CHAPTER SIX – It is one thing to know how to finance a business, but it is a different ball game entirely to successfully raise the funds you need.
Raising capital is one of the major business challenges faced by entrepreneurs; especially when starting a business from scratch. It’s much easier to raise capital as an established entrepreneur than to raise capital as a first time startup entrepreneur.
Now there may be times when you try to gather some money for your business—for example, by selling some of your assets or taking a job—but the cash just won’t add up. There may be times when your family and friends are not willing to give you the money you need. Times like these could be very frustrating, but successful entrepreneurs never bow to frustration. So, you have to find a way to work things out.
If the money you have is much less than what you would need to bootstrap, and you have no chances of getting more, then you may have to let go of some share of your business. That is, you may want to consider equity financing. This may be a very hard decision, but it’s better you take it than remain stagnant.
There are many possible sources of equity financing. However, one of the very first places entrepreneurs turn to when seeking capital is their family and friends. So in this chapter, we will be discussing how to raise funds; i mean equity, not gift this time—from family and friends.
Yes, the idea sounds good, since it’s very easy to get money from people who love you and have known you for years. They would be willing to write you a check because you are someone they trust and would readily help.
But instead of giving you some of the money you need, some friends and relatives would rather agree to invest some capital in return for some share of your business. While this may be a fair option, it means that they will have some say in the control of the business and will be entitled to a fraction of the profits you generate.
The importance of family and friends in the life of an entrepreneur can never be over emphasized; so this chapter will teach you how to leverage your family and friends to launch your business successfully.
- Now how do you leverage your family and friends to successfully start a business?
- How do you raise seed capital from your family and friends?
Raising startup seed capital from family and friends happens to be one of the easiest avenues for raising capital that entrepreneurs can exploit. But if wrongly done, you can get your fingers burnt and even end up destroying the existing good relationship you have with your family and friends.
Like other strategies for raising seed capital, raising money from close ones has its challenges, advantages, and disadvantages. You will learn about them below.
3 Major challenges of raising seed capital from family and friends
If you have finally decided to give a friend or family member some share of your business, here are some challenges that you should prepare to tackle:
- You may be naturally uncomfortable with the idea of involving your family and friends in your business matters. This may cause you to hesitate for long before approaching them. You must overcome this one challenge if you really want to get started fast. If you keep fretting, you may blow your chances of getting money from those who can readily give you.
- For reasons unclear to you, you may nurse fear of asking. That is, you may find it hard to approach your close ones, even when you are cocksure they will write you a check. You can overcome this fear with a combination of careful preparation and choosing a time and place that makes you and your prospective investor comfortable.
- You may also nurse the fear of rejection. It happens. Even when you are fully confident in your idea and you have perfectly completed your homework. Something keeps telling you from within that you will have your business idea rejected or laughed at. Never respect this challenge!
3 Advantages of raising seed capital from family and friends
Raising seed capital from close ones has a number of advantages. They include the following:
- Your friends and family members are more willing to invest in your business because you are not a stranger to them. And they are less likely to scrutinize every comma and semicolon in your business plans as angel investors do.
- You can raise money quickly, since your close ones are usually free of those factors that delay feedback from third-party investors.
- You will stand a good chance of getting even more money from outside investors. Raising money from your friends and family is a decent indicator that you can successfully convince someone to believe and invest in you. Even if it’s from your parents or your best friend. It sets a baseline precedent that you are capable and trustworthy of managing capital and this is very important for more meaningful capital raises and conversations later on.
5 Disadvantages of raising seed capital from friends and family
As rosy as the strategy might seem, raising seed capital from your close ones may have more disadvantages than advantages. Some of the cons of this strategy are given below:
- Raising money from friends and family creates personal and emotional issues that go beyond business judgment. For example, if you borrow $10,000 from Aunty Linda to start your business and fail to pay it back, you will have to fret each time you get to meet her at every holiday or family function. Even if she’s the forgiving type, she will no doubt keep reminding you about how you blew her money. She may even be tempted to tell the whole family about it—and you will look so bad to everyone. Worse, if she’s not forgiving, she will quarrel with you for the rest of her life. You sure don’t want that.
- Family and friends may expect more than they are entitled to when your business starts to generate profit. Because friend/family investments are usually made in a very informal way, misunderstandings can occur about precisely what the friend or family member expects in return for their money.
