F&F Investment Strategies: A Comprehensive Guide

Raising funds for a startup is a challenging task, and the first money you raise will likely come from friends and family (F&F) who believe in you and your idea. Approaching F&F for investment usually happens before angels or VCs would consider investing in your startup. It is important to note that F&F investment rules vary across countries and states, so due diligence on legalities is essential. When approaching F&F for investment, it is crucial to be ethical and transparent about the risks and fully explain the investment process, as they may not be familiar with it. You can help them understand the terminology, deal structures, and potential outcomes, both positive and negative.

Explain the risks and impact of failure

When seeking an F&F investment, it is crucial to understand and communicate the risks involved to potential investors, especially when they are friends and family. Here are some key risks and potential impacts of failure to consider:

Risk of Financial Loss

The first and most obvious risk is the possibility of financial loss. Early investors in a startup, such as friends and family, face a higher risk of losing their entire investment if the company fails. It is important to emphasize that this is not a loan that will be repaid but an investment with no guarantees. Ensure that potential investors are aware of this risk and can afford to lose the money they are investing.

Illiquidity of the Investment

Startup investments are typically illiquid, meaning that investors cannot easily sell their shares. Unlike mutual funds or stocks, where buying and selling are more flexible, startup investors usually have to wait for the company to go public, be acquired, or experience a similar liquidity event before they can exit their investment. This lock-up period can last for five to ten years, and investors should be aware that they won't have access to their funds during this time.

Dilution of Ownership

As the startup raises more funds and brings on new investors, the ownership stake of early investors will be diluted. It is important to explain this dynamic to friends and family, as it may seem counterintuitive to them. Emphasize that issuing options and taking on new investors is necessary to hire the best talent and fuel the company's growth.

Impact on Personal Relationships

When friends and family invest in your startup, there is a risk of damaging those relationships if things go wrong. It is crucial to be ethical and transparent when seeking investments from people close to you. Avoid painting an overly optimistic picture of the business, as this could lead to disappointment and strained relationships if the company underperforms. Ensure they fully understand the risks and potential outcomes.

Uncomfortable Family Gatherings

If friends and family invest in your startup and it fails, it could lead to uncomfortable conversations and dynamics at family gatherings. They may feel resentful or disappointed if they lose their investment, especially if they were not fully aware of the risks involved. Being transparent and ensuring they make an informed decision can help mitigate this risk.

Impact on Future Funding

If the startup fails to perform as expected, it could impact your ability to raise funds from other sources in the future. Friends and family who have invested and lost money may be less likely to invest in your future ventures. Additionally, their negative experience may deter other potential investors.

Understand the legalities of F&F investment

When it comes to understanding the legalities of F&F (friends and family) investment, it's important to recognise that regulations can vary depending on the country and state. Therefore, it is crucial to familiarise yourself with the specific laws and guidelines in your jurisdiction. Here are some key considerations to help you navigate the legal aspects of F&F investment:

• Accredited Investors vs. Non-Accredited Investors: In certain jurisdictions, friends and family members may be permitted to invest in your startup even if they are not accredited investors. However, it is essential to verify the rules in your specific region.
• Protecting Their Interests: Since your friends and family may not be well-versed in startup investing, it is your responsibility to help them understand the process and protect their interests. Provide them with educational resources, explain the terminology, and ensure they fully grasp the risks and potential outcomes of their investment.
• Ethical Considerations: When seeking investments from friends and family, always uphold the highest ethical standards. Avoid misleading them or presenting an overly optimistic picture of your business. Be transparent about the risks involved and ensure they fully appreciate the potential consequences of their investment.
• Investment Options: When individuals participate in an F&F round, they typically invest in one of four options: preferred stock, common stock, a convertible note, or a SAFE (Simple Agreement for Future Equity). It is important to understand the legal implications and requirements of each investment type.
• Legal Advice: Negotiating the terms of preferred stock can be complex and often requires legal assistance, which can be costly. On the other hand, SAFEs and convertible notes are more standardised and may help minimise the need for extensive legal advice, reducing time and expenses.
• Compliance and Regulations: Stay informed about any compliance requirements and regulations that may apply to F&F investments in your jurisdiction. Consult with legal professionals or experts in the field to ensure you are adhering to all necessary laws and guidelines.

Remember, the legal landscape of F&F investment can be intricate and subject to variation across different regions. Always seek the most up-to-date information and consider consulting with a legal professional to ensure you fully understand the legalities of F&F investment in your specific jurisdiction.

