The other question: If you do, should it be loans or investment dollars that are paid for with an equity share?
Bubble tea entrepreneur Filip Pejic knows why those are questions you will have to wrestle with because it has happened to him. But first he went in pursuit of venture funding. What he heard was: go away. “They told me to come back when our sales hit $1 million annually,” said Pejic.
A new startup, definitionally, has near zero sales.
Aren’t there exceptions where a startup that exists only on paper wins major funding? You bet. Venture capitalists do occasionally fund businesses that consist only of a sketch of a plan if the founders have had past success.
In August, according to The New York Times, Andreesen Horowitz — one of the superstars in venture funding — put a reported $350 million into Flow, a startup from Adam Neumann, the founder of WeWork (from which he was booted in 2019 after a messy public offering and other missteps). But WeWork today is still worth billions, so he got his foot in the door at Andreesen Horowitz and walked out with a huge check.
The takeaway: lack a track record and VCs won’t come up with what amounts to seed money for your startup.
That means you will most likely need to turn to friends and relatives to help fund the early stage of your startup. And that also means you need to think about the ways to do this and the impacts it may have on your friendships and your family relationships.
Ask Pejic. His startup, Pearly, sells DIY bubble tea kits and his belief is that he is ahead of the curve. Bubble tea, he said, is trending in big North American cities but in the hinterlands, there’s an unmet need. Pearly is intended to meet that need by selling both to consumers — so you can indeed have your bubble tea in rural New Mexico — and also to independent retailers. He sees the market as multi-million within a few years, and that is what he has told friends and relatives.
Pejic did get funding from relatives. He declined to say how much but indicated it was sufficient to launch Pearly. He also sweetened the terms for those early investors. The money came in buying equity in his business, but he promised that if the business failed he would repay it.
The Failure Rate to Remember
Shepherd elaborated on what this stark reality means when seeking money from friends and family: “Accepting ‘community money’ from family and friends is often a part of the growth process. As a serial entrepreneur and investor, I have been guilty of this and observe the phenomenon all the time. It's important to be cautious: treat your friends and family like any other investors and ensure they understand the risk involved with lending to your start-up endeavor.”
Juliana Whitney, founder of Cann Strategy and co-founder of Leafsheets shared her story: “I borrowed money from a rich uncle years ago when I first started my company and needed some marketing money. I told him I’d pay him back within a year, with 10% interest. I was confident that the marketing would result in increased revenue. Well — I worked with a marketing company that was referred to me that wound up not being anywhere near what they were touted to be. The results weren’t there, and it was my fault. I hadn’t spent the money effectively.”
The amount borrowed, Whitney said, was $18,000.
Whitney admitted that at first her inability to repay as promised caused a strain in the relationship. But then she did a bold thing: “That [strain] led to me having to open up about what I was struggling with in business, and let him know that I hadn’t taken his generosity for granted. Over time it wound up bringing us closer because I was sharing my life experience in a way I hadn’t before.”
Right there is a key lesson: if you hit bumps in your business’s road, be honest with your friends and relatives who put money into your venture. They just may grow closer to you as you share your vulnerabilities, dreams, and hopes.
(Whitney, by the way, eventually did pay back her uncle.)
Whitney also has not lost her optimistic energy. She said she is about to do a capital raise for her Leafsheets company, which sells tools and kits to simplify cannabis entrepreneurship, and her ambition is to pull in $1.5 million. Whitney stressed that in this raise she has no plans to ask friends and relatives for money. Her target is different and specific: “we are looking for our investors to also be advisors to fuel fast company growth in the direction of acquisition or IPO.”
Asking for Money the Right Way
Face this fact, however: most startups have no place to turn for cash except friends and family. While many startup entrepreneurs try to bootstrap their business on cash advances taken with their Visa or Mastercards, eventually many will begin knocking on doors of friends and relatives with a metaphoric beggar’s cup in hand.
How do you do this the right way? Michael Clouser, CEO and co-founder of The Startup Race, stressed that “it's important for an entrepreneur to be honest and disclose the full risks of the business to the friend or relative, and communicate that their funds are at-risk, and unsecured by any real assets.”
Clouser added: “If a friend or relative investor can´t afford to lose the entire sum of the investment, they should not be allowed to make the investment. The entrepreneur must avoid the temptation to take the funds from financially vulnerable relatives and friends. Sophisticated investors tend to understand the risks of startup investing well, but those who are not so seasoned often do not.”
But aren’t some family and friends simply skeptical, maybe too skeptical to open their checkbooks? That’s why Sukhi Jutla took another path to raise money — she used a crowdfunding platform where startups seeking money are screened before their campaign goes live. She pointed to platforms such as kickstarter.com and crowdcube.com.
In Jutla’s case, she is co-founder of MarketOrders.net — which lets independent jewelers buy directly from international suppliers of gold and diamonds, often at much more favorable prices than they could find working with traditional middlemen. The opportunity for MarketOrders is huge — independent jewelers are scrambling to survive against much larger competitors with huge buying power. MarketOrders wants to level that playing field by giving independents better prices and often a better selection of jewelry as well.
Jutla knew her business plan was solid, but she also saw an advantage in using a platform in which companies are vetted, and that would give investors a higher level of confidence, said Jutla. That extra dose of confidence just may help a possible investor who is indecisively sitting on the fence to take the plunge.
It worked for Jutla. MarketOrders raised £440,000 (over $500,000) and, Jutla said, 95% came from relatives and friends who got a 10% equity stake in the business. She added, “This was a lot of work. Emailing, calling.”
She also said there’s another consideration when friends and relatives become investors: “Once money is involved in any relationship, it does tend to change the dynamic of the relationship even if you think it won't. I found that I felt I now had more accountability and responsibility towards my friends and sometimes it can be hard to separate business dealings from your friendships. You may find you are being interrogated on that latest development in your business at the next summer BBQ your friends are hosting!”
Remember that the alternative to feeling that awkwardness at get-togethers with friends and relatives often is shutting the startup down.
You just may have to ask the people who know you best for financial help to keep the business alive. And now you also know the right way to go about this.
About the Author
Robert McGarvey, a veteran journalist who has long covered startups and small businesses, created and hosts the CU2.0 Podcast for credit union and fintech executives which is at 120 episodes and counting.