- Even if your family or friend are getting exactly what they are entitled to in returns, you can’t be sure other people will see it the same way. For example, if your Aunty Linda invests $10,000 in your business and then she dies after some months, you will no longer be dealing with her. Instead, you may be dealing with another greedy relative or individual who thinks Aunty Linda is entitled to more than what you bring forth—the same percentage that Aunty Linda gladly received while she was alive.
- Your friend or relative may take the stake they have in your business as an opportunity to dictate how you should run your business…in a way that might make you wish you had just paid them off…and in many cases, as co-owner, they will have a perfect right to do so.
- Because they have a stake in your business, your friend or relative may be watching your every move, then criticizing your new car or family vacation. At every opportunity, they raise concerns over your integrity.
Now putting the cons and challenges aside, raising seed capital from family and friends is quite easy if you do things the right way. After all, most successful entrepreneurs and drop out billionaires started business with capital sourced from family and friends. Example of successful entrepreneurs that raised startup capital from family and friends include Richard Branson, Bill Gates, Berry Gordy, John Johnson, Ingvar Kamprad, Orji Uzor Kalu, Aliko Dangote, Li Ka Shing, Howard Hughes, etc.
Now if these famous entrepreneurs can successfully start a business from scratch with seed capital raised from family and friends; I don’t see any reason why you can’t do it. So without wasting your time, here’s how to raise seed capital from family and friends.
9 Action Tips on How to Raise Seed Capital from Family and Friends without Wrecking your Personal Relationship with them
Do you want your friend or relative to invest in your business out of conviction that your idea is a brilliant one, and not out of their shyness to turn you down? Then here are nine tips you must adopt during your meeting to make them gladly write you a check:
1. Be in the right mindset
If you are not in the right mindset, forget about trying to raise seed capital from your family and friends. Now why do I emphasize you be in the right mindset before trying to raise capital from your family and friends? Well, the fact that you are trying to source capital from family and friends doesn’t eliminate the odds of disappointment.
- What if your trusted friend turns you down?
- What if your most loved one says no to your business plan?
- How will you feel if you get laughed at, mocked or looked down upon by your loved ones?
The answer to these questions is the reason i emphasize you be in the right mindset. Before trying to raise capital from family and friends; you must be prepared to face rejection, criticism and mockery. In fact, expect disappointment from even the person you love most. The reason i emphasize you be in the right mindset is because disappointment from your family and friends can strain the good relationship shared.
I have had a personal experience with respect to this case. I remember vividly when I caught the entrepreneurial bug some years ago and began nursing the desire of running my own business. I had some excellent business ideas which I was excited about and my determination to scale through, kept my head buried in books while my mates were partying. I even attended seminars to sharpen my entrepreneurial skills and learn how to build a business.
With a feeling of confidence and excitement about starting a business, I shared my business plan with my parents. But instead of getting a word of encouragement; all I got was a hard stare from my dad and a detailed explanation of how incompetent i was with respect to starting a business. My dad told me to my face that I was still a kid and advised me to face my studies.
To be sincere with you, I was very disappointed. In fact, I was annoyed with my dad back then. After all my effort and time spent developing a business idea, drawing up a business plan and honing my business skills; my dad had the effrontery to call me a (incompetent) kid, despite the fact that I had spent reasonable time running his own business. I felt like giving my dad a punch in the face for challenging my competence; and if not for the encouraging words from my mom, I don’t know what would have become of the sweet relationship between me and my dad.
As I lay on my bed and recalled this particular experience; it occurred to me that young entrepreneurs all over the world may also be going through this same experience and that was why I wrote this piece. No matter where you are sourcing your startup capital from; always respect the odds that you can get turned down. Don’t take rejection personal; it’s the norm in the business world.
2. Build up your credibility
Now since the odds of raising seed capital for your startup company remains the same despite the source you are exploiting; then how do you increase your chances of getting the financial support you need? The answer to that question is “good credibility.”
- What are you known for in your family?
- What’s your level of relationship with family and friends?
- Can you be trusted?
- How well did your past dealings with family and friends go?
- Have you handled any project on behalf of the family?
- How do you live your life?
- Are you an asset to the family or a liability?
- Are there any habits that could be a hindrance to your aspirations?
These are the questions you must answer before trying to raise capital from family and friends. Nobody wants to give money to a scumbag or an incompetent friend or relative, and neither would i. I once told my immediate younger brother that i would never invest a dime in any of his projects if he doesn’t gain a stronger control over his life and finances. I made this statement to help my brother have a greater sense of responsibility.
