Q. What’s one thing NOT do when trying to raise capital from family or friends for your startup?
The following answers are provided by the Young Entrepreneur Council (YEC), an invite-only nonprofit organization comprised of the world’s most promising young entrepreneurs. The YEC promotes entrepreneurship as a solution to unemployment and underemployment and provides entrepreneurs with access to tools, mentorship, and resources that support each stage of their business’s development and growth.
A. Don’t Rely on Memory Alone
Do not do business with friends or family — or anyone, actually — without a legally binding agreement. Interpretations differ, memories degrade, and if you’re relying on a handshake alone, then your relationship and business can suffer. It’s easier to envision contracts as a clarifying document to protect each person rather than some evil necessity.
A. Don’t Assume They Know Everything
Do not assume that they know what you know, or even how business investments works. Explain all terms, risks, conditions, alternatives, and exit strategies in a basic and understandable format, so that a future failure or success does not jeopardize your relationship. Put everything in writing and involve a third party as a witness of the understanding.
A. Don’t Think It’ll Be Easy
While your friends and family are much more likely to support your startup efforts, never be blasé about raising funds from this group. Give friends and family investors the same thoughtfulness, preparedness and consideration as you would a professional investor. And, like with Venture Capital or other traditional investors, make sure you have enough lead time with your deliberations.
A. Don’t Make Grandiose Claims
Unlike investors, your friends and family are people who will continue to be in your life whether your business succeeds or fails. Avoid making outrageous and inflated claims. Be conservative and allow your work to speak for itself.
A. Don’t Oversell
Simplify your pitch down to a single page, then speak in very plain language. Tell them that they could lose all of their investment. That it’s a risky investment. Even though you think you will succeed, they need to know that most startups fail. Be honest and you’ll still be able to go to Thanksgiving dinner without shame.
A. Don’t Take Money They Can’t Afford to Give
Your friends and family care for you and will be willing to take bigger risks with their money as a result. But don’t let them give you too much — even if you just need a little more money to finish development, that doesn’t excuse things like letting someone tap a college fund or a retirement account. I don’t care if you are certain you’ll be able to replace it in no time — don’t do it!
A. Don’t Beat Around The Bush
Be very straightforward about why you need the money, what you will use it for, and how they will get it back. If you aren’t realistic with them upfront then you are setting yourself up for a nightmare. Have a plan and strategy going into the discussion.
A. Don’t Think They Can Automatically Comprehend
Usually, family and friends are not investors so the deal has to be very easy to understand and to explain, otherwise they could feel ripped off. Use the same valuations and rules for all of them — again, they’re not professional investors. You could do a different deal with two experienced angels, but not with your friends and family — they may not understand it.
A. Don’t Accept Investments Essential to Their Retirement
Of course your startup is a “sure thing,” but circumstances beyond your control can come into play without notice. Clearly communicate the risks associated with your company and only accept discretionary capital from all private investors — especially friends and family.
A. Don’t Give Passive Investors Control
Although you want to take care of your family, you don’t want your families opinions to hurt your business. If raising money from family is a must — though I don’t recommend it — then you want to at least make sure that the family members do not get a vote or say in the direction of the business. If they want control, do not take them on as an investor.
A. Don’t Wait Any Longer!
Do not wait for the perfect moment to ask people for capital for your startup. You may be surprised at how much support you have from your friends and family, once you ask for it. Even if they say “no,” you have started the process of getting them to think about helping you, and sometimes you need to plant that seed before it grows. Let them see your commitment, and they may change their mind.
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