Should You Raise Capital From Family & Friends?

It’s really easy to find information about raising money from angel investors or VCs, but many people don’t think about another important way to fund a startup: raising money from family and friends. I’ve raised money from friends and family twice, and want to share what I’ve learned — so that you can raise money from your friends and family, and still be able to attend your family reunions.  Raising money from friends and family can be easier and less complicated than raising money from professional investors, but is not without drawbacks.

There are certainly pros and cons to raising money from family and friends, and when it came time to raise money with my first company, I had the choice to raise money via angel investors or from family and friends. We were able to raise six figures fairly quickly from a good group of investors, which helped us stay focused on running our business rather than raising money. Unlike working with an angel or VC groups that would have wanted to get to know us for at least three months, we were able to close our round in about six weeks. And four years later, we raised another round with significant friends and family contributions for Entrustnet, a website that helps people find, access, transfer and delete online accounts when someone dies, in about eight weeks.

How were we able to raise money quickly? How do you actually approach family and friends about investing in your business? What are some advantages to raising money from friends and family instead of angels? Here are some of the things we did:

  1. Be prepared. We were able to raise money quickly because we wrote a detailed business plan. We used our preparation and research to get our friends and family to believe in us. Before we asked for anything, we wrote a two-page executive summary of our business that included how much money we were trying to raise, our valuation, how much they would need to invest to own 1 percent of the company, why we needed the money and what we planned to do with the money when they invested. This exercise helped us really key in on how to explain our idea and plans to our family and friends in clear language, free of jargon. It’s important to avoid buzz words and cliches when writing a business plan, but it’s even more important when the intended audience is your family and friends. Friends and family are not professional investors and need you to explain your vision at a very basic level.
  2. Seek accredited investors. All of our investors had net worth of at least $1 million or a yearly salary of over $300k. Accredited investors helped us in two ways. Since they were high net worth individuals, they could afford to lose their entire investment if we did not succeed, which helped us avoid the mistake of raising money from people who cannot afford to lose it. Having accredited investors also meant less paperwork for us and our legal team because of laws that allow people with higher net worth to invest with fewer requirements.
  3. Put your cards on the table. We were upfront with our potential investors. While we were confident we were going to be successful, we told the investors that the worst-case scenario involved the possibility of them losing 100 percent of their investment. We told them that they might not see a return on their investment for five or more years. And our investors were comforted by knowing that we were being honest with them about all of the risks.  Don’t make promises you can’t keep just to get someone to open their checkbook. When you don’t fulfill a promise you made a few months down the road, your friends and family will not be happy.
  4. Don’t drink too much from one source. In my first company, our biggest chunk from one single investor was $70,000.  While we ultimately made him money and he could have afforded to lose his investment, it would have been more comfortable for everyone involved to have gotten a little less from one single source. It’s also not the end of the world if one of your potential investors turns you down. Don’t press for money from someone who is uncertain because they will be the first to complain when things are not going as well as you had hoped.
  5. Set a realistic valuation. Don’t set your valuation too high. While you are trying to get a good deal for your business, your investors should be getting a good deal as well. They are, after all, your family and friends.

A family and friends round can also set you up nicely for a second round from an angel or VC if it is necessary down the road. If you can show that your family and friends believe in you, and you’ve hit the milestones you’ve promised, it gives you credibility. You don’t want some angels watching your pitch thinking, “This guy couldn’t even get his Mom to believe in him, so why should I?” I encourage you to think about friends and family as a viable way to get your first round of funding.

Nathan Lustig, from Madison, WI, is the cofounder of Entrustet, a website that helps people access, transfer and delete online accounts when someone passes away.