Family & Friends
How to Decide Whether Raising Funds From Friends & Family is Right for Your Business
There’s no getting about it. Raising funds from sources like Banks, Venture Capitalists, and Angel Investors can be a tricky and difficult process. It’s even harder for start-ups and those in the very early stages of business development. That’s why so many entrepreneurs choose to begin their fundraising close to home – by asking friends and family to invest in their project.
In fact, raising money via the “Friends and Family Round” is a route over a third of startup founders choose. Over $60 billion per year is raised this way which is more than professional sources combined.
There’s plenty of compelling reasons to ask family and friends to help you with your US venture. But, there are also several potential disadvantages of this funding method. In this guide, we’ll take a look at Friends and Family funding, how to go about approaching people for funding, and what factors to consider before you move forward.
On This Page
- Friends & Family – Types of Funds
- The Advantages of Friends and Family Funding
- The Disadvantages of F&F Funding
- Should you Seek out a Co-Founder Before the Friends and Family Round?
- Preparing to Approach Family and Friends for Funding
- Asking for Funding – How to go About Having a Constructive Conversation
- Things to Consider When Making Funding Agreements
- US Securities Law
- Get In Touch with Mount Bonnell Advisors for Support With Friends & Family Funding
- Frequently asked questions (FAQs) about taxes, company formaition, and residency in the U.S.
- Get advice on taxation, company formation, and residency in the U.S.
Getting funds from family and friends for your US venture can take three main forms – Gifts, Loans, and Equity. It’s important to consider carefully which of these options you think is best when approaching people to invest in your company.
Gifts. Gifts are an amount of money that is given to you to help you with your business. This can take pressure off you as you grow your business because you don’t need to worry about paying it back. You are also under no obligation with regards to how you run your business. It’s important to be aware of the tax implications for the gift giver when accepting a gift. In many cases, a gift needs to be reported to the authorities on a tax return.
Loans. Agreeing on a loan with investors from your circle of friends and family can be a great way to raise funds. Because you can set the loan repayment terms between you, you will usually have much better terms than any other loan source.
Equity. Giving away equity in your business is another way to raise funds from friends and family. This can be an attractive option because you won’t have to worry about repayments on loans – but you will have to allow your investors some say in how you run your business.
There are several advantages to getting support from your family and friends to raise funds. Your friends and family know you and trust you. That means they are more likely to want to help you out and take a risk on supporting you in the early days of building your business. Many people are also excited to encourage a new venture and are emotionally as well as financially invested in seeing you succeed.
Other advantages to friends and family funding can include:
- Potential for your friends and family to make money if they have equity in your company or good loan terms.
- The process can be quicker and more informal than other sources of funding (although you should get a formal agreement in place for loans, gift or equity).
- If you are getting funding in the form of a loan your interest rate and repayment terms can be set at a lower rate with more flexibility than with bank loans or alternative financing loans.
- Friends and Family are far less likely to want collateral in exchange for loans.
- If you choose the Equity route your friends and family may be less concerned with the return on their investment than other investors might be. This can take the pressure off you as you grow.
- Your family and friends may also be able to offer you more than just financing. They may well have experience, skills, and expertise you can benefit from to help you as you grow.
If all goes well, choosing to grow your business using funds from friends and family could be a wonderful opportunity to not only get the funding you need but make those closest to you a real part of your success. But, it would be foolish not to consider that gaining funding from those close to you can come with some very real risks.
Although family and friends might seem like an attractive or even only option for funds when you are in the startup stage you need to be aware of the potential impact this type of fundraising could have on your relationships.
The stark truth is that 70% of funded startups fail and that rises to 90% during the startup financing phase. So, you need to be very realistic with yourself and your potential investors about the risks involved.
Some of the disadvantages of raising funds via a Friends and Family round include:
- The very real potential for damaged relationships with your friends and family if your startup doesn’t succeed and money invested is lost.
- You should be clear with yourself about whether you are likely to risk relationships if things go wrong – and if so, are you prepared to take that risk?
