Friends and family
You’ve got a great idea and you’ve put together a great team. All you need now is the seed capital to launch your venture. Do you ask your friends and family to become your first investors? It’s a question with no easy answer and any decision you make will come with a host of both personal and legal ramifications.
Assuming you value your relationships with your friends and family, before you take a dime from them, you should be sure that everyone understands the risk they will be taking. If it all goes well you could make your early investors wealthy, and everyone will be happy. But the truth is, most startup ventures are far more likely to fail than they are to succeed. Are your friends and family investing money they can afford to lose? If not, you shouldn’t even ask. How would you feel about losing a sizable chunk of your grandmother’s retirement savings? Probably not very good. You should have a frank discussion with your friends and family about the risks of investing in your business and be sure they understand that they may lose all of their investment.
Even if things go reasonably well after raising money from friends and family, you will probably eventually need to raise additional capital. At that time, your early investors will be faced with a tough choice: invest more capital, which they may not have the means or desire to do, or face at the hands of your new investors. This dilemma can be particularly acute if your new investors are professional investors, like venture capitalists. Professional investors are in business to make money, and their assessments regarding how much risk to take, whether and when to sell the company to find and other matters are very likely to be different than those of your early investors. If you expect that your business will require more than one round of funding make sure you and your seed investors understand that this is the case and how it may impact them.
If everyone is comfortable with these risks, the next challenge is to make sure that the terms of the investment are clearly memorialized. All too often entrepreneurs accept checks from seed investors without having the terms of the investment properly documented. “Hey, we’re all friends here, we can figure it out later.” This approach is almost always a recipe for disaster as future confusion about the exact terms of the investment can sour a relationship between a founder and his investors and can threaten the company’s future financing plans. If the investment is a loan, what are the repayment terms, what is the interest rate, is it a convertible loan? If the investment is in equity, is the company issuing or ? What, if any, rights come with the stock being offered? What does the company’s pre- and post-money look like? These are all important questions that should be addressed before an early investor’s check is ever cashed.
Accepting an investment from friends and family has the potential to not only sour your personal relationships, but it can cause legal headaches as well. Taking an investment from someone who is not an “” can create legal and business headaches for the company both at the time of the unaccredited investor’s investment and in the future. Any decision to allow unaccredited investors to invest in the company should be carefully considered with legal counsel in advance. Read more about accredited investors.
If your friends and family really want to get involved in your venture, but you are concerned with taking an investment from them, consider whether there are other ways you might get them involved in your business that don’t require them to write a check. Can they serve as an advisor to the company or as an early member of your ? Perhaps they can help with a particular skill or introductions to others in the company’s field that might be useful to your venture. While it may be easier to ask your friends and family to invest in your startup than it is to go out and convince strangers that you have created a compelling investment opportunity, taking money from those closest to you can often involve a number of potential complications that should be carefully considered before moving forward.