If you haven’t got control over your life and the way you spend money; then it’s high time you change and reconsider you life’s pattern because a single bad habit can reduce your chances of raising money from family and friends. Remember that these two groups know you to the core; they know your strengths and weaknesses. In fact, they know personal things about you that even venture capitalists and angel investors may never find out.
Don’t walk up to your members of your family or friends and try to raise money without a good business plan. No matter how much they love you, they will still want to know what you need the money for. Even if you are not going to share the intricacies of your business plan with them; at least they deserve to get an overview.
You also need to understand your plans like the back of your hands especially when you are coming from a family of intellects or trying to raise capital from learned friends. If your plan sounds too shallow or incomprehensible; you may be denied the financial support you need. But before sharing your business plan with your family and friend; you must make sure the step one and two above are sufficiently taken care of.
4. Approach them like strangers
Forget for the moment that your investor is a friend or family member. You need to present your well-prepared business plan, not a rough draft. Make it an “arm‘s length” transaction, and insist on the same sort of legal documentation you would prepare if your investor were a total stranger. Give all the necessary explanation, and most importantly, allocate a reasonable share of your business that equates with their investment
5. Have a Good Story to Tell
Do you have a good story backing your business plan and intentions? If your answer is no; then you better reconsider your approach because your proposal and request may be thrown back at you. The fact that you are trying to raise capital from family and friends don’t mean you should take them for granted. Threat them professionally with a touch of informality and back your business plan with a good story.
- How did you develop your business idea?
- What are your chances of success?
- How viable is your idea?
Try sharing the answers to these questions with your family and friends because it has been proven that humans listen to stories more than anything else. So share a story worth telling about your business plan.
6. Be straightforward
Be very straightforward about why you need the money, what you will use it for, and how they will get it back. If you aren’t realistic with them upfront, then you are setting yourself up for a nightmare. Have a plan and strategy before going into the discussion.
When it comes to business, leave out informality. Prepare well ahead of your meeting with friends or family members. And be serious during your presentation so that you’d be taken seriously.
When stating your facts, be specific so that you will come across as serious-minded fellow. And when asking for the money you need, state the specific amount, not a rough estimate.
Nothing encourages an investor more than the awareness that you have really done your homework well. And nothing creates this awareness than a specific and straightforward presentation.
7. Select your Targets
A good rule of thumb when raising seed capital from family and friends is this; “don’t go telling every dick and harry in your family about your plans.” Select a few prospects among your family and friends that have the potential to provide the capital you need and prepare a pitch tailored to their life pattern.
For instance, when I was trying to pitch my dad to invest in my business idea; I prepared myself properly because my dad was a strict individual who knows the fundamental intricacies of business. He doesn’t believe in throwing money around; and when it comes to money issues, he is strict about it with his children.
So knowing my dad was a no-nonsense person; I had to be straight and clear while pitching my ideas to him. Though, I still got turned down; I left his presence with some lessons about the challenges involved in raising capital. The lesson I am trying to extract here is this;
“The way you pitch a family member of high academic intellect will be very different from the one used to pitch a friend who is already an entrepreneur; or a family member who is stingy when it comes to money.”
Different pitch for different people and situations; never use the same words for people with different core values. What may attract a professional investor may turn off an academic scholar.
8. Sell Yourself
The next key to successfully raising seed capital from family and friends is your ability to sell yourself.
- Why should your family and friends give you their hard earned money?
- How are they sure the money will be used judiciously?
- How are they sure you are not trying to con them?
- You have failed on a previous project, why should they trust you on this one?
This is where selling yourself comes in. This is where you sell your potentials and competence to members of your family and friends; this is where you prove that you know your onions.
Your ability to sell yourself is key to your success. You must explain in details why your friend or family member should invest their hard-earned money in your business. Show them proof that the business is potentially lucrative. Instill in them the same enthusiasm you have about your idea, and they will ready write you a check.
Never approach them with the idea that they will give you some money without asking any questions simply because they are close to you. This is a money-related issue, so they won’t be that dumb!
If you successfully carry out step one to five and you miss it here; all your effort will be in vain. You will never get the needed capital.
9. Ask for the Money
If step one to six goes successfully; then you have to take the next action step which is asking for the money. Before asking for the money; you must be definite on your plans, you must know how much you need and the terms involved.
