What is friends and family funding?
When you're trying to get a new venture started, friends and family funding is often the first place you turn to raise some capital.
In essence, friends and family investors are a form of crowdfunding. You might take small amounts of money from several family members or close friends, to raise a more significant overall sum.
Friends and family investors may be willing to put money into your business venture on an interest-free basis. Alternatively, you might draw up a friends and family investment agreement that promises interest, an equity stake or some other form of reward for lending you the money you need.
What are the advantages of friends and family funding?
Friends and family funding often takes place on a much less formal basis than bank business loans, angel investments or even peer-to-peer lending from strangers.
It's a way to raise money at a very early stage in your business. You might not yet have a complete business plan or any proof of value, such as initial orders for stock.
Most friends and family investors will be willing to put their trust in you to deliver on your business plan, no matter how concrete or vague it may currently be.
Investing with friends in this way can allow you to keep full control of your business, and it can also be exciting as you embark on your new project with your loved ones along for the ride.
What are the disadvantages of friends and family funding?
There are risks involved with any investment, but in family and friend investments, the close bond you have with your new financial supporters can add to the stress if your venture does not succeed quickly.
You might feel more of a responsibility to give your loved ones a positive return on their investment, or at least to pay them back the money they lent you whether with or without interest.
In the worst cases, if your business fails, you risk not only your personal savings but also potentially a large amount of money from many of the people who are closest to you.
Whereas a professional investor will be able to absorb this risk by spreading their investments across multiple different ventures, it is more likely that family and friend investors have put all of their money into your project.
That means that if you fail, you and a lot of the people around you could be left out of pocket by a large amount, which can put a lot of strain on personal relationships and damage your quality of life too.
Types of family and friend funding.
Although it's often quite informal, family and friend funding falls into a few common types. These share some features with other methods of investment, like peer-to-peer lending, crowdfunding and angel investment.
Two of the main kinds of family and friend investments are business loans and equity funding. You promise you will repay the loan with interest or give an equity stake to your friend or family member as a thank you for their support.
In the very early stages of your business, it can be hard to know how much to promise. An equity stake is a scalable way to offer your supporters a fair share of any future profits, but you might not want to give away too much of your company as early as the pre-seed funding phase.
Business loans from family and friends.
Startup loans from family and friends are a common way for them to give you the money you need to get your venture started. Friends and family loans are often early in the history of your business, around the pre-seed or seed funding stages. In some cases, entrepreneurs also use startup funding from family and friends as a bailout option when things are not going well over the short term.
Like any loan, a friends and family business loan can include an interest rate that determines how much you pay back overall. However, it's also quite common for friends and family investors to accept an interest-free arrangement just because they want to see you succeed.
Either way, make sure all parties are very clear about what you have agreed and put the repayment terms in writing so there can be no disputes later.
Equity funding from family and friends.
In some cases, you might want to offer equity in exchange for financial support from family and friends.
Like any equity investment, this means you give away some of the control of your company, so it's essential to think carefully about how much you give away and the value you place on it.
Remember that equity investment is commonplace later down the line. So if you are using family and friends investment as a source of pre-seed funding, don't leave yourself with little to no 'spare' equity to offer to later institutional and angel investors.
Equity investment is a good option because it means the amount you owe your investors depends on the future value of your business.
But it can also give your investors a stakeholder position in the running of your company, so make sure you have a plan for how to deal with this if your friends and family start trying to make decisions about your business.
Repayment terms and contracts.
It's always sensible to have written repayment terms and contracts for any investment, even if you are raising money from family and friends who you trust implicitly. A friends and family investment agreement is a sensible safeguard so that if anything goes wrong, you both know what the correct course of action is.
Common problems range from financial disputes to personal disagreements, for example:
- If you are unable to keep up with the promised repayments
- If the venture makes unexpected profits and your investors demand a share
- If your friends and family investors try to interfere with business decisions
You never know when a business relationship will start to interfere with a previously close personal connection, so be ready to deal with any problems sensibly and professionally.
By keeping up with your promised repayment schedule and making clear what your supporters can expect to receive in total, you can preempt any such problems so that everyone gets what they hoped to receive for their investment.