For many entrepreneurs, starting a business requires an initial investment, and more often than not, this first injection of capital comes from their friends, family, and people in their close personal network.
While there is plenty of upside to a doing an initial friends and family (“F&F”) round, accepting money from loved ones to fund your startup also comes with financial, psychological and emotional risks, so it’s imperative to think ahead before accepting those generous and supportive cheques.
We recently discussed this topic with one of our portfolio company founders, Daniel Eberhard, shortly after he was cited in a piece on Love Money in the Financial Post.
Daniel is the Co-Founder & CEO of Koho, a banking startup geared at millennials, which just closed an oversubscribed $1M seed round. A proponent of friends and family money, but also conscious of mitigating risk, Daniel says having honest upfront discussions is a critical first step.
“We always told people not to participate unless they could afford to lose the money,” he explained of his previous business, which he and a co-founder launched with a $100,000 F&F round. “We also told them that once they were in, they should treat the money as though it had gone to $0. A really high percentage of startups don’t return money to the investors, and we made sure everyone knew that. I also made rules that we weren’t allowed to talk about it at family dinners and get togethers.”
Down the road, once you have more validation and start pitching angels and VCs, that initial funding — and the results you were able to drive with it — can also offer you a positive edge.
“There are optical advantages to friends and family money,” Daniel explains. “It means the founders have more on the line, which improves your alignment to investors. You’re not going to disappear into the night with family money. It also provides the founder with additional sources of motivation — and pressure.”
One of the biggest questions entrepreneurs have at the F&F stage is how much equity they should give.
“It’s not a question of how much equity you should give,” Daniel says, “It’s a question of what you need and what a fair company value is. Put it through the company lens first. Convertible notes are a good tool for F&F rounds because you don’t have to have the company value conversation until your next round of funding, at which point you should have professionals involved.”
When faced with the choice of giving up equity or taking out a loan, Daniel suggests “you should definitely give equity. If it goes to $0, it doesn’t matter if it’s a loan or equity, so it makes sense that family should get to see the upside.”
Like any topic in this industry, you’re going to hear varying thoughts on F&F money. Do your research, talk to knowledgeable leaders, then — no matter how intense the social pressure gets — make the decision that’s best for you and your business.
Read more about raising friends & family money:
- Raising Money From Friends and Family (Forbes)
- Avoiding the pitfalls of raising money from friends and family (PandoDaily)
- 5 Lessons for Raising Money from Family and Friends (Fast Company)
- Startup Funding – The Friends and Family Round (AngelBlog)
- The Ins and Outs of Raising Money From Friends and Family (Entrepreneur)