Let’s talk money: The ins and outs of raising startup capital from friends and family

Before approaching venture capital firms or even angel investors, founders often look to their friends and family for startup capital.

At the earliest stages of a company’s journey, and maybe after you and your cofounders have put in your own cash, a relatively easy and fast way to secure a small amount of working capital is to approach your close friends and selected members of your family (that is, if people in your network have the means to contribute such funding). This is especially important in extremely early stage technology companies that are running out of their initial funding, wherever that money came from, and that are still too early to approach pre-seed funds, economic and venture development agencies, or early stage angel and angel investor groups.

The “friends and family” list includes lifelong friends, college friends, coworkers, bosses, professors, neighbors, service providers, extended family members, and their personal contacts. It also certainly includes any cofounders as well.

Yes, there are always emotional and potentially ethical issues associated with approaching people close to us with the intent of discussing money issues. The important thing to remember is to always focus on the business, and to treat the conversation in the same way to that you address any other investor.

I have done this in my companies and I will tell you my secret to avoiding the whole “uncomfortable conversation”: On day one of your business, create a personal list of people who care about you and might be interested in being informed about your journey. Write them, and sometimes call them, on a regular basis. Set yourself a schedule, and keep to it. Your company is moving fast, so update them on a monthly, if not biweekly basis. Keep them informed on everything you are doing all that is happening, and transfer your passion and energy to them. Ask for their input on your concept, too.

Do you have 10 persons you can approach, each of whom can write a check for $5,000, or better, $10,000? If the answer is yes, then we have the seed of a friends and family round.

You will be surprised. At some point some of them will ask back: “How can I help?”

And there you have it: The door is open to either broach the subject, or set up an appointment to discuss your needs and your company’s needs.

Friends and family financings are always the easiest to complete, often taking a few short months from start to finish. Friends and family rounds usually raise $25,000 to $250,000 in total. In one of my companies, I received commitments of $150,000 before I even opened the doors, based on my evolving business plan and investor pitch alone, and my email updates, during this incubating period.

How much money you accept from each is really up to you. I have taken checks as small as $5,000, and I have personally invested as little as $3,000 in a startup. I usually ask my mentees something along the lines of: “Do you have 10 persons you can approach, each of whom can write a check for $5,000, or better, $10,000?” If the answer is yes, then we have the “seed” of a friends and family round. Keep in mind that one day each investor may wind up a shareholder, as their debt converts to equity, and this will complicate your capitalization table. (But this is subject of a different discussion.)

Your very first investors are those who believe in you and your ability to execute on an idea, and unless you’ve done this before, your friends and family are those who believe in you most. The purpose of this round is allow you to reach your first fundable milestone: The point at which you can raise money from the above-mentioned angels, angel groups, and venture development organizations. The friends and family round should be structured to carry you through the next six to nine months of growth.

If you search the internet about this subject, you will find plenty of advice about approaching friends and family be email. I do not agree. To me “friends and family” equals “persons who care.” So take the old fashioned sales approach: Meet with them and talk to them.

General considerations

A family and friends round may appear less formal as the parties are familiar with each other. Even so, you should treat the round with caution, professionalism and with a long-term strategy in mind. In other words, treat the friend and family round like any other fundraising effort.

Do not discuss this subject with relatives or friends in a social environment. Make time separate from your social life. This separates the business and the personal. Bring your pitch deck and demo materials, and be prepared to answer questions. It’s also a good idea to schedule your pitches from easiest to toughest — you’ll be amazed at how much better your pitch gets with each successive meeting.

Here is a little advice from my favorite entrepreneur — my son, who is currently leading his third venture:

“When it comes to friends and family, never ask for money from people who cannot afford to lose it. And never ask for it if you are relatively certain that you cannot pay it back either in cash or equity. The best way to pay back any investor is to grow your sales!” He adds: “There is only one investor to whom you can guarantee re-payment: a customer.”

In other words: Make sure they can afford to lose whatever they invest, and understand the risks going in. As one of my angel investors once told me: “Here is my check. Keep in mind that as I am handing it you, I have already written it off.”

Have a defined fundraising goal. Make sure you have enough money to reach your next fundable milestone. This milestone is defined by the reaching the point where you have raised your company’s value by completing key, well defined, goals, and can raise the next round:

• Product and/or research development
• Voice of the customer studies
• Early sales and marketing
• Inventory, assets, and facilities

Terms of the deal

If you do secure capital, I would strongly advise against any equity-based offering. Not only will this force you to put a value on your baby, and formally add to your capitalization table, but it will force you to abide by securities laws, something I am not able to discuss here. (There is plenty of information available on this subject, and you certainly should seek the advice of counsel.)

A debt instrument, in the form of a convertible note, or a SAFE, is easy to implement, fast to execute, and offers an upside to these early risk takers.

Make sure you document everything properly. This is not just good business, but it is important with regards to future rounds. Remember the concept of due diligence? You will have to show future investors that you run your business the right way. An attorney will be important to you so that you may draft he appropriate investment documents for this round.

Communications

I treat every investor like a customer. You will need have a systematic method to diligently and regularly communicate with your shareholders:

• Good news get shared instantly by email, stripping away the most confidential information
• Key investors get regular personal phone calls or coffee/lunch meetings. Who are the key investors? Super angels, and others who invested significant amounts; angels who invested multiple times; angels who are also important personal advisors, mentors, or confessors
• Everyone gets a quarterly letter faithfully on the first day of the new quarter. Always soften bad news or challenges. In your letter, include the following important topics: key milestones achieved during the quarter, R&D, testing, clinical, business development, strategic development, fundraising, financial
• You hold a shareholder meeting once per year. (This is law in Pennsylvania.) I did mine at a restaurant and served wine and light tapas. I used the venue’s wide screen TV to present a PowerPoint on the company’s activities. There are important votes that must be held each year: elect the board of directors; appoint the company’s accountants; any other critical matters
• Finally, due diligence requests are 95% identical. I always hated peer CEOs who “were too busy” to keep things updated and delegated the job to their admins. I kept a due diligence folder up to speed all the time, and this allowed me to answer an investor’s due diligence request in less than an hour.

Remember, shareholders and note holders are customers. Keep them happy and they will likely buy from you again, or refer other customers to you. Displease them, and you will face new challenges.