Creating A Friends & Family Investment Fund: Getting Started

Raising funds for a startup is one of the biggest challenges for new businesses. Friends and family funding is a common first step in startup fundraising, especially for early-stage ventures. This type of funding is a form of crowdfunding, where small amounts of money are collected from several family members or close friends, to raise a larger overall sum. This approach has several advantages, such as the ease of raising funds and the flexibility it offers. However, it is important to carefully consider the potential risks and disadvantages, such as the impact on personal relationships if the business fails. To mitigate these risks, it is crucial to have clear communication, realistic expectations, and proper documentation in place. This includes creating a detailed business plan, understanding the different types of funding, and seeking legal advice to structure the investment appropriately.

Understanding the types of funding

• Loans: This is a common type of funding where friends and family lend you money with the expectation of repayment over time, possibly with interest. This type of funding is similar to a traditional loan but often comes with more flexible terms and lower interest rates. It's important to clearly outline the repayment terms and put them in writing to avoid disputes later on.
• Equity Funding: With equity funding, you offer your friends and family a share of ownership in your business in exchange for their financial support. This means they become stakeholders and may have a say in business decisions. Equity funding can be a strategic option, as the amount you owe investors is tied to the future value of your business. However, it's crucial to carefully consider how much equity you give away to maintain control and meet future fundraising needs.
• Gifts: In some cases, friends and family may choose to support your venture by giving a gift, which does not need to be repaid and for which they receive no compensation. This type of funding is less common and may be more applicable when the amounts involved are smaller.
• Interest-free loans: Friends and family may be willing to lend you money without expecting any interest or financial reward. This type of funding is based on their desire to see you succeed and their belief in your venture. However, it's still important to clearly communicate and document the terms to avoid misunderstandings.
• Convertible Notes and Preferred Stocks: These are more complex instruments that can be used in structuring friends and family investments. Convertible notes, for example, may allow your investors to convert their investment into equity at a later date. Preferred stocks may give them priority in terms of dividends or liquidation proceeds. These options provide flexibility but require careful structuring and understanding of their implications.

When seeking funding from friends and family, it's essential to consider the potential risks and benefits of each funding type. Consult with a lawyer who specializes in business or startups to ensure that the chosen funding structure aligns with your goals and protects all parties involved.

Pitching to the right people

When pitching your business idea to friends and family, it's important to be mindful of the different dynamics at play compared to pitching to professional investors. Here are some tips to help you pitch to the right people effectively:

Understand Their Motivations:

Friends and family invest primarily because they want to see you succeed and are often more interested in helping you achieve your dreams than seeking a substantial financial return. They may be more willing to take a risk on your idea because of their belief in you. Keep this in mind when crafting your pitch, and emphasise your passion and commitment to making your venture a success.

Start with Trusted Loved Ones:

Consider starting your pitching process with those closest to you, such as immediate family members. They are more likely to be supportive of your idea and will probably be more forgiving of any initial mistakes or nerves. As you gain confidence and refine your pitch, you can then branch out to close friends, former classmates, colleagues, and mentors.

Be Clear About the Risks:

Mixing money and personal relationships can be tricky, especially if things don't go as planned. Be transparent about the risks involved and ensure that your potential investors understand the possibility of losing their entire investment. Emphasise that they should only invest an amount they can afford to lose. This honesty will help set clear expectations and protect your relationships.

Tailor Your Pitch:

Consider the background and relationship of each person you're pitching to. A close relative might prefer a face-to-face conversation, while a former colleague may be happy to receive an email. Keep technical details to a minimum for those unfamiliar with business and startups, focusing instead on the opportunity, timelines, and milestones. For savier investors, provide a more detailed plan with specific metrics and profit margins.

Set a Communication Schedule:

Once you've secured investments, manage expectations by setting a clear communication schedule. Let your investors know that they will receive periodic updates, perhaps monthly or quarterly, to keep them informed about the business's progress. This helps maintain a professional relationship and fosters a sense of team spirit as they cheer on your successes.

Creating a business plan

Determine the Length of the Plan

The further out the plan forecasts, the more unreliable it becomes. It is recommended to focus on the next six months and be conservative about expenses and revenue. It is always better to undersell an idea to investors, especially when they are friends and family.

Detail Your Funding Requirements and Sources

Be clear about how much money you need and how you plan to use the funds. Specify the exact reasons you need the funding, such as purchasing inventory, assets, or financing early-stage employees. This will help your friends and family understand the purpose of their investment and ensure that you are requesting an appropriate amount.

Outline the Repayment Period and Terms

Explain the repayment period and how long you expect to make the payments. If you are offering interest, specify the rates and the number of shares or profits that investors will receive. Clarify whether the business investors will have any financial liabilities. It is important to be transparent about the risks and ensure that your loved ones understand the possibility of zero-dollar returns.

