You may have heard of the "elevator pitch" for raising money from venture capital investors. But have you heard of the "kitchen table pitch"? I use this term to describe how entrepreneurs approach their relatives and friends for startup capital.
More than 50 percent of startup capital is raised from family, friends and other informal investors. The total amount raised in this manner--tens of billions of dollars--exceeds the total amount raised from venture capital investors, yet the media tends to focus on VC financing and ignores money from family and friends. But you shouldn't. If you're thinking about seeking money from those close to you, the following guidelines will help you craft your kitchen table pitch.
1. Know your investor's motivations. The impetus for investing in a friend's business ranges from pure altruism to pure greed. In my experience, I've found that most family-and-friend investors decide to put money into a business started by someone they know because they're motivated by a complex combination of financial self-interest and a desire to help you become a success. At times, these business angels are quite angelic in their approach to supporting you; however, a few hours later, these same investors will argue over specific clauses in the investment agreement that have little likelihood of being exercised. However, no matter whom you approach, it's likely you'll find that family-and-friend investors enjoy the thrill of investing: the idea that they're able to benefit financially from speculation.
Before you make a kitchen table pitch, make a list of all the potential private investors you could approach, and outline their likely motivations for investing. Your parents may have very different motivations than your in-laws, who in turn may have different objectives than your former boss. Each pitch should be tailored to its audience.
2. Debt is better than equity for relatives and friends. Unless your business has a high likelihood of being purchased, be wary of raising money in the form of equity. It's tempting for entrepreneurs to sell stock with no scheduled repayment obligations rather than take on debt, but this isn't a smart idea when raising money from relatives and friends.
Let's take a long-term view of a specific example. Assume you sell $10,000 worth of stock in your new restaurant to your brother-in-law. The business grows and prospers in its early years, but it has little chance of being bought or paying dividends. In fact, the restaurant closes abruptly after five years because you and your spouse decide to move out of state. Legally, your brother-in-law has little recourse and will be frustrated because he's depending on you to pay him for his now worthless stock. If you'd decided to structure his investment as debt, you would have been able to pay him in installments--perhaps $2600 per year (assuming 10 percent interest) or $200 per month (assuming 5 percent interest). In practice, many entrepreneurs treat family-and-friend equity much like long-term personal debt: If the business fails and is unable to pay shareholders, the investment morphs into personal debt to save the relationship.
3. Provide options for investing. Unlike VCs, family-and-friend investors don't invest out of the fear of losing the deal. So don't give them a take-it-or-leave-it proposition. Instead, give them investment options. For example, let them chose between different loan terms: Offer a high interest loan that's long-term or a short-term loan with a lower interest rate.
Some entrepreneurs also use creative repayment schedules such as interest-only loans, graduated repayment loans (low payments in early years that increase over time as the business grows), or seasonal loans (installments payments in summer months only, for example). For your reference, I have listed below three sample investment options, which could be offered to your relatives and friends when you make your kitchen table pitch. Although each option assumes you can afford monthly payments of $200 to $400, they enable you to raise very different sums of money.
|Option||Amount||Interest Rate||Repayment Terms||Payments|
|Option 1||$10,000||6%||5 years, after a grace period of nine months||$201.19 monthly, starting in month 10|
|Option 2||$25,000||8%||10 years, after a grace period of 2 years||$1,049.61 quarterly, starting in quarter 9|
|Option 3||$40,000||10%||10 years, interest-only loan repaid annually with a lump-sum||$4,000 every year, with a lump sum payment of $44,000 at the end of the loan|
4. Make the pitch verbally, then follow-up with something in writing. Experts tell you to present a business plan when raising money. While this is sound advice, it should be modified a bit for a kitchen table pitch. Most of your relatives and friends don't want to see a slick business plan presentation--they want to look you in the eye and know that you're not taking advantage of them. I've found, through years of experience, that it's better to make the pitch verbally, to explain your business plan in your own words. And get your investors to agree to the investment verbally. Once they have done so, tell them you'll follow up in writing with proper documentation so there's no misunderstanding and to protect your relationship.
Some investors will insist they don't need documentation in order to give you money. Be wary of this. Again, let's take a long-term view. Assume you accept a $20,000 informal "investment" from your aunt and uncle. You launch your business and decide to take a vacation a year later--before you've repaid their investment. (C'mon! Even entrepreneurs need vacations.) While you may have every intention of paying them back in the future, your aunt and uncle may view your vacation as a frivolous expense, which may put a strain on your relationship, particularly at family gatherings. But if their investment were formalized--for example, with a scheduled repayment plan--they'd be less likely to worry that "their money" was being used frivolously.
When making a kitchen table pitch, you have to anticipate the dialogue at the Thanksgiving table as well. If you're not comfortable with how the investment will impact your personal relationship with your friends or relatives, don't raise money from these people for your startup. But if you decide to go ahead, I encourage you to follow the guidelines listed above. It'll be worth the effort: For many entrepreneurs, money from relatives and friends is the cheapest, quickest and most flexible source of financing available.
Asheesh Advani is CEO of Covestor, an online marketplace for investors. He founded CircleLending, which was acquired by Virgin.