Nothing annoys me more than an entrepreneur pitching me with his business plan and when I ask how much in capital he wants to raise; he or she becomes speechless or uncertain. So when raising capital from family and friends; it’s advisable you know your business plan like the palm of your hands, sell yourself excellently and ask for the money.
Don’t approach a friend or family member until you’ve read this!
Now, you have just been reminded that your family and close friends can help you with the funds you need to start your business. Stumbling upon this idea could be really exciting—especially when you are very sure it would work for you.
But don’t get too excited. It would be silly of you to conclude in haste that the disadvantages highlighted above won’t apply in your case.
Don’t assume that you know your family and friends enough. Always bear in mind that money changes people—and not necessarily for the better. With that in mind, i advice you consider the following hard and fast rules before you approach that family member, distant relative, friend, neighbor, or colleague.
8 Helpful Rules for successfully raising funds from family and friends
1. Don’t expect it to be easy
While your friends and family are much more likely to support your startup efforts, never be blasé about raising funds from this group.
Give friends and family investors the same thoughtfulness, preparedness and consideration as you would a professional investor. And, like with outsider investors, make sure you have enough lead time with your deliberations.
2. Don’t think they know everything
Never assume that your friends and family know what you know or how business investments works. Explain all terms, risks, conditions, alternatives, and exit strategies in a basic and understandable format, so that a future failure or success does not jeopardize your relationship. Also, you should put everything in writing and involve a third party as a witness of the understanding.
Generally speaking, it’s better for you to land one professional angel investor than to raise money from a dozen rich uncles. A seasoned angel is typically well connected, cognizant of the risks, and can draw on years of experience to guide an inexperienced founder.
4. Be upfront about the risks
Bear in mind the bitter fact that most startups fail—and yours can, too. So, don’t pressure or entice your friend or family member to invest what they cannot afford to lose.
Some of close ones might be tempted to invest money they can’t afford to lose under the impression that you business idea is the next big thing. Discourage them from doing that. Should your business fail, would you like to tell your uncle or best friend that you have blown their kids’ college tuition?
5. Give preference to well-connected and experienced friends and family
If that wealthy uncle hobnobs with highly respected professionals, businessmen, and your potential clients, ask him for an introduction. You may end up landing some clients or customers even before your business launches. And even better, you may get to meet investors willing to invest in your idea.
Also, if a friend or family member has invested in early-stage startups in the past, approach them first. Such people have more experience, and they understand the intricacies and challenges of business.
6. Keep away from inexperienced ones
If a friend or family member wants to be informed about every minute detail—and worse still, if they expect to impose baseless opinions about your product or service—you are in trouble. If you don’t keep away from such people, you can get socially pressured into doing something you don’t want to do.
Similarly, an uncle or friend who is overly—and only—interested in how much ROI he will get is a bad investor who is unlikely to accept a loss in good faith. So, if your uncle is giving you too many silly advices on how to double your profits, raise your bullshit detector!
7. Don’t make grandiose claims
Unlike investors, your friends and family are people who will continue to be in your life, whether your business succeeds or fails. Avoid making outrageous and inflated claims. Be conservative and allow your idea and plan to speak for itself.
8. Be plain and honest
Simplify your pitch down to as few pages as possible, and speak in very plain language.
Tell them that they could lose all of their investment. That it’s a risky investment. Even though you think you will succeed, they need to know that most startups fail. Be honest and you will still be able to go attend family events without shame if your business crashes.
This is probably the most important piece of advice you should never forget. Do not wait for the perfect moment to ask people for capital for your startup. You may be surprised at how much support you will have from your friends and family, once you ask for it.
Even if they say “no,” you have started the process of getting them to think about helping you, and sometimes you need to plant that seed before it grows. Let them see your commitment, and they may change their mind.
As an adage goes, “fools rush in where angels fear to tread,” and the same applies to raising capital for your business from friends and family. The personal relationship should act as an extra warning flag to you that such transactions should not be treated lightly or casually.
When times are hard and other sources of available credit dry to a trickle, friends and family can be a lifesaver. But whether the funds are offered to you—or you affirmatively ask for them—take them with caution. The tips you have learned in this chapter will help smoothen the path and make sure everyone gets a fair deal.
As a final note, these are my seven strategic action step plan to raising seed capital from family and friends. Remember, the key secret to raising startup capital from any source is creativity; thorough understanding of the business fundamentals and a good presentation. Once these three keys are locked in synergy with the seven action steps listed above; you will be able to raise any amount of startup capital you need.