Raising Money from Family and Friends

It’s really easy to find information about raising money from angel investors or VCs, but many people neglect another important way to fund your startup: raising money from family and friends.

There are pros and cons to raising money from family and friends, but for your first round (especially in your first company), I think that the pros outweigh the cons (if your family can afford it), especially if you follow some common sense rules so that you can still go to your family reunions.  It seems to me that many in the startup world look down on companies that are funded by family and friends.  I think that’s a mistake.  I’m writing this post because I wanted to share my experience raising money from family and friends so that others can see it is a viable option.

When it came time to raise money with my first company, I had the choice of whether to try to raise money via angel investors or from family and friends.  After doing some research, I decided that family and friends was the route I wanted to take.  We were able to raise six figures fairly quickly from a good group of investors, which helped us stay focused on running our business instead of raising money.  Whereas many angels and angel groups would have wanted to get to know us for 3-6+ months, we were able to close our round in about 6 weeks.

How were we able to raise money quickly?  How do you actually go about approaching family and friends for money?  What if your family doesn’t have much money?  Why should you do it and why are they better than angels/vcs?

We were able to raise money quickly because we wrote a detailed business plan, did our research and found people who were willing to believe in us.  At first, we wrote a 2 page executive summary of our business that included how much money we were trying to raise, our valuation, how much 1% of the company would cost, why we needed the money and what we planned to do with it.  This exercise helped us really figure out how to tell our family and friends what we were doing.  It is especially important to avoid the curse of knowledge when writing your business plan, but its even more important when the investors are your family and friends.  Next, we developed our full business plan, making sure to be as clear as possible.  We made it clear that we were asking for investment in exchange for ownership in the company, rather than loans.

Next, we talked to our lawyer about how to raise money.  He helped us write up an offering summary, amended our operating agreement to allow us to take on investors and filled out all of the necessary forms for the government.  He also helped us add to our business plan to make it more understandable to non-tech people.  Our professionals that were working with us (lawyers, accountant, professors) were able to point us in the right direction of people with money.  This is even more important if your family does not have the resources to invest in your startup.

All of our investors were accredited investors, which means that they have net worth of at least $1m or a yearly salary of over $300k.  Accredited investors helped us in two ways.  First, since they were high net worth individuals, they could afford to take the risk of losing their money.  While we were confident we were going to be successful, we still knew we could fail and lose our investors’ money.  Second, having all accredited investors meant less paperwork for us and our legal team.  Having accredited investors helped us avoid the mistake that some people make: raising money from people who cannot afford to lose it.  This is a huge mistake, even if you think you are going to be successful.  It is the quickest and surest way to give yourself way more stress than you need and get yourself taken off their holiday card list.

We were up front with our potential investors.  While we were confident we were going to be successful, we told the investors that the worst case scenario involved them losing 100% of their investment.  We told them that they might not be seeing a return on their investment for 3+ years and tried to think up scenarios that would cause these bad outcomes to happen.  It was clear that our investors were more comfortable with us once we showed them that we had done our homework and were not simply selling them snake oil.  Don’t make promises you can’t keep just to get someone to open their checkbook.  They will not be happy with you when you are not fulfilling your promises a few months down the road.

Make sure you don’t set your valuation too high.  While you are trying to get a good deal for your business, you want to make sure that your investors are getting a good deal as well.  After all, they are your family and friends.  Another key is to not take too much money from one single investor.  In my first company, our biggest chunk from one single investor was $70,000.  While we ultimately made him money and he could have afforded to lose his investment, it would have been more comfortable for everyone involved to have gotten a little less from one single source.  It’s also not the end of the world if one of your potential investors turns you down.  Don’t press for money from someone who is uncertain because they will be the first to complain when things are not going as well as you had hoped.

Many angel investors will tell you that their investment comes with connections that you will not get from your family and friends.  While there is some truth to this statement, I think that it is overrated.  Your family and friends will get you money more quickly and be more willing to take you at your word.  A family and friends round will also set you up nicely for a second round from an angel or VC if it is necessary down the road.  If you can show that your family and friends believe in you, it gives you credibility.  If I see a startup without some amount of family and friends money, I wonder “wow, this guy couldn’t even get his Mom to believe in him, so why should I?”   It brings up questions in my mind, but is not a deal breaker.

I have had good experiences raising money from my family and friends and I think more people could benefit from thinking about going this route, rather than just thinking about angels/vcs.  Check out my list of Dos and Don’ts and Pros and Cons of raising money from family and friends below:

Do

• Write a simple executive summary and longer business plan
• Be upfront and honest about potential losses
• Be honest about the time horizon for payoff
• Make sure your investors can afford to lose 100% of their investment without any hard feelings
• Seek out accredited investors from your professionals

Don’t

• Oversell yourself, your company or the opportunity
• Underestimate risk
• Take too much money from a single source
• Set your valuation too high
• Get mad if they turn you down

Pros

• Raise money more quickly
• Better valuation and less stress than angels/vcs
• Potentially make your family/friends money
• Easier to get money than from angel groups for first time founder

Cons

• Can be awkward if you fail
• Doing business with family/friends can be nerve wracking
• No network

What do you think?  Have you had experience raising money from family and friends?  What did I miss?