Friends and Family Startup Funding
Bankrolling an exciting startup idea with the help of friends and family is a common method for entrepreneurs to fund their business. In this guide, we will break down what types of friends and family funding options are available as well as how to get started while maintaining positive relationships. Let’s get started!
What Is Friends and Family Startup Funding?
Friends and family funding isn’t just a convenient way to finance a startup — it’s incredibly common. Many entrepreneurs use the help of friends and family to fund their startups; however, it isn’t as easy as asking for some money over a cup of coffee. Receiving funding from friends and family, whether it is a gift or a loan, is dependent on clear communication, cemented conditions, and requires written agreements to ensure all parties’ needs are met.
Pros of Friends and Family Startup Funding
Funding your startup with people you already know means you have a level of familiarity with your funding sources. This established familiarity makes funding easier, but there are even more benefits in addition to this.
A few of the pros of friends and family startup funding are:
- You’re securing financing from people whom you have mutual trust with
- Family and friends care about your goals and the vision you have for your startup company
- Unless you are receiving funding in exchange for equity, you don’t relinquish any ownership of your startup, unlike with other funding sources such as venture capitalists
Cons of Friends and Family Startup Funding
As with any funding source, there are some disadvantages to sourcing your startup funding from friends and family. It is important to understand the potential risks beforehand to ensure your relationships stay intact and your startup doesn’t suffer.
Here are some of the cons of friends and family startup funding to be aware of:
- Mixing business with your personal life can get messy. If your startup fails or hits roadblocks, it could interfere with your personal relationships.
- Friends and family may feel they aren’t able to say no to your inquiry about financing the startup, which can cause your relationship to turn rocky.
- Friends and family may not be comfortable pointing out potential problems and room for improvement within your proposed startup model.
Types of Friends and Family Startup Funding
There are a few different ways friends and family can choose to financially support your startup. The most common are gifts, loans, and equity, each suiting investors differently depending on their financial situation as well as your startup’s needs.
Startup funding given by gift has one major perk: it’s free money. However, acquiring this type of funding can have tax implications depending on the amount. This is what’s known as the gift tax fee, and it is applicable for any domination of $14,000 or more and must be paid by the donor.
Additionally, if you are receiving funding via gifts from friends or family, it is important that you have a written agreement about what that gift means in the context of your startup. Since this is a predominately personal relationship you have, ensure that the gift is not connected to any expectations or requirements before accepting it.
Much like a standard business loan, friends and family loans are repaid incrementally to the lender. The contingencies of the payment will be decided between you and the lender and should be put in writing.
If you’re using the loan to satisfy an existing debt or bill, avoid being the middleman. Instead, create a direct line between your lender and the source of your debt to lessen the temptation to use funds for another expense and to keep the relationship as professional as possible.
Rather than a repayment plan, equity investments are made in exchange for a share of the company that results in a return on investment. The benefits of equity investments are that there are no monthly payments, which frees up cash to invest back into the company, and you are providing more lucrative investment opportunities for your friend or family members.
Comparatively, equity investment requires you to give up a share of your startup which means you will be a part-owner of the company rather than the sole owner. In addition, this can mean you have less agency over your startup unless otherwise stated in your written agreement.
How to Get Startup Funding From Friends and Family
As with any funding source, financing your startup with investments from friends and family takes planning, calculating, and communication to maintain a positive relationship. Before you can even inquire about funding, you need to have a good understanding of your startup’s needs and the trajectory of your business. Here’s what you need to do:
Calculate Your Startup Costs
The first step to securing any startup funding is to calculate your estimated startup costs, so you know how much money you need to launch and sustain your startup. Every startup has different startup costs both in terms of volume and type of expenses.
Generally, there are two types of costs you need to consider: fixed and variable costs. Fixed costs are unchanging expenses that are paid at regular intervals, such as rent, utilities, or insurance. Variable costs are the opposite; these are expenses that fluctuate such as inventory, credit card fees, or commissions.
Make a detailed list of the costs you can expect to pay when launching and operating your startup and total them up for your estimated startup costs. Once you have this number, you can move on to the next step.
Write a Business Plan for Your Startup
Your startup’s business plan is essentially a roadmap to the first three to five years of the business’s lifespan. This guide outlines the milestones you hope to reach as a company as well as vital steps to achieving them.
For startups, there are two types of business plans commonly used: traditional business plans and lean canvas business plans. Traditional business plans are an in-depth analysis of everything you and your investors need to know about your business, including market research, financial projections, and more. A lean canvas is a much shorter version, sometimes only as long as a single page, and contains much of the same information without including the details and data that a traditional business plan includes.
For friends and family funding, a lean canvas business plan may be suitable. However, in many cases, investors prefer to see a traditional business plan to give them an idea of the trajectory and potential of their investment.
Perfect Your Pitch
Now that you have your estimated startup costs and a business plan, it’s time to focus on your pitch. It is important to remember that while you are asking friends and family for funds, this is still a business matter and should be treated as such. This means crafting your pitch to accurately portray your startup goals and motivate your listeners to invest.
To do this, first determine the essential information about your startup that is crucial for potential investors, such as long-term goals, expenses, and your startup’s business model. Your pitch should be concise while still providing the listener with everything they need to know in order to make an informed decision.
Secondly, help them get to know your startup’s personality, such as what the company stands for, who the target market is, and why it is a great investment. Your friends and family know you, but they need to know who you are as an entrepreneur, and that means getting to know what your startup is all about – and believe in its potential.
Get It In Writing
Regardless of your close-knit relationships with your family and friends, their involvement in your startup should include a written agreement. This is to protect all parties involved and solidify the terms and conditions of your agreement.
To start, you need to have concrete repayment terms that provide your investors with peace of mind, knowing when they will see either repayment or a return on investment. If the money is given as a gift, this should be put in writing as well. Essentially, any plans or agreements made between you and your investors (family and friends included) need to be solidified in writing.
Keep Financial Documents Updated and Organized
No matter who is investing in your business, they will most likely want to know the state of their investment and the financial wellness of the startup. Keeping financial documents updated and organized not only enables you to effectively manage your startup’s finances but it makes providing accurate financial reporting to investors easier.
If you’re not already a strong organizer, consider using a free or low-cost financial planning and management tool such as QuickBooks to help you keep track of your startup’s expenses, revenue, and more. Then, you will be able to give your investors peace of mind and maintain a positive relationship.
When you go into business with a friend or family member, your relationship changes. Basically, if you rarely talk to your family member and they decide to invest in your business, you need to make a change to ensure you are communicating with them effectively.
Important things to make sure you communicate with your investors are updates and changes to your startup, especially if it impacts the business model you initially presented or changes the trajectory of your company. In addition, regular financial reports may be requested by your investors. Be sure to learn beforehand the amount of communication they would like to have and what they want to know before accepting their investment.