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The Right Way to Get Funding From Family and Friends

 

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Most entrepreneurs I know are so passionate about their new idea that they are surprised when family and friends do not line up to invest in their new venture. Yet, they tend to ignore this problem, and move on quickly to professional investors. They do not realize that most angel investors and venture capitalists will also decline to be first, if you have no commitment from friends and family.
The reality is that investors, including myself, believe that the entrepreneur is key to business success more than the idea. Thus, they look for evidence that people who know you well are willing to bet on you, even before your idea has a chance to show traction. Do not let your lack of acumen with friends and family spiral your startup into the ground waiting for someone to go first.
On the positive side, friends and family probably will not be as demanding on your financial projections as a professional investor, and they likely will be satisfied with an initial offer of a convertible note (loan with option to convert to equity later), so you do not have to give away the store before you get started. But they do expect you to take them seriously, as follows:
1. Proactively and sincerely engage each potential investor. Some entrepreneurs do not want to put friends and family on the spot, so they keep all discussions very casual. I recommend making friends the first formal test of your elevator pitch, your investor slide deck and your business plan, and earnestly ask for their advice (not money) early.
2. Sell your idea in simple terms with both logic and passion. Vision alone rarely convinces people to invest. You need to convince family and friends, in terms they can relate to, that your idea makes logical business sense and you have done your homework on real customers, competitors and costs. Demos and prototypes are key.
3. Demonstrate your own financial commitment and progress. Just like professional investors wait for friends and family to go first, friends will wait for you to show “skin in the game.” A startup founder that is not the “lead investor” in time and money should not expect anyone else to jump in front and lead the way. Talking loudly is not enough.
4. Outline the financial options and ask for the close. Most new entrepreneurs are not surrounded by people who understand convertible notes, startup equity investing and exit strategies. They do not know what questions to ask, so they will likely wait for you to lay out the alternatives and respectfully ask for some financial help in that context.
5. Carefully explain how you intend to use the funds requested. Asking for your dream budget, with no specifics on milestones, will likely remain a dream. Outline critical tasks, with a timetable, to cover the next few months. The idea is to gain credibility with initial investors by showing them results, before asking for new and larger investments.
6. Document your commitments, as well as theirs. Loyal friends and family will want to know specifically what they are signing up for, even if negotiated informally, including the risks and contingencies. Non-specific and open-ended agreements are the quickest way to break up family and friend relationships when things get tough, and they will.
7. Use friends and family as advocates to network to professional investors. Warm introductions from friends and family to existing investors are far more productive in fund-raising than email blasts, social media connections, or cold-calls to famous investors. You need all the help you can get to build your network before desperation mode sets in.
8. Limit the role of family and friends in your actual business. Professional investors love to see contributed funds from all sources, but they are wary of startups operated by family and friends. The stress and skills required to build a startup break up too many prior relationships, so key roles should be limited to partners with skills and experience.
Overall, friends and family should never be treated as an entitlement, or as a last resort. They are a key source of investment for your startup, but if not handled professionally and sensitively, can be your worst nightmare. These situations can bring new meaning to the old adage about the first tier of startup investors as friends, family and fools. Do not let it happen to you.


Reprinted by permission.

About the author: Martin Zwilling

Martin is the CEO & Founder of Startup Professionals, Inc., a consultancy focused on assisting entrepreneurs with mentoring, business strategy and planning, and networking.

Martin for years has provided entrepreneurs with first-hand advice, mentoring and business plan assistance as a startup consultant. He has a unique combination of business and high-tech experience, and executive mentoring and connecting startups with potential investors, board members, and service providers.

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