How to Raise Friends & Family Financing in 6 Steps

Friends & family is one of the most common source of financing for many startups: 38% of all startups raise friends & family money. So if your startup to raise pre-seed and/or seed money, friends & family might be for you. How to raise friends & family? What are the different instruments available? How to structure a friends & family deal?

In this article below we’ll go through 6 steps you must follow if you want to raise friends & family financing for your startup. From the amount, the financial instrument you should use and the percentage ownership you might have to give away, we’ll tell you everything you should know about structuring your friends & family round.

What (Exactly) Is Friends & Family Funding?

Most startups need external financing to fund growth. Yet, the more early-stage a startup is, the more difficult it is to get funding.

Indeed, early-stage startups often don’t have yet a MVP, nor a complete founding team, customers, revenue. Sometimes, founders only have an idea when they raise money. As such, friends & family is a form of pre-seed or seed startup financing.

This is where friends & family comes into play: in their early days, founders often get financing from their own network of friends and family. These are individuals that generally invest anywhere from $5,000 to $50,000 from their own personal finances.

How is friends & family different vs. angel money?

Because they’re both a form of early-stage financing, friends & family and angel funding can easily be misunderstood. Here is a comparison table so you understand their key differences:

	Friends & family	Angel investors
Type of investor	Private individual, usually a personal connection (either a friend of family member). Not necessarily a high-net-worth individual	Private high-net-worth individual. An angel isn’t necessarily a personal connection to the founders
Average investment size	$25,000	$75,000
Funding round	Pre-seed (or less often, seed)	Often seed but can also participate at future rounds (Series A or higher)
Startup valuation	Typically < $1 million	Typically > $1 million
Other benefits	None (friends & family is very often only a source of funding)	Due to their experience and/or own network, angel investors can bring substantial benefits to early-stage startups, other than money. They can advise on business and/or strategic matters, open doors to their own network (investors and/or customers), etc.

Why is friends & family so attractive for founders?

For founders, friends & family is a very attractive source of capital. Indeed, because it is mostly based on trust between friend relationships and loved ones, it is often very flexible and inexpensive.

Indeed, it isn’t uncommon to see startups get no-interest business loans from friends & family.

Yet, because friends & family isn’t a standardized form of financing with clear legal documentation, it’s often misunderstood and can also lead to significant problems down the road.

Friends & Family: Pros And Cons

As any other form of financing, friends & family come with their own pros and cons for startups.

The pros

1. It’s often the only source of financing available

Beyond founders’ own pocket money, there is often no possibility to get angel investors. For a complete checklist of what you need to raise seed money from angel investors and VC funds, read our article here.

So if you can’t show any of these elements on our seed funding checklist, friends and family might be the only option for your startup.

2. Access to funds is immediate

Because you’re raising money using established trust from people who already know you, and because friends & family aren’t necessarily experienced investors, there’s little due diligence (if any).

Also, friends & family typically comes with little legal documentation. Money is sometimes disbursed to founders without any form of legal contract (yet you shouldn’t do this – see below).

Therefore, little (or no) due diligence, and a light legal documentation means shorter time to access funds. You can easily get money within a few days, as long as you can convince your friends and loved ones you’ll repay them in the future

3. Terms are very flexible

For the same reason of trust we discussed above, friends & family typically are investments which are fully customized, and terms are agreed on a case-by-case basis.

Therefore, there are plenty of choices to choose from: business loan (with or without interest and/or maturity), equity, convertible debt, warrant, etc.

Yet, because they’re often not experienced investors, friends & family investments unfortunately aren’t well defined either. This can create problems as we will see below. To avoid these problems, we strongly recommend reading up on term sheets and their key terms. Also, make sure to hire a lawyer to review your contract, as simple as it may be.

4. It can be pretty inexpensive

If it is structured as a debt investment (like a loan), friends & family investments can be very cheap for founders.

Let’s assume your startup raises $50,000 funding from friends & family as a loan with 20% accruing interest. This means you’ll have to repay their investment in the future: $60,000 in one year, or $72,000 in 2 years, and so on. This is very attractive for 2 reasons:

• You don’t lose any ownership. Selling equity early stage is always a big problem, as valuation is difficult to assess to know how much equity percentage you should leave friends & family. See more on that below. Instead, if you raise friends & family as a loan, you’ll keep 100% of your business and the returns that come with it when you exit
• You keep all the upside. This follows what we just discussed: equity investors enjoy upside potential (the value of their investment to go up). Instead, debt investors have downside protection: they’re the first in the line to be repaid. The problem for debt investors that invest in early stage startups is that, in case of a bankruptcy, they almost never get repaid (unlike mature companies, startups are cash poor). This is bad for debt investors, but great for founders. Think of it that way: assume you raise $50k as a business loan when your business is worth maybe $500k, that’d be 10% if you raised equity right? With debt instead, assuming you repay the loan in 2 year, using your seed funding then at a $3 million valuation, you’ll only have to repay $72k, which otherwise would have costed you $300k (10% of the $3 million)

The cons

Friends and family members are your inner circle. Therefore, things can quickly get messy when money is involved. This is especially true when the terms aren’t clearly defined upfront (more on that below).

1. It can easily lead to difficult situations

As we explained earlier, friends & family is the most flexible form of funding a startup can get.

It’s fully customised based on what you need as a founder, and what the investor is willing to agree to. Trust is generally more the bond than the contract itself.

Yet, this doesn’t mean you should overlook legal documentation either. Problem may arise for a number of reasons.

