If your face was on the ten o'clock news, how many people would look up and say, "I know that person!"? The list is probably longer than you'd think--and includes more prospective investors than you'd imagine. They need not be millionaires, and they need not be loyal relatives.
If you're like many small-business owners, you first reaction to the topic [of raising money from friends and family] may be, "But I don't know enough people with money, much less people I'd feel comfortable asking for money." Don't let that initial reaction stop you. Asking people you know to pitch in on financing a new or growing business is anything but a radical idea. Before anyone ever heard of banks, informal, person-to-person loans were the way many businesses got started--and the way many investors made money.
Although modern banks have reduced the need for private financing, they haven't supplanted it. With approximately five out of every 100 adults in the United States having invested privately in someone else's business within the last three years, it's clear that private financing remains alive and well. It is, however, often hidden behind the doors of the family home. A whopping 42 percent of private investors are close family members, such as a spouse, sibling, child, parent or grandparent. If you add in the 10 percent of investors who fall within the "other relative" category, that's more than half of all private investing coming from someone related to the entrepreneur.
But let's not overlook the fact that nearly half of all private loans and investments come from people who are not related to the entrepreneur (29 percent friends and neighbors, and another 19 percent who are work colleagues, strangers and others). Clearly, you should cast your mental net widely when thinking about your circle of contacts.
Chances are that you, like many entrepreneurs before you, will need to piece together business capital from several small investments. Finding one person who can provide all the financing you need is unlikely and could be overly time consuming. To assemble your capital, you may need to both rekindle old relationships and start new ones. "Many of the most successful entrepreneurial ventures--those that create jobs, wealth, innovation and economic growth--got off the ground because of the founder's ability to tap into his or her personal network for capital," says Carl J. Schramm, a leader in the field of entrepreneurship.
The three main steps toward tapping your network are to:
1. brainstorm a list of the people you know,
2. narrow your list based on trust, money, experience and lack of emotional baggage, and
3. create a summary, "best bets" list.
Brainstorming a List of People
Your first step is simply to draw up a huge list of names, including your family, friends and beyond. You're in search of people with whom you already have, or can establish, a trusting relationship. You also want to identify people who are interested in seeing you succeed, either for personal or business reasons.
To make the process of thinking up names somewhat systematic, visualize the people you know as occupying three concentric circles. All three circles are in orbit around you, at the center of this mini-universe. (Just don't tell people that you think if them this way!) The innermost circle includes your nearest and dearest, the middle circle includes your other current relationships, and the outermost circle includes people with whom you aren't in direct, regular or current contact.
It will be easiest to start your list with the people in your inner circle--those with whom you have the closest relationships. The obvious suspects include parents, aunts, uncles, cousins and in-laws, as well as close friends and neighbors. Go through your brain for people whose names, phone numbers and e-mail addresses are already there. Then check on who is programmed into your cell phone or written on the babysitter's emergency contact list. And don't forget the relatives you rarely contact because you know you'll see them every year at Thanksgiving or at the beach.
The middle circle includes people with whom you are a bit more distant relationship-wise but with whom you are currently and regularly associate, particularly in the course of your professional life. These should be folks who think well of you because of what you do and how you do it. Think about business associates, fellow volunteers, members of your church, temple or mosque, people with whom you've worked in current or past jobs, and supervisors or employers in those workplaces. If you're in business right now, consider which of your customers or suppliers really like what you do. Also think about any potential business mentors or entrepreneurs--people who may have good knowledge and information about the kind of business you're in and whom you either know already or could get to know. Most of the contact information for people in this circle will likely be in your address book or computer.
Finally, the outermost circle reaches to folks with whom you've had contact in the past, friends or acquaintances you rarely see, and people you know only through someone else. These people should either know your name, or recognize and think highly of a mutual acquaintance. Beyond your business experience, think back to teachers, college friends, mentors, professors or coaches, and others who might have an interest in seeing you succeed. If you happen to know any business angel investors--affluent individuals with experience and an interest in helping new businesses get started--add their names, too, if you haven't already.
To come up with some names for this circle, skim through your address book, e-mail database, holiday greeting card list, old school yearbooks, alumni directories, employee rosters from old jobs and even party invitation lists.