- Friends and family are often not professionals and may lack the business or financial experience to fully understand what they are getting themselves into.
- In the long-term tension could occur if one of your startups fails that used Friends and Family funding but a future one succeeds. How will you manage the situation if this happens?
- The amount you receive from each investor is likely to be smaller to mitigate risk, and also smaller in the case of gifts.
- You might be on the receiving end of pressure from your family and friends with regards to many aspects of not only how you run your business but your life generally – it can be very hard to separate personal and business with family if they have invested in your project.
- On occasion, gifts can turn into an expectation of repayment – particularly if your business takes off. So you should have mechanisms in place to formalize the gift.
- You may find that even with a gift comes the expectation of involvement in the decision making and day-to-day operations of your business. If you sell equity in your company you need to be prepared that your family and friends will have some say in the running of the business. Be honest with yourself about whether you’re prepared to discuss how you run your business with close family, and give them a say in decision-making.
These are serious considerations when it comes to choosing this method of fundraising. But, with careful planning and a realistic approach to discussing funding with your friends and family you can mitigate many of these risks
Asking friends and family to help you with funding your US venture should not be taken lightly. One way to show that you are serious about your business is to invest any capital you already have in the business. If this is not possible to achieve because of a lack of personal funds then one option is to seek out a co-founder for your business.
If you decide to take this route then it’s likely you will be looking at a long-term partnership and will have to share a significant portion of your equity in exchange for help with founding and initial funding. Therefore you should choose the person (or people) you co-found with very carefully.
Make sure the co-founder you choose has a skill set that is going to be of use to the business and who shares your vision, values, and ethics. If they have expertise in areas of business you don’t have skills in this can be extremely helpful.
You should always reference your potential co-founder and find out they have the skills and experience they say they have. Make sure that the skills they have are complementary to yours so that you can fill gaps in knowledge between you. Don’t rush into any kind of agreement before you have got a good handle on them as a businessperson – their temperament, talent, and abilities.
Having the right co-founder can be a very smart move as they can support you in the planning and development of your business and help you with sourcing family and friends funding. They may be able to increase the circle of people you speak to with their own network of contacts.
Whatever you choose to do make sure that you take your time before you decide to move forward. The wrong co-founder can cause significant issues for you as you progress.
A good way to succeed with seeking funding from family and friends is to approach it as a funding round in of itself. Even if you are not very far along in your business development, you should still develop a business plan and have a realistic idea of how much capital you need and how much you are asking people to invest.
Although you might have had plenty of informal discussions with those close to you about your business goals, it’s important to create a formal structure to use during the process of fundraising.
One way to do this is to create a “Kitchen Table Deck” that you can use when approaching people to ask for funding. This is a short pitch deck of a few pages that can showcase your business, what sort of investment you are asking for and the terms of the investment (for example loan repayment suggestions, or equity offers). You should also create a 1-2 page Executive Summary to highlight key aspects of your business.
Asking for funding from friends and family can be a nerve-wracking experience. Although in many cases you can have an informal chat to gauge interest, the actual request for money can feel awkward if you don’t prepare how you will make the request.
Here are some things to consider to maximize your chances of being successful (and avoid potentially negative outcomes).
- Draw up a list of potential investors and consider carefully how best to approach each person. Some people might prefer an informal chat and then a more formal follow up. Others might find a direct conversation difficult – especially if they find it hard to say no. If you are concerned about putting anyone on the spot you could consider sending an email as an initial query.
- Carefully consider whether the people you talk to have the skills and experience necessary to make the decision to invest. A friend or family member might have access to funds, but not necessarily have the know-how to understand the risk they might take investing in your business.
- Be mindful of people’s financial situation and what they can afford to lose if things go wrong. Relationships can be irrevocably damaged if someone close to you loses an investment that puts them in financial hardship.
- Be very honest and realistic about the risks involved and that there is a chance that investments might not pay off. Don’t over-promise or sugarcoat the potential challenges you will face.
