Friends and family remain the best shot that many entrepreneurs have to raise outside money to launch a business.
In 2010, 5% of U.S. adults polled said they had provided funding to someone starting a business in the past three years, according to a survey by the Global Entrepreneurship Monitor, a research consortium which includes Babson College. Of those respondents, 32% said the funding went to a friend or neighbor, 26% to a close family member, 11% to some other relative and 8% to a work colleague.
While preserving important personal relationships with people who fund your business can be a daunting prospect, clearly some entrepreneurs have figured it out. If you're thinking about asking friends and family for seed money, here are five tips for doing it right.
1. Choose a strategy.
Do you want to solicit large chunks of money from a few investors, or small amounts from many?
There's less pressure associated with small sums. "You're less likely to ruin a relationship over $25," says Cornelius McNab, founder of Atlanta-based 40billion.com, which facilitates friends-and-family loans and gifts. Most of the site's fundraisers target a few dozen people for sums between $100 and $500 apiece.
But typically only 10% to 20% percent people asked will contribute. So if you want to raise, say, $5,000 at $100 per backer, you'll need to woo 50 people. This means reaching out to 250 to 500 people.
Contacting a smaller, more targeted group for larger sums may require more gumption and planning upfront, it could be easier for the time-strapped.
San Francisco entrepreneur James Lee raised more than $1 million from friends and relatives in 2008 for his venture sale.com. He sat down to casual meetings, often over coffee, with 15 people and persuaded 10.
2. Choose an investment type.
When you accept money from others, strings will be attached, no matter how you structure the transaction.
Consider whether you want to accept and pay back loans, have your friends and family own an equity stake, or offer up a token of thanks -- say, some amount of free access to your product or service in exchange for a gift.
If you take on investors, you may have to give up a portion of your company, and perhaps make one or more board members. Even friends and family will want a return, which can mean eventually selling the company, buying back shares or paying dividends.
Loans have to be paid back on schedule, which can have an impact on cash flow and profitability. If you go the microfunding route, you could be juggling 50 of them.
Even gifts aren't free of strings. If you do accept them, thank the giver profusely in writing and acknowledge that the money is a gift rather than an investment or promissory note, says Denise Beeson, who teaches small-business management at Santa Rosa Junior College in California. "Just think if you gave Bill Gates some start-up funds. Would you want, after the fact, a return on your money? You bet," she says.
3. Write down your pitch.
Unless your friends and family are professional investors, they probably don't want to read a 50-page business plan. More likely, they'll prefer to sit down with you over coffee and hear you explain your idea, as Lee did.
Lee says that because his backers were people who knew him well and "were essentially investing in me," they didn't require a business plan.
To avoid being too informal, McNab suggests drawing up a five- to 10-page document that sums up what you want to do, how you'll do it and what you'll apply the money toward. Such a summary ensures you've made important disclosures, such as the key challenges, risks and competition the business faces, and that your backers understand what their money is going toward.
4. Keep your documents and communications business-like.
When you're dealing with people you know well, it's easy to want to keep agreements informal out of concern that official documents might make things feel less friendly. But don't be too casual.
If you don't want to involve a lawyer (but if equity is involved, you should), you may want to consider trying websites such as 40billion, Caplinked or LendingKarma that can help you structure, document and manage investments from friends and family.
5. Manage expectations.
Another upside of bringing in friends and family is that they are typically more patient than professional investors. "When we failed at plan A and at plan B, these people weren't looking for our heads," Lee says.
It's a good idea to send a monthly email update to your backers, even if they've given money as a gift, says McNab. Lee, for example, makes a point of reaching out to all of his backers informally about once a month by email, phone or get-togethers.
Be honest about what's going well and what could be better. You might want to raise more money later, and it can be easier if your backers have been able to watch your progress. "I've seen people ask for and get more from their backers in later rounds," McNab says.
If things aren't going well, friends who have a stake in your success are more likely than others to provide the advice, contacts or referrals you need to turn things around. Says McNab, "These are the people who will try to help you if they can."
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Comments:
You should have a solid plan for your business, before asking anybody for investment. Your documents and presentation should be enough attractive that it can attract the investors interest. It is only possible when you have deep knowledge of your business and you have important points to attract them.
I loved the whole article and loved #5 .If we manage to update the recent developments then everything would be fine.
I think a full slideshow presentation after a dinner you host would be very helpful when asking for funding.
I've been through the start-up of one business where I used family and friends to finance it initially and it worked out pretty well. I am on my second now with a website that will help a property manager find vendor to provide service at their property. I am trying to boot strap it this time but may be looking to friends and family REALLY soon.
Baking a cake or building a house, both require a plan (recipe or building specs)....small business owners seeking investment from family and friends should have some written plan outlining a profitable and sustainable business model. Would you eat a cake that has half of the ingrediants or build a house with no roof or walls? Think about it? Denise
It is quite simple. If you want money, ask for advice. If you want advice, ask for money.