Help them understand the process

Help your friends and family understand the process of investing in your startup by creating educational resources that explain the terminology and the most common deal structures. This will ensure that they are informed about the risks and potential rewards of their investment.

Firstly, explain that this is not a loan that you will repay, but an investment. If your company succeeds, they will be able to sell their shares at a profit. However, if the company fails, they will lose their entire investment. Make sure that your friends and family can comfortably afford to lose the money they are investing.

Secondly, they need to understand that the investment is illiquid. Unlike other types of investments, they won't be able to buy and sell at will. Typically, nobody can sell their shares until the company goes public, is acquired by a public company, or is acquired for cash. This could mean that their investment is locked up for five to ten years.

Thirdly, explain how you will use their money. Show them how their investment will directly contribute to the growth of the business. Discuss the specific results and milestones you plan to achieve with their funds.

Finally, let them know that their ownership will shrink as you issue options and take on new investors. This is a good thing, as issuing options allows you to hire the best people and grow the company. Taking on new investors allows you to raise capital to accelerate growth.

Remember to maintain open communication with your friends and family throughout the process, and keep them updated on the progress of your startup.

Be ethical and transparent

When making an F&F investment, it is crucial to prioritize ethics and transparency to ensure positive outcomes for all involved. Here are some key considerations:

Understand the Risks and Be Transparent

Explain the risks and potential downsides of the investment to your friends and family clearly and concisely. Help them understand that this is not a personal loan that you will repay but an investment with potential financial risks. Be transparent about the possibility of losing their entire investment, especially if the company fails, as most startups do. Ensure they are aware that startup investments are typically illiquid, and they may not be able to sell their shares for five to ten years. It is essential to confirm that they are comfortable with the level of risk and can afford to lose the money invested.

Communicate the Investment's Purpose

Clearly articulate how you will use their money. Show them that their investment will directly contribute to the growth of your business. Discuss the specific results and milestones you plan to achieve with the funds they provide. This transparency will help them understand the impact of their investment and feel more connected to your venture.

Provide Regular Updates

Don't forget to keep your friends and family informed once they have invested. Send them regular updates on the business's progress, including important milestones and achievements. Remember that they want to see you succeed, and witnessing your growth and success is one of the most rewarding aspects of early-stage investing for them.

Avoid Painting an Unrealistic Picture

While it's essential to be enthusiastic about your venture, avoid painting an overly optimistic or unrealistic picture of your business. Doing so could lead to uncomfortable situations and potentially damage your relationships. Be honest and transparent about the opportunities and challenges you face.

Help Them Understand the Process

Recognize that your friends and family may not know much about investing in startups. Take the time to educate them about the process, protect their interests, and help them make informed decisions. You can create informative materials or share resources that explain startup investing, common terminology, and deal structures.

Prioritize Ethical Practices

In addition to financial considerations, evaluate prospective investments through an ethical lens. Assess whether the company's actions align with its stated commitment to ethics. Examine its environmental, social, and governance (ESG) practices, including its impact on the environment, its approach to social issues, and the transparency of its accounting methods.

Keep them informed

Communication is key when it comes to keeping your friends and family informed about your startup investment. Here are some essential steps to ensure they are well-informed throughout the process:

Explain the Investment Process:

Clearly explain the process of investing in your startup. Help them understand the terminology, the different investment options, and the potential risks and rewards. Remember, they might not have experience in investing, so make sure to answer their questions and address any concerns they may have.

Set Clear Expectations:

Be transparent about the potential outcomes of their investment. Explain that this is not a loan that you will repay, but an investment with potential financial gains or losses. Emphasize that startup investments are illiquid, and they may need to hold their shares for several years before they can sell them.

Share Your Business Plan:

Show your friends and family how their money will be used. Explain how their investment will contribute directly to the growth of your business. Share your short-term and long-term goals, as well as the specific milestones you plan to achieve with their funds.

Provide Regular Updates:

Don't forget to keep your investors informed once they have made their investment. Send them regular updates on your business's progress, including important milestones, achievements, and any challenges you may be facing. Let them share in your successes and be a part of your entrepreneurial journey.

Discuss Ownership Dilution:

Explain that their ownership percentage may decrease over time as you issue options and bring in new investors. While this may seem counterintuitive, emphasize that it is a positive step to grow the company and that you firmly believe the resulting growth will outweigh the dilution.

Remember, keeping your friends and family informed and engaged throughout the investment process is crucial for maintaining strong relationships and ensuring they feel valued as investors.

Frequently asked questions