Raising money from Friends and Family often has nothing to do with how capital is raised in any other investment class. The fact is most people are investing in you as a person, and as a method to make a big return on investment secondarily.
In your formative years there are typically very few truly viable options for getting your business off the ground. You don't have customers or a track record to bank on. You may not be eligible for loans or other products to help facilitate the launch of the business.
Reaching out to friends and family therefore becomes the norm for most entrepreneurs, looking to raise less than $100,000 in capital.
It's also the fastest way you'll likely get funding because of your pre-existing relationships. Most other types of funding including loans, angel investments and venture capital deals, rely on some level, relationship between the investor and the entrepreneur.
At the same time, most entrepreneurs don't have those types of relationships until their business becomes more viable, so their only alternative early on is to seek friendly capital sources.
Get it in Writing
Although raising money amongst your close relationships can be a bit awkward, it should still be isolated as a business transaction, as best as possible.
Typically lengthy legal contracts or formal agreements are overlooked on the basis of trust and pre-existing relationships. Unfortunately this can quickly lead to disastrous scenarios where both parties aren't forthright about the intentions of the relationship.
When raising money from your personal relationships, consider having written documentation of the terms of the investment at the very least.
One of the benefits to getting terms in writing is that it gives both parties an opportunity to confirm the nature of the investment. Many things can be overlooked in a conversation but a well-articulated agreement can help flesh out some of the more mundane but useful details, like what happens when the company raises more money, gets sold, or files bankruptcy.
You can even do this without lawyers if you're really uncomfortable with the legal formalities, as most people tend to be amongst friends and family. In this case, consider just putting together a one page bullet point list of what the expectations for both parties are with a signature at the bottom.
You'd be amazed at how much more serious people get about their commitments when they have to sign their name next to them!
The Real Cost of Friends and Family Deals
The real cost of raising capital from those close to you really isn't an interest rate or return. In fact it's not financial at all. It's the emotional cost of having to blend business issues with deep emotional ties.
The reality is most businesses fail, so the probability of returning capital to someone close to you does not work in your favor. For that reason raising money from friends and family presents a unique risk of straining personal relationships for the sake of the business.
There is no absolute way to avoid this risk, but there are a few ways to mitigate it.
Keep open lines of communication with your close investors and let them know when you're running into problems and why. Most relationships strain not because problems arise, but because people stop talking about the problems to begin with. Then problems turn into surprises, and no one likes those types of surprises!
Working with friends and family is a very common and accepted method of putting together startup capital, but of course it has its drawbacks. It's fair to consider this form of capital first before anything else.
As long as you are comfortable managing the personal side of the business relationship, this is likely your best bet to get started.End