There are online services that cater to friends and family loans. Specifically, I am referring to LendFriend (www.lendfriend.me) that helps create a loan proposal as well as schedule monthly repayments. They help remove the awkwardness of asking friends and family for loans.
goood
Some great advice. The key mind-shift that is necessary, is that you are not just asking for money, if you believe in your businesses then you are offering them early entry into an investment that could produce very significant returns.
This article shares insightful tips for successfully managing relationships with investors. Point 5 is key - the people funding you should have an honest of your startup's progress. As Business Insider points out, it's critically important to maintain relationships while fundraising. However, many firms fail to reach a point where they can pay back investors because they don't have enough cash flow. Entrepreneurs who can manage their cash and accounting can maintain relationships with their investors and produce results. I've found some fascinating material about cash flow, accounting, and other small business tips, in the blog and video at http://bestsmallbizhelp.com/meet-dawn-fotopulos-your-small-business-coach/ - David
Eileen, your five tips described are helpful to entrepreneurs when they consider raising capital from friends and family. I encourage anyone considering such an arrangement to be very careful and to involve a good business transaction Attorney to help with this form of capital raise. In my nearly thirty years experience working with hundreds of entrepreneurs, I have found such arrangements--particularly those made with friends--rarely work out well. I can only think of one that worked out so well that both the lender/investor and the entrepreneur are friends today and would do it all over again. I have also observed a common mistake made when starting a business is the scenario where a friend is asked to contribute sweat equity in exchange for an equity position in the company sometime in the future. This almost always ends in a messy dispute. Start-up entrepreneurs have access to several free articles to address this subject at: www.exitpromise.com. All the best, Holly A. Magister, CPA, CFP
Keep the relationships with your investors on a professional plane by providing monthly financial statements. Trust me, you can fit an entire set of financial statements on a single page and make it readable for everyone (especially you). And your investors will not be the only beneficiaries of this type of disciplined, yet simple, communication and performance review. Just by summarizing your financial and operational results on a monthly basis, your results will markedly improve.If your accountant or bookkeeper can't get it right for you, I'd love to...www.adifinancial.com
Wouldn't your friends and family have to be accredited investors in order to offer them equity in exchange for money?
In 2009 there were approximately 7.8 million millionaires, and 1 million “ultra high net worth individuals” with assets of more than $5 million in the U.S.It is time for more of these people to seek out the investment opportunities in their communities and in their fields of interest to benefit themselves and the economy. We need to usher in an era of activist investors concerned with the bottom line, yes, but also with the well-being of their communities and the growth and health of the American economy. Startups Across America is a free state-by-state interactive map of potential investments for friends and family –and other- investors. Visit at http://startupsacrossamerica.com According to the Angel capital education foundation report Friends and Family invested 60 billion dollars , three times more then Angel investors. Using friends and family money creates perhaps even more of a moral imperative to plan and manage funds responsibly. Whether friendly investors are demanding or not, the entrepreneurs should be fully prepared to succeed through sound planning on the http://fundingroadmap.com
i love blogging too! it serves as my outlet on whatever I want to say using this online technology. actually, there are many things online world can give us, just like providing us sites that offers services of different sort like yipees.com that provides easy, and convenient to find needed local services without having to go through huge internet listing services or the Yellow Pages.
yes, sometimes wee need some extra fund to run our business from our closest ones.. maybe friends, family, neighbor, and so on.. one thing we must remember, don't let this business ruin your relationship.
DOM”T DO IT!!! should be the1st tip... As for adding your own personal funds to the pot, well, I've had many co-investor tell me there money is in it too and truthfully, that makes no difference when the deal goes south. Now two people feel like losers instead of one. Cash reserves are the key to dealing with private investors especially friends and family... regardless their level of sophistication, your documentation or license. You must be able to buy them out within 3 days max or your local newspaper will superimposes your picture leaning on a limousine on the front page of your local newspaper as the private investor taking advantage of the little old lady or widow and her orphan children. Don't believe me? try it, you won't like it. Be a pro and do business with business people. Just a thought and thanks for reading. Kent
Sorry, I'm still a subscriber to "don't mix business and pleasure." - www.awkardengineer.com
As much as you need help from others, I'd also recommend being sure that you are adding your personal funds to the pot, too! I can't imagine lending money to someone who is not willing to invest in his own idea, even if it is just a small amount. Be sure that you are able - and willing - to invest at least some of your own money, too. Lisa www.StartYourOwnSmallBiz.com
Remember what Hamlet said: Neither a borrower nor a lender be; For loan oft loses both itself and friend. If you have to borrow from your family, make sure you repay them FIRST. Others can wait. Ivan