What would you do if you sold a 15% equity for $100k, yet 12 months down the line your business is so successful that it’s now worth $5 million? Your friend made a 7.5x return over a year, not bad. You, comparison, made a terrible mistake and misjudged your valuation back then.

Another example:

Let’s assume you agreed to a $100k convertible loan with a 1 year maturity. At maturity, you haven’t managed to raise equity yet, so your friend (or family member asks you to repay the $100k). What do you do if you don’t have this $100k? This can easily to a bankruptcy, damaged relationship, or both.

2. It can be very expensive

Pricing an equity investment for an early stage startup is challenging, as we saw in our 7.5x return example above.

It’s even more difficult that you’re asking a friend to accept a relatively low percentage of equity whilst your business isn’t even generating revenue yet, nor doesn’t have a MVP.

That’s why many founders accept ridiculously attractive terms in their early days. This is a problem as you’ve already given away too much too early which can be a turn off for future, more experienced investors. Also, as a founder, you’ll likely lose control of your business sooner.

How to Raise Friends & Family in 6 Steps

1. Assess How Much You (Actually) Need

Entrepreneurs sometimes overlook this important point as they wrongly think raising more is always better. It isn’t.

This is very important as it demonstrates investors you have done the work in preparing your financial projections. As such, you are a clear idea of where you want to go, and how much you will need to get there. You also understand what is your runway, breakeven, cash burn and all these sorts of things investors will ask for.

For more information on how to assess much you should actually raise (and why more is not always better) check out our article here.

2. Choose the Right Instrument

The second step is to choose the right instrument you will use to raise friends & family financing.

As discussed in our article here, friends and family are the most flexible type of investment you can get as a startup.

Therefore, there are plenty of choices to choose from. First, you should ask yourself: are you looking to raise debt or equity? Both come with pros and cons that you need to be aware of.

Whilst debt will ensure you keep control of your business, it also means you’ll need to repay the loan at some point in the future. As you know, startups are often cash poor in their early days, therefore it may be a deal breaker for you as a founder.

With equity, in comparison, no need to repay the investment. Instead, you agree with investors on your business’ valuation to determine the percentage ownership you will have to sell as part of the round.

Fortunately, there’s a third option: convertible debt. It has become a very attractive form of financing for early-stage startups over the past few years. Indeed, convertible notes combine advantages from both equity and debt. See more about the different types of convertible debt that exist (+ templates) in our articles on SAFE and KISS notes.

3. Determine a Valuation

Unless you’re raising standard debt, you’ll need to prepare a valuation for your business.

• If you raise equity, you will need a valuation to know how much you need to give away to the investor(s) coming in
• If you raise convertible note, you won’t need to agree on a valuation with your friends & family investor(s) today. Yet, as a founder you will need to get a clear idea of valuation to set a valuation cap that makes sense in your convertible note term sheet. For more information on what caps are and how to set up a cap that’s best for you, read our article here

There’s a number of methods you can use to assess a fair valuation for your startup. All methods will require you to build financial projections for your business.

4. Prepare a Term Sheet

When structuring your friends & family round, choosing the right type of instrument you need isn’t enough. You must also include legal clauses in your legal agreement that define the terms of the investment and what should be done in case some scenarios occur.

The agreement content and structure will depend on the type of instrument you would have chosen. For example, convertible notes can be as short as 2 pages.

To know what you should include in your legal agreement, use financial terms and clauses that are typically included in term sheets by experienced investors. See our article on term sheets (+ 2 free templates).

We strongly recommend you include clauses that will protect you as a founder in case things don’t go as planned. Governance, control, exit and liquidation clauses are some examples of terms you want to define upfront, whatever amount you’re raising.

Setting up in a contract what should happen in hypothetical situations (such as the sale of the company or even bankruptcy) will ensure there is no misunderstanding if these events happen.

This will not only save your relationship with your friend or family member, but also avoid potential future investors to back away from the deal. Indeed, angels and VC funds are very reluctant to invest in startups where previous investors’ terms have been loosely defined, or worse, haven’t been defined at all.

5. Prepare your Pitch Deck

Before you actually reach out to your inner circle, you will need to prepare your startup’s pitch deck and financial projections. Of course, some of your connections will not require a lot as the investment might be only subject to trust.

Yet, preparing a solid pitch deck will give a edge to convince the people who otherwise might have not agreed to invest first.

6. Build your Financial Projections

Your pitch deck will need to include your financial forecasts. Generally, 3 years of financial forecasts are enough for most seed investors, but you can opt for 5 years as well.

Founders sometimes overlook the importance of their financial projections. Be careful: they aren’t a mere tick-the-box requirement. Also, the fact you’re early stage and the future is by nature very difficult to predict isn’t an excuse not to have rock-solid financial forecasts for your startup.

6. Get a Lawyer

Once you have agreed on a term sheet with your investor(s) – and again, friends & family investment terms can be on case-by-case basis – you will need to make sure your legal agreement is in good shape and there are no blind spots.

Unless you’re a lawyer yourself, we strongly recommend you hire a lawyer to either advise, write and/or review the final document.

It done correctly, if shouldn’t take a lawyer more than 2-3 hours to go over your existing cap table, and the proposed term sheet for your friends & family deal.

A lawyer will be able to advise you on potential red flags but, more importantly for friends and family rounds, a lawyer will make sure you have included all the necessary clauses that will govern what to do in cases things don’t go as planned.