It is tempting. It is difficult to raise funds from angels and VCs, especially when most of what you have is just an idea. I get it. Friends and family are right there, they have known you for a long time, your whole life. They believe in you. Many, if not most start-ups do it – statistically, they tend to raise between $25,000 to $150,000 that way. The process is generally much faster, too, compared with angel and VC deals.
Think about friends and family financing carefully, though. Mixing your personal and professional life is often not a good idea. Friends and family often lack the expertise to assess valuation, structure, risk etc. of the deal. And the fact that your parents’, sister’s etc. money is in your venture kind of compounds the pressure that you are already face to succeed.
Fast forward: You thought about it, and decided to do it anyhow, which is fair. In this case, make sure that the process is as arm’s length as possible. To that end, keep in mind these few pointers to make the venture a win-win for everyone:
Keep it professional: Schedule separate meeting(s) to discuss your venture, don’t mention it in passing while watching a ball game. You want to make your potential investors focus and you have his/her undivided attention.
Keep it formal: Treat friends and family like any outside investor. Deliver a pitch that includes all information they need to make an informed decision. Disclose the risks. Talk about how you came to the valuation.
Consider debt over equity: Both in people’s minds and legally, shareholders and lenders live in different universes. Shareholders expect a decent/big/out-of-the-ballpark return, and often have a distinct opinion how to get there. Lenders generally want their money back with a decent coupon. If you would like to offer a hybrid, a convertible note may be a good way to go. They are standard in angel rounds as well.
Formalize the arrangement: It is imperative to memorialize the arrangement in writing. This is a non-negotiable. Keep it simple.
Be mindful of securities regulations: Check with counsel whether there are securities law implications. This is a consultation and does not have to be expensive. Many lawyers do it for free.
I worked on an IPO where one of the largest shareholders had loaned his friend eighty thousand dollars for his start-up and put it on his credit card. Last I heard is that he (the friend) remains independently wealthy. Needless to say they are still friends. It’s all about managing expectations, I guess.