Though the media typically focuses on venture capitalist funding as the primary source of start-up cash for entrepreneurs, the truth is that more than half of the tens of billions of dollars raised every year by entrepreneurs comes from donations by family and friends.
It’s not very glamorous, like most things about running a start-up. Most entrepreneurs struggle with finances, digging in every corner they can manage to keep their venture afloat, and frequently turn to trusted family members, friends, and acquaintances for help. In fact, in the early round of funding, most start-ups are unlikely to receive funding anywhere else, least of all big-time venture capitalists.
But as you certainly know if you have started your own business, approaching family or friends about money can be awkward, tense, and has the tendency to bring out the worst in people. There may not be one right way to do it, but there certainly is a wrong way, and if you want to avoid it, follow these steps when pitching to your family.
Think Like an Investor.
We’d like to think that our family and friends are motivated by an altruistic desire to see us succeed in our ventures. This is just not true. Granted, your family and friends generally have your best interest in mind, but the second you start talking about investing in your company, you may see a side of them you haven’t seen before.
You have to remember that everyone is captivated by the idea of start-ups, and that everyone wants to be rich. Because most people don’t know anything about start-ups, they sometimes think that they can become rich if they invest in your business, or that by investing they are entitled to help run your business by proxy. It can get ugly.
The trick is to anticipate how each person you pitch to will respond. Your parents, for example, will probably have different motivations in investing than your distant uncle, who will have still another set of motivations than your friends. Make a list of all your potential private investors and frame different pitches for all of them — or at least for everyone you think will have different motivations.
Avoid Equity Like Ebola.
Privately held equity in your business can be like a plague that destroys it from the inside. If you sell $10,000 worth of stock to your aunt, for example, and your company doesn’t sell, or fails for some other reason, you will be responsible for paying out that same $10,000 back to her for her stock.
Taking on debt, on the other hand, allows you to pay your family members and friends back slowly, which shouldn’t be quite so much of a burden if your company is doing well. And even if it folds, at least you will already have a structured repayment program in place, instead of a huge sum of money that floats ambiguously over you and damages your relationships with your investors.
Furthermore, as suggested above, when an investor has part ownership of your company, he or she also often feels that he or she should be allowed to make business decisions — especially if that investor is a family member. I’m sure I don’t need to go into detail about how uncomfortable and aggravating this could be.
So Many Choices…
When you pitch to an investor, you will generally have very little time to make an impression, so your pitch strategy has a kind of frantic, take-it-or-leave-it style. This same style might put family and friends off, and make them feel pressured or bullied. So, don’t assume a one-size-fits-all investment plan.
Rather, create a variety of plans, with varying terms, amounts, and interest rates, from which your private investors can choose. Remember that, because they are your family and friends, you don’t have to give them the hard-sell; mostly they will want to help you. But not every private investor will be able to afford the same kind of investment, so develop three or four different investment plans that range in amount to get the most money.
Always Get It in Writing.
The title says it all. No matter what you decide on, get the decision in writing. There are too many ways an investment can go bad when it wasn’t put in writing to even list here, so I will just stress how important it is that you not be satisfied with a verbal agreement. Hammer out all the details verbally — repayment schedule, amount, interest, etc. — and then write up some documentation that formalizes the discussion. Doing so will save you from straining your relationships and losing friends.
Family members and friends are more flexible than other funding sources, but should be treated with as much or more respect than venture capitalists or angel investors. Don’t take advantage of them, and don’t let yourself be taken advantage of.