- Focus on talking to people with business investment experience and those with skills and expertise that can be helpful to you as you grow. Remember to carefully consider whether the people you accept investments from are those you believe you can work successfully with – especially if you’re offering Equity.
- Make sure you have a clear idea of how much money you want to raise and how much you want to ask each person for. Focus on specific milestones and show how you plan to achieve them.
- Give potential investors time to make a decision and seek advice if they need to before you press them for an answer.
- Make sure you are happy to hear a “no” and that you don’t take it personally.
In the end, it will be up to you how you approach each individual and the way you go about making a request. Those very close to you, such as immediate family, might offer gifts once you explain your idea, or ask what other ways they can help.
But for those you are less close to, it is better to put your idea across simply and in a way that allows them to ask for more details if they are interested and gives them an easy way to refuse if they are not.
If all goes well, you should hopefully find a range of people who are willing to invest in your business. Once you have a list of interested investors you should take steps to formalize funding agreements.
Different investments might call for different kinds of agreements and formalization processes. Although it might be tempting to go on a handshake and a promise with close relatives or friends, further down the line informal agreements could become a problem.
Unforeseen circumstances, differences of opinion, misunderstandings about what was agreed or even someone just changing their mind can all strain your relationships or even land you in hot water financially.
If you are ready to start putting agreements in place you should seriously consider hiring a lawyer and accountant to run numbers and draw up formal agreements between you and your investors. This can help protect you and give your investors confidence that you will do all you can to keep to factors such as repayment agreements for example.
- Think forward when it comes to creating your agreements. If your company grows you may be looking at going into rounds of funding with banks or other professional investors who will want to check out your books and see how you have approached your investments so far. So start early with a structure for formalizing and reporting on agreements.
- You should make sure you are aware of any tax implications for you or for your investors when it comes to gifting you money or investing in equity or any other investment. Make sure you take advice from an experienced professional about the relevant laws in your country and keep all your investors up to date on any responsibilities they might have.
In the US it’s incredibly important to comply with Securities Law. These are laws that relate to the way you are allowed to raise money from investors who expect to get a return on their investment. This might include security such as shares or a loan.
Securities Law in the US applies on Federal and State levels so you must research the state your business is in and make sure you comply with any relevant requirements. On the Federal level, you are expected to register your offering sales of securities – which is very expensive and requires the services of underwriters. For this reason, most businesses find an exemption for registering.
Many budding entrepreneurs wrongly believe that they qualify for a “Friends and Family Exemption” but this doesn’t actually exist. Instead, one way to avoid registering an exemption is to use Accredited Investors in the US.
An Accredited Investor is someone who is considered to be wealthy. The criteria are an earned income of $200,000 in the last two years, with an expectation that this income will continue in the future for a single person. For a couple, the amount is $300,000. Another measurement is to consider the investor’s net worth – which must be at least $1,000,000, exclusive of the residence they live in.
There is a way to use non-accredited investors for an exempt unregistered offering via rule called Rule 504. This allows you to raise up to $1,000,000 over a 12 month period. However this must be exclusively from those you already know – you are not allowed to engage in widespread advertising or promotion.
Please note that the above information applies to US Securities Law. There may be equivalent rules or restrictions on fundraising via accredited or non-accredited investors within your home European country – so you should seek out expert advice before you begin formalizing funding agreements.
There’s a lot to consider when it comes to choosing to ask those close to you to help fund your US business. You will need to think carefully about the risks involved – not only to your business if things go wrong, but potentially to the relationships you have with people in your inner circle.
If you’re considering a Friends and Family funding round but are not sure whether you want to move forward then please feel free to get in touch and book a consultation with Mount Bonnell Advisors.
We can also support you if you have decided to go ahead with a Friends & Family funding round by:
- Advice and support to approach family & friends.
- Help to create a short Pitch Deck and Executive Summary.
- Assistance to draw up formal agreements and check for tax implications and any other requirements you and your investors need to meet.
Frequently Asked Questions (FAQs) About Taxes, Company Formation, and Residency in the U.S.
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