- Hold a formal pitch meeting. You may decide to do this all at once in a group setting or hold separate meetings with your potential investors. You don’t necessarily need to negotiate in the initial pitch meeting. You can keep it informational to avoid putting any pressure on your family and friends.
- Follow up after the pitch and see who is interested in investing.
- Choose your investors and finalize the terms of the agreement.
- Put everything in writing with formal documents. For a debt arrangement, use a well-written promissory note. For equity investments, use a subscription (purchase) agreement and a buy-sell agreement. For gifts, make note of that and have them sign it for your records.
Preparing for a Friends and Family Round
If you’re considering raising money from friends and family, there are a few things you should do to prepare:
First, understand the various funding types. There are three common types of funding: loans, gifts, and equity. Loans are the simplest form of funding – the investor gives you money and you agree to pay it back with interest. Gifts are just that – gifts with no expectation of repayment. Equity investors become part-owners of your company and receive a percentage of ownership in exchange for their investment.
Second, know how much money you need and what it will be used for. This will help you determine what type of funding to seek and what terms to offer.
You also want to get your finances in order before creating your business plan so you can show your excellent business leadership through the numbers.
Next, create the business plan. As mentioned earlier, this will help you communicate your vision to potential investors and make them feel confident in your ability to execute. You can find business plan templates online to get started.
Finally, consider hiring a lawyer. This is especially important if you’re raising money from friends and family because you’ll want the legal documents in order.
The Best Way To Approach A Friends And Family Investment
It’s important to approach the situation carefully when fundraising from friends and family. You don’t want to strain your relationships by asking for money.
Here are a few tips for approaching a friends and family investment.
Choose a Selective Group:
While you may be tempted, don’t try to pitch your company to everyone you know. A shotgun approach to selling can backfire, making you appear self-serving and frenzied. You also simply don’t want every friend and family member meddling in the process, offering unsolicited advice, or impatiently awaiting repayment.
It’s best to target only potential investors with solid financial judgment and who have shown a realistic perspective of your business plan.
Consider the Medium and the Message
The timing and approach you use with friends and family are just as important as the substance of the offer. Consider how a text message presents differently from a dinner conversation. In which situation would you be more likely to agree to make a sizable investment?
Come Prepared to Share Details
Have a specific number in mind that you’re looking to raise. Friends and family are more likely to invest if they know the parameters of the deal so they’re not investing blindly. If you’re not sure, an overestimate is better than an underestimate. Also, consider when you would like the payment – upfront or as an installment plan?
Know What They Want
Just as much as you should know what you want and need from the deal, you should also know what your potential investors will want from it.
What is their expected return on investment (ROI)? Are they looking for a percentage of ownership in the company? When do they expect to see a return on their investment?
The more you can answer these questions, the smoother the negotiation process will be.
Don’t forget that you’re negotiating with people you know and love. That doesn’t mean you should be less assertive, but be mindful of the delicate balance between being an innovative entrepreneur and a pushy relative. Find a good moral code and stick with it.
Maintain your professionalism both in the way you speak and the way you manage your investments. Keep good records and pay them back on time.
The Power and Potential of the Friends and Family Funding Round
There are a few things to keep in mind when pursuing friends and family funding, such as staying professional, being realistic and specific about what you’re asking for, and selecting the right audience. If done correctly, the friends and family funding round can be a powerful tool to raise the initial capital you need.
A friends and family funding round is often the first capital a startup receives. Using these funds, your startup can start to develop a prototype and generate traction that can be used later to attract capital from other sources, like angel investors.
If you’ve completed a successful friends and family funding round and are looking for further investments for your revolutionary tech startup, reach out to angel investor Steve MacDonald of MacDonald Ventures.