Raising Capital From Friends / Family

After depleting your savings, maxing out your credit cards, and selling your unwanted valuables in order to support your venture, who do you go after next? The people who know you best… your friends and family.

Albeit, the relationship that you have makes them feel more prone to hand over the check, it also creates a flurry of questions/concerns/comments. Here are three important points to cover in order for both the venture and investor to feel comfortable with the transaction. 

Use of Funds

The first and most important point to hit on is: “What will the investment be used for?” By having a clear understanding from both parties on exactly what the investment will be used for is extremely important. Creating a timeline which encompasses specific milestones and the resources required would be a good method to depict what and how will the venture use the money that they receive. This timeline can be placed in a legal contract and used to measure progress. 

By outlining specific milestones, the investors will strengthen his/her confidence in the team and Entrepreneur as they achieve their predetermined goals. As the Entrepreneur, your plan can always change but the end result (each milestone) should remain constant. 

Amount of Ownership vs. Investment 

The sticky and difficult question of all: “How much should you give up?” Well there are a few methods of determining the value of a company, our finance friends will always be an advocate of the Discounted Cash Flow method or looking at industry comparables and assigning a valuation based on past and present companies. But, for a startup these valuation methods do not hold much ground. 

The first step is to determine whether the investment is a loan that is expected to be paid back or a direct equity investment into the company in return for stock. 

If it’s a debt investment, you need to determine the following:

- The payback period: how long you have to pay the amount back 

- The interest: how much interest you have to pay back on top of the initial principle amount .

- Covenants: does the company have to meet certain milestones in order to receive money

- Defaulting on a loan: the course of action if you cannot pay back your investor 

If it’s a equity investment, you need to determine the following: 

- Equity ownership: how much is each percent of your company worth. Please take a look at the equity portion of my previous post Venture Debt vs. Equity

- Vesting ownership: does the investor receive a fixed percentage from the beginning or do they receive a pre-determined percentage as the company grows

- Covenants: does the company have to meet certain milestones in order to receive money

- Defaulting on a loan: the course of action if you cannot pay back your investor 

In both situations, highlighting the return, timeframe, and outcome for the investment must be established and documented. 

Outcome

Lastly, the outcome of this investment must be agreed on by both parties. Answering the following questions will help alleviate some uncertainties: 

- What happens if the company fails? 

- Does the investor have any say in the company operations? Silent partner? Active Partner? 

      o  Silent partner: is an investor but does not have any management responsibilities

      o  Active partner: is an investor and takes active responsibility in managing the company

- What are the restrictions on the investment? Can other people invest at the same time? 

- How will the venture report back to the investor and how frequently? 

The previous points MUST be addressed and also documented for legal purposes. No matter whom you are receiving money from, make sure to have it in writing. It is imperative to have a contract for any transfer of capital in order to avoid future headache and also not to hinder your relationship. 

IF you have any other recommendations for Entrepreneurs raising money from their friends and family, please share them below. 

If you have any other questions, send me an email or post a comment.

Ashkan

Ashkan[at]greenhornconnect[dot]com