Friend and Family Funding
• 02 Mar 22
There’s a well-known saying which tells us to never mix friends and family with business. Yet, contrary to popular belief, there are instances whereby this happens successfully. In fact, Entrepreneur.com states that raising money from friends and family to fund a Startup business is actually one of the most common forms of funding there is. This is likely due to the fact that friends or family are more likely to take a chance on you based on their connections to you, than a bank or loan institution would. This article discusses the various aspects of friends and family funding for Startup businesses so you’re able to make the decision on whether or not this is an option you’d like to explore.
What is friends and family investment?
When you’re looking to raise capital for your Startup business, friends and family funding is an option you may want to explore. Essentially, it is a form of crowdfunding, whereby you get small amounts of money from various friends and family members to raise a more significant sum of capital.
If this option is viable for you, friends and family investors are an attractive option due to the likelihood of not having to pay interest on your loan. There are also options to draw up an investment agreement which promises an equity stake or another forms of reward for their contribution to your capital investment.
What are the advantages of friends and family funding?
Let’s identify the top three advantages to financing your Startup business capital through friends and family investing.
First and foremost the biggest advantage when gaining business capital through friends and family funding is that there would likely be a much less formal process than that of which you’d get from angel investors or a bank.
Trust and interest-free
Friends and family have that initial trust in you and are way more likely to invest in your business than a third party who sees things in black and white. As mentioned above, there is also a bigger chance that you won’t have to pay an interest fee back to them.
Retain 100% control
Using this form of investing also allows you as the business owner to continue to have full control over your business.
What are the disadvantages of friends and family funding?
As attractive as this type of capital investment sounds, there are of course some downside to it too.
Any investment retains a slight risk. This could add strain to your personal relationships should the business not succeed.
Because you’ve essentially loaned money from your close friends and family, you might feel more added pressure of having to succeed quickly. This sense of responsibility to give a loved one their return on their investment can add a ton more responsibility to your plate than you already have,.
When you invest with a professional investor, should things not work out the way it was anticipated to, these investors are likely to have other ventures and are able to absorb the risk. However, friends, family and your personal savings don’t have the backup needed to be able to absorb the financial risk should anything not go to plan.
Types of family and friend funding
There are two main forms of family and friend funding, namely business loans, which is when you’ve loaned the money with the expectation of repaying it back once your business is in a position to do so. Repayments can be setup, and interest rates too.
The other type is a form of equity funding from family and friends which is where in exchange for the money loaned, your loved ones will get shares in the business,
Repayment terms and contracts
Whether or not you have an interest-free agreement with your family and friend investors, setting up a legal contract where by you stipulate the terms and conditions of the repayment is absolutely vital to protect not only you, but the investors, too. A friends and family investment agreement is a sensible safeguard so that if anything goes wrong, you both know what the correct course of action is.
Differences between friends and family and angel round?
The biggest difference from an angel investor to a friend of family funding situation, apart from the family having a personal relationship with the founder, is that they might not necessarily have any knowledge around the business or be a high net worth individuals.
Family and friends funding usually involve an average investment or about $ 23 000.
An angel investor on the other hand, is a high net worth individual, who has a solid understanding of the Startup environment and therefore is able to make investment decisions based on facts and business outlooks, rather than personal relationships. Angel investors are also able to help your business grow by taking on an advisory role. The average investment here is around $75 000.
To conclude, keep these points in mind when deciding on the best route for your Startup funding.
When you accrue debt for capital, you’ll have to pay it back, and in some cases with interest. However, you will remain in full control of your company. When you look at equity funding, this means a part of your business will belong to the investor and legally, they’re now your business partner.
When you can, try to tie all payments to your cash flow. Try to avoid obligations with fixed repayment schedules. The cashflow direction is when your investor will receive a percentage of your operating cash flow until they either have been repaid.
Know that the option to have no-voting stock in your business exists. If an investor, or a loved one wants shares, they still won’t have any say in your management decisions.
When it comes to legal basics, it can seem overwhelming at first. But, it doesn’t have to be. GLS offers a host of free Startup resources to help set you on your way. You can also browse our list of over 200 Legal Templates and Tools, to choose the products your Startup needs at each critical stage of business.
We also offer a wide range of subscription based Legal Support Plans created specifically for Startups who want a 360 degree service in creating their own virtual legal dept.
*The above content does not constitute, nor is it offered as, legal advice of any kind. GLS Solutions Pte Ltd is not a law firm and any support provided pursuant to this entity is not regulated legal advice or legal opinion.