Most Angel investors and venture capitalists are hesitant to invest in your business if you lack commitment from friends and family. Generally, investors believe that an entrepreneur is more crucial to a business’ success than the actual business idea. Hence they expect to see evidence that people who know you well are willing to take a chance & invest in you, even before your idea has gained momentum. It’s refreshing though, that friends & family might not be as demanding on your financial projections as a professional investor. Plus they are most probably satisfied with your initial offer of a convertible note (i.e. a loan with an option to convert to equity later).
Banks and independent investors might not want to risk money on you. Thus, it’s important to be abreast with key aspects that you need to be cognizant of when raising capital from friends & family. I’ll discuss some of those issues here in so that once you go down this route you are well-informed on things to consider and look out for.
Be Strategic With Your Initial Approach
It could be wise to initially pitch your idea to them through an email or any other impersonal but formal means. This is to avoid putting them on the spot and possibly making them make decisions they might not necessarily mean because you have ambushed them. So initially send an email or something and give them time & room to decide whether or not they would like to discuss and hear more about the idea in person. This allows them to graciously decline, if that be the case, without any awkward or tense settings.
Pitch The Business Idea To Them As You Would To A Professional Investor
There is a natural tendency to pitch your idea to them in both a casual manner & in casual settings due how close they are to you. However, it’s advisable to separate business & personal domains by using time & an environment that’s not connected to your personal lives. Pitch the idea in successive & cumulative meetings, gradually moving from the easiest to the toughest parts of your pitch deck.
Be Simple & Ignite A Value Perception In Them
Be very simple, logical & sincere in selling your idea to them. Convince your family and friends by demonstrating to them that your idea makes logical business sense. Make it apparent that you have done your research with respect to target market, competitors, and costs. Be empirical in your presentation by providing evidence-based information.
Inculcate An Impression That You Lead By Example
You as the founder must be the lead investor. Prove this with respect to how much time and how much money you are investing yourself. Show that you are committed to leap in front and lead the way. Talk is cheap, so go beyond that and prove yourself exemplary.
Clearly Outline All The Financial Aspects
Most people don’t understand financial terms or jargon such as convertible notes, start-up equity investing, exit strategies etc. They most probably won’t know what questions to ask, so they will likely wait for you to lay out the alternatives and respectfully ask for some financial help in that context. So make sure they understand all the financial aspects. Clearly explain how you intend to use the funds requested. It’s also important to explain the degree of risk, because without this disclaimer, relationships could suffer if the investment fails to work out as envisaged.
Despite them being family and friends, you must have the same contracts and terms you would have had it been a professional investor. This also communicates that this is a serious business relationship. Your friends and family would want to know specifically what they are signing up for, even if negotiated informally, including the risks and contingencies. Non-specific and open-ended agreements are the quickest way to break up family and friend relationships when things get tough, of which they will.
Ensure It’s Clear In What Context They Are Giving You The Capital
Be clear from the start and make sure you state your terms with absolute understanding on both sides. The capital could a gift, a loan or an equity investment in the business.
Gifts: Gifts don’t have to be paid back, which is a plus. The disadvantage is that you can’t raise as much as you would had you offered a potential return on the money. Note that gifts can quickly turn into loans in the minds of friends and relatives in the event that you succeed. A signed document, even a letter saying the money was given as a gift would be a prudent thing to do to avoid fall-outs in the future.
Loans: Many experts suggest loans as the optimal way for friends and family to invest because there are set repayment terms. Time frame needed to pay back the loan and the interest, if any, will be known to you and the concerned party. Having a business lawyer draft a “promissory note” detailing the terms of the loan would be indispensably important here.
Equity: This means you don’t have to pay them back until you start making a profit or cash outs. It’s also important that you involve a lawyer in this.
Have Objective 3rd Party Advisors
Involved parties should have objective professional advisors protecting their interests. Owing to the close relationships, one or more parties may be inclined to give more than is appropriate, which will strain the relationship if problems arise. So these advisors would aid in promoting mutual understanding & abating any conflicts that may arise.
Stay Away From Making Grandiose Claims
Your friends and family are close to you and will always be an integral part of your life, whether the business sails through or not. Thus it’s important to desist from making outrageous and inflated claims that will be proved wrong in time. Be modest & allow results to speak for themselves.