Articles and Advice

Are family and friends the right kind of investors?

In the early days of a new venture, the easiest way to achieve funding is usually along the path of less resistance. The obvious choice is often mum, dad, friends, and well-meaning family members. It’s certainly less daunting than approaching venture capitalists or angel investors. But if those who love you most turn you down, the consequences can be downright embarrassing. (“You can’t even sell this idea to your mum? Why the heck should I invest?”)

Entering into a business transaction with a friend or family member is not a decision to be made lightly and is far more complicated than doing business with an investor or another entrepreneur. There are emotions and important relationships at stake. If things turn sour, how will you face each other at Christmas dinner?

If it’s too good to be true….

It’s easy to understand why startups turn to friends and family for initial funding. Those who are new to the game will have limited access to investors and will face considerable difficulties in finding initial capital. Family and friends are easy to access, are willing to give you their time and are likely to be lenient if things are a bit shaky at the start.

Investment from friends and family is the obvious choice. Just make sure you have given serious thought to the pros and cons of seeking investment from those you have a personal relationship with.

The Pros

Practice makes perfect

Presenting your business case to friends and family is excellent practice. This is your chance to get clear on what you are doing, why you are doing it, and what you want. Standing in front of friends and family requires clarity (remove those buzzwords and jargon) and most importantly, honesty. It’s a great way to iron out the kinks before second round funding.

Trading on confidence

If you’re successful in achieving first round funding from friends and family, you’re in a better position to approach VCs or angel investors for second round funding. With a financial base behind you, you can confidently show an investor you are capable of presenting a good case and that your idea is a solid one.

The gift horse

One of the best things about family and friends is that they are likely to be generous and lenient with investment terms. And if you’re very lucky, you may have a family member who is generous AND wealthy and funds may come in the form of a gift. Mixing family with business is always a risky game, so if you’re accepting a gift get it down in writing. Even a well-meaning gift can end in the kind of scenario that causes life-long family rifts.

The Cons

Things can, and will, go wrong

The inescapable truth of any new venture is that things can, and do, go wrong. Before you enter into any deals with someone you care about, it’s vital to have an honest, upfront discussion. If things go wrong, you run the risk of putting a strain on the relationship, or at worst, losing it.

They’re professional investors for a reason

Professional investors are familiar with the risks of sinking funding into new ventures. They know there is always a chance they may lose the investment. Usually, the difference between an investor and a family or friend is that an investor can sustain such a loss should it occur. If you’re speaking with someone who isn’t able to sustain a major loss, then they aren’t suitable investors.

Sudden surprises

Make the terms of the investment crystal clear. Family and friends aren’t professional investors, so there is always the chance they will have a sudden change of heart and ask for their money back. Put it all down in writing and get it checked by legal. It’s important your investors can wait for their return and won’t demand their money back at a time when you are unable to get it out for them.

3 Tips For Seeking Investment From Friends and Family

Just because they are friends and family, don’t skip the formalities.  Treat friends and family exactly as you would a professional investor or financial institution. Present a business plan with an executive summary outlining how much you are hoping to raise and why you need the investment.

Make it a good deal. Entrepreneurs are most like to approach friends and families when the venture is still in its very early stages. Whether the investment is in the form of equity or a loan, make the terms favourable. Without them, you may not be going anywhere.

If it’s easy to get funding from friends and family, there can be a tendency to be less cautious with spending. Make sure you’ve done the hard graft and raised some capital by your own means. And don’t forget other options like crowd-funding or fellow entrepreneurs.

After weighing up the pros and cons, you may decide you want to stay well clear of awkward family situations and stick to the professional investors. The impact of things going wrong with friends and family can stay with you long after your new business has failed or succeeded.

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