One of the first places many startup entrepreneurs start when raising capital is to look to their friends and family. But I’d caution you prior to taking that step.
1. How it works
Typically an entrepreneur’s friends and family that invest will get common stock in exchange for a non-controlling interest in the company
These types of investors usually have very vague expectations
A typical example might be the situation of your aunt Sue who has a lot of money and thinks of you as her favorite nephew. She gives you a check for $50,000 and says “good luck” to you.
2. Key Advantages
The advantage of friends and family investors is that it’s the easiest capital for a startup to raise because these are people that know you well
This kind of investment is best for small amounts of capital
3. Key Disadvantages
There are three primary disadvantages with these types of startup investors:
This is a very informal process and it can be an uncomfortable “ask” – you may feel like you are begging and they may feel unduly pressured into investing because of their relationship with you
Your relationship with your friends and family will absolutely change when they go from being merely “Aunt Sue” or your college roommate, to being an investor. Suddenly, they are always bugging you every time you communicate. Your startup will seemingly never launch fast enough, grow fast enough, or sell fast enough to suit them. You cannot go back again to merely being the nephew or the college friend.
Another problem is that this is almost always a “no win” situation. Here’s why: Let’s say your Aunt Sue invests $50,000 in your startup in exchange for 10% of the company and you go on to build the company and sell it for $10m and give her a check for $1m. While she will be very happy, all of your other family members will be mad that you didn’t “let” them invest. Of course, that’s easy for someone to say or think after the fact – but they will. And it will create hard feelings. Every time Aunt Sue enthuses about her success, it will only rub it in for the others at your family gatherings. On the other hand, let’s say things don’t go well and Aunt Sue loses all of her money. Now she’s mad at you at every family gathering and you are no longer her favorite nephew. And just seeing the two of you in the room reminds everyone else in the family that you lost her money. And it’s the same with friends. Imagine how uncomfortable your reunion gatherings will be with your college friends. Either someone is mad that they didn’t invest or mad that they did. You can’t win.
Avoid taking money from family and friends, but if you do, treat them as a professional investor and not just family
Only approach those with both business savvy and deep pockets; the last thing you want to do is take money from family and friends that really cannot afford the risk