Introduction to Funding: Friends and Family
A commenter on a previous funding post noted that I discussed having personally done different sorts of financings including Friends and Family but then didn’t elaborate on this point. I’ll remedy that now in a short post on the matter.
There are two things I hate about friends and family financings and one thing I really like about friends and family funding.
First, the good news. I generally think these are great ways to finance companies that might not need much more capital. If you can get off the ground with a small financing that friends and family can perform and that ultimately takes the business to cash flow positive, then this is a great way to go. You don’t have investors that necessarily need to get liquidity at some point, you probably have much more favorable terms, etc. You can grow the business at your pace and everybody’s happy.
However, as the commenter on my previous post noted, the more emotional connection that one has to friends and family investors can be a real problem and may lead to one or more of the following: a) not throwing in the towel when you really really ought to throw in the towel, b) not being honest with your friends/family/yourself about the state of the business if things aren’t going well (and you’re going to want SOMEBODY to turn to!). Finally, there's the general emotional distress if you are in a situation where you aren’t as far along as you thought you’d be at this point and your friends and family "need their principal back". Uh-oh, that’s not going to be a good time for anybody.
The second reason to dislike friends and family funding is when you follow it up with a more formal venture financing. Your venture investors are going to want preferred stock with all sorts of special rights and privileges and now you are in the uncomfortable position of telling your Uncle why John Doerr’s dollar is worth more than his dollar. Although that wouldn’t be too uncomfortable a position as you could follow that by describing some of John’s other investments, but I digress, and hopefully, you see my point.
One last thing – the comment on my other post asked that I blog how it worked out when I raised friends and family money. Fortunately, it worked out fine. It was my first entrepreneurial endeavor, it was family not friends money, and when things were rough sledding after a few months, there was a healthy dose of motivation due to “owing” the family money that probably got me through some early jitters and second thoughts.
Comments
Another great post -- one way to solve the negative piece on friends and family is either to do it all as a convertable security -- or -- if your friends tend to be private equity guys anyway -- just set it up as a preferred round off the bat.
Posted by: AlFromChicago | March 2, 2007 09:37 PM
As an Entrepreneur who might have family and friends who can help provide some helpful initial funding, I have two questions:
(a) how do I deal with the fact that my family and friends are not accredited investors?, and
(b) how much would be the minimum you would suggest that I ask each friend for (below which would be too much overhead for the benefit of the money)?
Thanks!
Posted by: Anonymous | March 3, 2007 03:45 AM
I remember reading about S-Corps being allowed to take money only from wealthy individuals having a Million or more of it. Is there a way for S-Corp to take funds from friends/family who are not millionaires? Would that be sore point during further rounds of funding?
Posted by: Vijay Sivasankaran | March 5, 2007 12:11 AM
I personally think that raising funding from friends and family is a terrible idea, one to turn too only when there's no other option.
If you're successful then it all great, but what happens if you fail? (and let's be honest, you're more likely to fail than to succeed). That could spell trouble for your relationships with the people you care most about. Businesses come and go, but families don't and neither do good friendships. I just don't believe that it's worth risking the latter for something transient, especially if you have other options.
Now, don't get this wrong - I'm not saying that your relationships with those people will definitely be ruined. Most likely they won't be. But they'll definitely be strained, and even the possibility of ruining an important relationship is enough IMHO to steer clear of this course of action.
Posted by: Elad Kehat | March 30, 2007 08:54 AM