Expect investors to take an active role
The friends and family members that invest in your business may want a say in how things are done. It is also something you should discuss before raising money from people you are close to. Investors, even if they are your parents, will want to protect their investment. Expect them to check in, ask questions about the business, and give you unsolicited advice. Don’t take it personally – it is a business relationship, and you should treat it as such.
Above all else, you want to show your family that you are professional and prepared. Show them you’re ready for the big time by having all the necessary documents and by answering any questions they have. Practice your pitch before hand, and think through your answers to any potential objections.
Keep investors in the loop. Once you receive funding from your family and friends, continue to communicate with them about your business. Talk about the good and bad, because learning from mistakes is part of the process. If you eventually need additional investments, keeping your investors updated should help with the process of asking for more money. Frequent and candid communication about the progress of the venture will enhance family communication and potentially prevent feelings of hurt or anger.
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Be prepared with a formal agreement and a thank you
While so much of your relationship may be built on blood being thicker than water or friendship as thick as thieves, trust is always better when it’s on paper. Your term sheet is a documented agreement used to outline your investment terms and conditions. This dictates the investment type, interest rates, and agreed-upon company valuation.
A formal agreement is necessary when borrowing from family and friends. Few things can destroy an otherwise good relationship faster than a misunderstanding over money. If you are asking for funding for a business purpose, make it a business transaction. Even if the lender says that formalizing the loan or investment capital is not necessary, it is – not only to protect the person who is giving you money but to protect yourself and your business as well.
Insist that the terms of borrowing or investing, as well as any repayment terms, are clearly spelt out in a contract or agreement. Make sure all parties involved in the transaction sign it before you accept the cash.
The agreement ensures that all parties are on the same page about every aspect of the loan. It helps you stay on track with spending and paying back the money. And, it keeps lenders focused on their roles in the loan. If you don’t, bitter arguments are bound to sour the relationship eventually. Even some minor detail, such as the timing of interest payments, can cause great friction if arrangements aren’t backed up in writing.
Communicate your plan and the risks up front
Carefully explain how you intend to use the funds requested. Asking for your dream budget, with no specifics on milestones, will likely remain a dream. Outline critical tasks, with a timetable, to cover the next few months. The idea is to gain credibility with initial investors by showing them results, before asking for new and larger investments.
Document your commitments, as well as theirs. Loyal friends and family will 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, and they will.
Remember that no investment is a gift, and everyone who buys in deserves to hear what you plan to do with their investment and expects regular updates from you along the way.
Conclusions
When you ask family and friends to fund your startup it means you have made a first serious step at creating your new company. There is no backing out now, so you should be 100% serious and ready to go forward from this point on.
This means that your business plan better be sound before asking for money and if you are still not sure if it is good enough, you should return to the drawing board. Also on the positive side, friends and family probably will not be as demanding on your financial projections as a professional investor, and they likely will be satisfied with an initial offer of a convertible note (loan with option to convert to equity later), so you do not have to give away the store before you get started. But they do expect you to take them seriously.
Overall, friends and family should never be treated as an entitlement, or as a last resort. They are a key source of investment for your startup, but if not handled professionally and sensitively, can be your worst nightmare. These situations can bring new meaning to the old adage about the first tier of startup investors as friends, family, and fools. Do not let it happen to you.
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