Raising Money from Friends and Family For Your Start-up Company
Raising capital from close personal contacts often sustains the life of an early stage
business. There are many advantages as well as risks to this strategy. In addition there
are a variety of legal implications and procedures that must be considered.
Easier to Raise Capital – the money that an entrepreneur raises from their friends and
family is often the easiest round of financing to close. The trust factor has already been
established and the financers are typically lending more based on that relationship of
trust, rather than a thorough analysis of the business opportunity.
Faster Time to Close – One of the more challenging parts of raising capital is the time
aspect. For the most part, no matter how long an entrepreneur expects its going to take,
it will take longer, often much longer. Investors take a great deal of time on due diligence
and will sometime delay the funding process to have more leverage in the negotiations.
By contrast, the friends and family round is typically the fasted round of financing for the
entrepreneur to close.
Best Terms – an integral part of any round of financing is the term sheet. Investors will
negotiate the valuation of the company as well as the right and privileges of their stock.
At times the interests of the entrepreneur and the investors may not be aligned and there
may be a stalemate in the fundraising process. Issues relating to the terms typically are
less prevalent in the friends and family round. The entrepreneur can keep a larger
percentage of his/her company and they don’t usually have to make as many concessions.
Leverage for Future Rounds – subsequent investors (angel and VC) often want to see that
the entrepreneur has some “skin in the game”. Namely, that they have risked their own
resources of time and capital into the venture. Investors are more secure in putting capital
into a company where the entrepreneur as co-invested a substantial amount. Other ways
entrepreneurs demonstrate this is by raising capital from their friends and family. Outside
investors may be more likely to invest in a business where the entrepreneur has raised
money from those sources first, because they know the entrepreneurs won’t want to loose
the money of all their closet relatives.
Pressure & Harm – along with the benefits there are some unique risks. Raising money
from friends and family usually has more pressure associated with it than outside investors.
Whereas, professional investors understand the risks and perhaps have the capital to
spare, entrepreneurs have a much heavier weight associated with taking capital from their
loved ones. Sometimes this is an important variable that drives the founders towards
success. But the pressure to keep the capital investment secure can often cause harm to
personal relationships. In addition, to protecting the investment, arguments can also rise
when money is made and it was unclear how the profits or windfalls were supposed to be
spilt.