Friends and family can be counted to provide lot of things — a ride to the airport, a warm meal, or a shoulder to cry on. But should they serve as initial investors in your New Jersey start-up?
Many new ventures have difficulty securing loans or attracting venture capital funding in the early stages. When founders tap their own resources, friends and family can be a welcome source of capital. Startups can often raise $50,000 to $500,000 and more through this type of financing. And it generally only takes a matter of weeks, as compared with the often-complex venture capital fundraising process.
Of course, there are pitfalls. So before you make the call, there are several points to consider:
Keep it professional: While you may be accustomed to meeting with your friends to watch the ballgame over beers, your request for financing should receive their full attention. This means scheduling a separate meeting to discuss your venture. While a formal boardroom is not necessary, you will want to ensure that you have their undivided attention.
Make a presentation: Don’t assume that your friends and family have been paying attention to your business plans. Treat them like any other potential investor by delivering a pitch that includes all the pertinent information they will need to make an informed decision.
Have a Written Plan: You will need appropriate written documentation of what you present, including: a discussion of how much you are intending to raise; what it will be spent on; what you expect to accomplish; what the investment purchases in terms of equity interest and/or debt; and, who the management team is and their backgrounds. It is also best to disclose known or foreseeable material risks.
Consider debt over equity: If you don’t want your friends and family to have an active say in how you run your company, it is advisable to ask for a loan rather than to offer a stake (equity) in your company in return for funding.
Formalize the arrangement: Even if your parents or college roommates are the ones helping your business get off the ground, it is imperative to memorialize the agreement in writing. For a loan, you will need to prepare a promissory note, and for an investment in equity you will need a subscription agreement. Loans may be permitted to convert into equity, depending on the structure of the transaction and the documentation used.
Be mindful of securities regulations: Friends and family financings will likely involve offering securities which are regulated under the Securities Act of 1933, as well as state laws. To avoid burdensome registration and filing regulations, consult with experienced counsel to determine whether one of several regulatory exemptions may apply.
Lastly, it is important to remember that business dealings with friends and family can be more delicate than arms’ length transactions. So, if you want to remain on good terms, it is essential that everyone be on the same page.
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