First post of a series with all you need to know about private investors for startups and small businesses.
“How should I fund my startup business?”
“How much funding do I need?”
“What’s the best source for funding?”
The short, unsatisfying answer is: “it depends”. Every startup is different, and so is the optimal funding strategy.
It is always thrilling to start a business. However, most startups lack sufficient funding for their growth. As they attempt to finalise their product or service, ramp up sales and achieve traction, it becomes more difficult for them to set aside time to raise funds for their business.
To take some strain off their finances, the startup founders often rely on private investors. So, who exactly are these private investors and how do they fund startups?
In this series of blog posts I will deep dive into 4 sources of investment money:
- Friends and family,
- Angel investors,
- Venture capital,
- Late stage venture capital.
My goal is to help you make the right funding decision – what kind of startup funding options are available in different stages, what the strategies are for pursuing them, and how founders can determine a funding path that is right for them.
This first blog post is dedicated to raising private investments from friends and family.
Who and friends and family?
Also called “friends, family and fools (FFF)”, these are often the first point of contact that startups turn to. They’re a great resource for pre-seed funding, as friends and family already have that base of trust that founders usually have to build from scratch with other private investors.
If you need a smaller amount of money (under €50,000 or so), this may be one of the first avenues to check out. These are the people that believe in you and want to see you succeed, so they will be less willing to cash on interest and how quickly you pay any money back. They are more likely to buy into you and your idea and need little evidence of your business succeeding.
How does raising private investment from friends and family work?
Friends and family are a great source of early investment, but it can be a tricky relationship to navigate. It’s common for people to feel like they can be casual with these types of investors because their relationships with them are personal. That’s a mistake.
Founders should treat investment from friends and family as a professional addition to their existing personal relationship. It’s a good idea to get a written contract stipulating the terms of the investment and also to make it clear that it’s very likely they won’t get their money back. This is about setting expectations straight from the beginning. Also, you may lose the friend, if the startup fails.
Advantages of working with friends and family
The biggest advantage of raising money from friends and family lies in the fact that a founder already has an established, trusting relationship with these people. That means they’re easier to get a meeting with, more inclined to say “yes,” and are more likely to be flexible with their expectations and timeline.
The structure of the investment will also likely be simpler than an investment from more formal investors like business angels and VCs. Founders borrowing from friends and family don’t have to fulfill complicated due diligence processes like they would with larger financial institutions.
Finally, raising from family and friends allow founders to keep their ownership high and remain independent.
Disadvantages of working with friends and family
There are many reasons why an entrepreneur may not want to invest with friends and family members and focus more on angel or VC equity financing, small business loans or public grants.
Introducing large sums of money into a relationship that was previously entirely personal has the potential to ruin that relationship.
That’s a particularly big risk if a startup fails and investors lose all of their investment. So it’s important for founders to be very clear about the potential for loss when accepting business funding and investment money from friends and family.
Friends and family members also may not be able to add value to a company in the same way that more formal, established private investors can. VCs, for example, typically invest in startups in fields that they are familiar with. Having that kind of knowledge on board is a huge advantage for any new company looking for private funding.
Finally, the amount that founders can usually raise from family and friends might be too little to sustain a longer run. Growth will need to focus on reinvesting profits or looking for other sources of financing fairly soon.
Every startup is different, and so is the ideal funding path. Usually founders start by raising early-stage capital from friends and family to validate their value proposition, build initial traction and find their first customers. This is what investors refer to as: “early product-market-fit”.
As you’ll notice in the next posts of this series, additional funding alternatives from different sources are best suited for different startup stages. Choosing the right one can give you the boost you need. The wrong one might hold you back or lead you in the wrong direction.
In the next post, I’m going to take a deeper dive into the pros, cons, and tactics of raising private investments from business angels.
Sign up to our newsletter to get funding insights right into your mailbox.
Marco Torregrossa is private investments advisor for Innovation Manager Finland Ltd. Follow him at @MarcoTorreg