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Navigating the Financial Waters of a Friends and Family Funding Round

Posted by Melissa Hollis to Investment, Business Advice, Business, Funding

Asking friends and family for money to fund your business

Early in his company’s history, entrepreneur Greg Vetter achieved a seemingly impossible feat: he convinced Whole Foods to distribute his family’s line of salad dressings on a national level.

Although the green light from Whole Foods provided an incredible opportunity, Greg knew it meant he needed capital—fast. So, he liquidated his and his wife’s 401(k)s, maxed out his credit cards, and even used his parents’ home as collateral to secure a bank loan. Then, he raised an additional $1 million from about 30 friends and family members.

Greg’s decision-making and salesmanship paid off. These days, thousands of stores nationwide stock Tessemae’s All Natural salad dressings and marinades, and the company’s annual sales exceed $25 million. The Tessemae’s story isn’t just about the runaway success of Tesse’s homegrown recipe, but the powerful impact friends and family can have on a fledgling business.

 

But not every family gets along like the Brady Bunch...

If you’re a business owner or Shark Tank enthusiast, you may have heard stories similar to Greg’s and thought, “easier said than done.” Yes, contributions from friends, family, and co-workers may constitute more than 40% of startup funding; but taken on a case-by-case basis, this kind of arrangement is hardly a stress-free loan.

Are you ready for your next round of funding? Download your guide to fundraising now.

Not all of us are in the same position as Greg—able to take a chance with tens and hundreds of dollars furnished by friends and family. Personal relationship dynamics are complex and, for a multitude of reasons, you may not want a sibling, parent, spouse, or best friend involved in your company if they aren’t already. Plus, by accepting investment from loved ones, you risk jeopardizing those crucial relationships if your business fails or plans fall through.

 

In The Startup Founder’s Guide to Fundraising, Justin DiPietro, Co-Founder and COO at SaleMove, who came from a long line of entrepreneurs, expressed his concerns about seeking investment from family and friends “I would rather not take friends and family money. It would add a massive amount of personal awkwardness and stress.”

 

Still, compared to a bank, venture capital group, or crowdfunding campaign, friend and family financing is frequently a safer bet. For startups in need of seed funding, a “friends and family round” is perhaps the best place to start.

 

Proceed with Caution: Advice for Asking Friends and Family to Fund Your Startup

Asking friends and family for money to fund your startup is tricky

When Pitching to Personal Connections, Choose a Selective Group

While you may want to, don’t try to sell your business to everyone you know. A shotgun approach to pitching can backfire, making you appear disorganized, overzealous, and self-serving. Moreover, you almost certainly don’t want every friend and family member involved, offering management advice, miscalculating risks, and breathing down your neck for reimbursement. As the U.S. Small Business Administration recommends—and we strongly agree—it’s best to focus only on potential investors with proven financial sense and who have demonstrated a realistic view of your business plan.

 

Be Considerate About the Message and the Medium

First and foremost, write down your business plan and practice your pitch. Next, wait for the right moment. You may need to warm up the person or people you’re hoping to borrow from over the course of weeks or months before you launch into a request for money: tell them about your company or idea, give them regular updates, and ask for their input. Doing so helps others know your business is more than a fantasy, that you’re concerned with its long-term success, and that you value their opinions.

 

How and when you decide to approach friends and family with a business offer matters as much as the substance of your proposal. Consider the difference between a text exchange and a conversation over dinner: In which context are you more likely to say “yes” to a request for several thousand dollars?

 

Come Prepared to Be Extremely Clear About What You Need

Whenever possible, have a precise number in mind when seeking capital from friends and family. If you truly can’t calculate what you need, it’s better to err on the side of asking for too much. Too little amounts to nothing but a sunk investment when your business can’t get off the ground. Think about whether you require the entire investment up front, or if an installment plan would meet your needs, as this sort of deal can help you hedge your bets and set the stage for a repayment structure that feels fairer to your investor.

 

Know What They Want in Return and When They Want It

When do your friends and family hope to be repaid, and with how much interest? What happens if you can’t pay them back? Think about contingencies before making a formal request, and you’ll be able to alleviate your investors’ fears. Second, consider how you can add value to the offer: ownership shares, complimentary services, discounts, and even free swag can all incentivize a potential investor.

 

Some friends and family members may be shrewd enough to ask for equity while others would be more than satisfied to have a product named in their honor or simply thanked on your website.

 

Always Remain Professional

Keep a good record of all investments and financial interactions with friends and family members, and make sure to give copies of these documents to the other parties. Pay your friends and family members back promptly and answer their questions thoroughly and honestly.

 

If a personal acquaintance becomes involved in your business, treat them the same as you would others in their position. But take it from us and keep your business and personal interactions as separate as you can, as to not endanger your authentic relationships.

 

That is, be yourself. Remember that professionalism is a matter of respect, not formality. As long as you respect your business, your friends and family members—and yourself—you’re golden.

 

Cover Your Bases and Theirs

Putting in a little extra effort to dot your I's and cross your T's goes a long way when fostering a healthy professional relationship on top of a personal one. A few basic best practices can ensure everyone feels comfortable putting and keeping their skin in the game:

1. Put together a term sheet (yes—even if it's just for family and friends):

While so much of your relationship may be built on blood being thicker than water or a friendship as thick as thieves, trust is always better when it's on paper. Your term sheet is a documented agreement used to outline your investment terms and conditions. This dictates the investment type, interest rates, and agreed-upon company valuation.

 

2. Organize Your Finances:

Show your connections that you're not just an awesome friend or family member, but you're also an outstanding business leader. Having the relevant financial reports and accounting policies in place based on your growth stage will speak volumes to the fact that you mean business. It also gives them good context for how much they'd want to invest and what advice they may have about budgeting and prioritization.

Don't be surprised if they get vocal—these conversations are a perfect opportunity to hone your skills for even tougher discussions with angel investors and VCs in the future.

 

3. If Necessary, Hire a Legal Professional:

Sometimes, however, through no fault of your own, relationships turn sour. That’s why it helps to have access to specialized advisors such as accountants and attorneys. I’m not recommending you hire a lawyer for the sole purpose of arbitrating a potential dispute with a loved one down the road, but legal and financial professionals can save you from disaster. They will help you navigate disagreements and difficulties, keep investments legally sound and tax-efficient, negotiate the details of a repayment agreement, and give your investors overall peace of mind.

Are you ready for your next round of funding? Download your guide to fundraising now.

Sources:

https://www.sba.gov/blogs/6-tips-borrowing-startup-funds-friends-or-family

http://hbswk.hbs.edu/item/when-founders-recruit-friends-and-family-as-investors

http://guides.wsj.com/small-business/funding/how-to-borrow-from-family-and-friends/

http://articles.bplans.com/how-to-ask-friends-and-family-to-fund-your-business/

http://women2.com/2014/06/25/6-secrets-raising-friends-family-round-funding/

http://www.entrepreneur.com/article/219693

http://www.nolo.com/legal-encyclopedia/private-loans-investments-raising-money-29499.html

About the author
“Melissa

Melissa Hollis

Melissa Hollis is a content marketer and lover of all things West Coast. She enjoys waking up every day and getting the chance to rethink the obvious and enable the dreams of aspiring entrepreneurs.


Disclaimer: The inDinero blog provides general information about tax, accounting, and business-related topics. It is not intended to provide professional advice. Read more in our Terms of Use.

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