Choose the Type of Funding

There are typically three ways that friends and family can invest in your company:

• Loans: This type of investment will be repaid over time and may include interest. It is important to have a clear repayment plan and put the terms in writing to avoid disputes.
• Gifts: This investment does not need to be paid back, and the individual giving the gift does not receive compensation. However, it is still important to put a formal agreement in place to avoid misunderstandings later on.
• Equity: In exchange for investment, a piece of the company is given as compensation, and the investor becomes a business partner. This option requires careful consideration as you will be giving up some control of your company. It is important to involve a lawyer and sign a formal agreement.

Create a Pitch Deck

While friends and family funding is often less formal, it is still important to create a pitch deck that outlines your business idea, team, financial projections, and milestones. Practice your pitch and be prepared to answer any questions they may have. Start with close family members and then branch out to close friends and other connections.

Seek Legal Advice

Consult a lawyer who specializes in business or startups to review your business plan and investment agreements. This will help protect both you and your investors and ensure that all necessary documentation is in place.

Remember, when creating your business plan, focus on communicating your passion, ideas, and defined goals. Be transparent about the risks and keep your loved ones updated on your progress.

Setting terms and conditions

Types of Funding

Firstly, it is important to understand the different types of funding that can be offered by friends and family. The three main types are loans, gifts, and equity investments. Loans involve a planned repayment, which may include interest. Gifts do not need to be repaid and the giver does not receive compensation. Equity investments involve giving away a piece of the company in exchange for funding, making the investor a business partner. Each type of funding has different legal implications and requirements, so it is important to understand the specifics of each.

Communication and Documentation

Clear and transparent communication with potential investors is essential. Be honest and upfront about the risks involved, including the possibility of zero returns. Provide periodic updates on the business's progress and be responsive to investor inquiries. Properly document all transactions and agreements to avoid future disputes.

Repayment Terms and Contracts

It is crucial to have written repayment terms and contracts in place, even when dealing with friends and family. These agreements should outline the repayment schedule, interest rates (if applicable), and any other relevant terms. This helps to protect both parties and provides a course of action in case of disputes or unexpected events, such as financial difficulties or unexpected profits.

Professionalism and Boundaries

While friends and family funding can be informal, it is important to maintain a level of professionalism. Treat your friends and family investors with the same respect and transparency you would give to professional investors. Set clear boundaries to separate business matters from personal relationships. Be mindful that the dynamics of the relationship may change once money is involved.

Legal and Tax Considerations

Consulting with a lawyer who specializes in business or startup law is highly recommended. They can help you navigate the legal complexities, ensure compliance with regulations, and protect the interests of both parties. Additionally, consider the tax implications of the investment and seek appropriate advice to avoid future issues.

Investor Selection

Be thoughtful and strategic about who you approach for funding within your personal network. Look for individuals with solid business skills and a good understanding of the risks and benefits involved. Choose investors who believe in your vision and have faith in your ability to succeed. Maintaining relationships and managing expectations can be easier with investors who truly want to see you succeed.

Managing expectations

Communication

Once you have secured funding from friends and family, it is important to manage their expectations. Be clear with investors about what they can expect from you in terms of periodic updates and keep them posted on the progress of the business. It is a good idea to set a clear communication schedule, such as monthly or quarterly updates, to ensure that everyone is on the same page. This will also help to foster a team spirit and keep your investors cheering for your success.

Risks

It is your responsibility to be candid about the risks involved in investing in your company. Make sure your investors are aware that there is a possibility of zero returns. Pick the right fundraising strategy and ensure that any transactions are properly documented. Consider creating different pitches for different investors, depending on their level of familiarity with business and startups. For example, a close relative might appreciate a face-to-face conversation, while a former colleague might prefer an email.

Overstepping

Be prepared for the possibility that some investors may overstep and feel that their investment gives them a say in business matters. Others may pester you with calls seeking updates or trying to interfere with business decisions. To avoid this, make sure to set clear boundaries and communicate that while their input is valued, you are the one running the business.

Professionalism

Approach the process of seeking funding from friends and family with professionalism. This will help to reduce the risk of damaging your relationships if the business does not succeed. Treat your friends and family as you would any other investor, with clear terms and conditions, and put everything in writing to avoid disputes later on.

Future Investments

While it can be tempting to rely on friends and family for funding, especially in the early stages of your business, it is important to force your business into the discipline of professional investors. Too many cash infusions from friends and family can make your cap table unwieldy and may turn off future investors. Instead, focus on maturing your business toward traditional financing options.

Frequently asked questions