If your brainstormed list feels short, you might ask a trusted friend or colleague to help pout. He or she may know of local people who have invested in other businesses or simply remember a mutual contact that you'd forgotten.
Narrowing Your List
To turn your long list of contacts into a short list of prospects, evaluate each person in terms of the following four characteristics. Circle the names of people who possess at least two of these characteristics:
- Trust in you
- Ability to afford the investment
- Business experience, and
- Lack of emotional baggage
1. Trust in you. Identify those people who know your character or abilities and trust that your deeds will match your words. Family and friends with whom you have good relationships, and people with whom you've worked, especially your supervisors or employers, may fall into this category.
2. Ability to afford the investment. The higher a person's net income, the more likely he or she is to agree to an informal investment. While it's great to have a long list of people who trust and adore you, the ones who can't spare the cash--or can't spare enough to make a difference--should simple be crossed off your list.
How do you figure out whether a person can afford a private investment in your business? You may know that the person already makes private loans or investments, through gossip by family members or word-of-mouth among friends or colleagues. If you know a "cashed-out dotcommer" (someone who made a lot of money during the internet bubble of the late '90s), he or she probably has money to invest.
Observing the cars that people drive or the vacations they take can alert you to some who have money. (But watch out for the people who simply spend every dime of their own income.) Other people are less showy in their behavior, and you may need to spend some time building the relationship to get a sense of their financial situation.
For each prospect on your list, ask yourself: "Can he or she afford to lose the investment?" For equity investors, this is a real risk, and for each one, you should be able to answer "yes." For lenders, the risk is a bit lower, especially if you secure the loan with your business or personal assets. However, even lenders should still be able to say that losing the money wouldn't sink them financially. Andrea Lang, who has been raising money from over 20 people to start her café, says that she has never and will never ask for money from someone she knows can't afford to lose it. It's simply one of the fundraising principles she's set for herself.
Finally, finding people who can provide larger amounts means less work for you overall. If you can, for example, raise $50,000 in two $25,000 loans, it will require a lot less effort (both before and during the loan) than raising $50,000 through ten $5,000 loans.
3. Business experience. People who are themselves entrepreneurs are the most likely to invest in other businesses. Perhaps the reason is that, [as noted in a recent study,] "they understand the entrepreneurial process; they are able to evaluate the prospects of another entrepreneur's venture; and they like to support other entrepreneurs with both money and advice." Pundits say that the average successful entrepreneur has private investments in three other businesses, and the average successful senior level corporate executive has investments in five other private ventures. So if you think that people who own their own business have their hands too full to invest in yours, think again. Your business may be just the extracurricular activity they're looking for.
Business experience is not a necessary characteristic for a lender. After all, the lender's level of involvement in your business is totally up to you. But business experience is an important characteristic to have in an equity investor. While you may get some "love money" (an equity investment from a relative who doesn't really know or care about the business), most equity investors won't invest until they've carefully analyzed the opportunity. They are likely to take their role as shareholder quite seriously, requesting information and calling to get business updates. Finding knowledgeable investors who can advise you based on their experience will prove invaluable.
4. No emotional baggage. Emotional baggage is the stuff that weighs people down. Review your list to make sure there are no people with whom, in your gut, you feel nervous about entering a financial relationship. If you find any, cross them off.
Past conflict between you and the other person is the biggest red flag, especially if it remains unresolved. For example, if just last year, you didn't speak to your brother for six months due to a misunderstood remark to his girlfriend and your relationship is still a bit shaky, you should probably not consider him a prospect--not even if he has the money and related business experience to make him a good prospect. Similarly, you should not ask a person for money if you aren't on good terms with his or her spouse or partner. A private loan or investment can be a great source of friction within the home if the couple does not see eye to eye on it.
If asking your parent or parents for money could cause tension in the family, avoid that as well. Many families do quite well at sharing their resources between generations. But you know your family best. If you believe that the loan or investment would only cause tension with your siblings and anxiety on the part of your parents, crossing them off your list at the beginning might be best.
Whatever you do, don't ignore relationship issues when considering whom to ask for money, particularly when it comes to family members. If the business fails, people will take sides and things could get very uncomfortable. Be honest with yourself about whether the personal relationship can handle the financial risk of a private loan or investment.
Asheesh Advani is CEO of Covestor, an online marketplace for investors. He founded CircleLending, which was acquired by Virgin.