Startups – Friends and Family Financing
One of my responsibilities as an Executive Coach is helping founders advance from the “Idea Stage” to the “Build Stage”. Most early stage businesses, what we call the “Build Stage” business, need monies to “build” their Idea into a business. Most of us start by using our checking and savings accounts, along with our credit cards. However, we all have our financial limits. When we hit that “financial wall”, we need to find outside funding. When this happens, we often think of Friends and Family Financing.
Pros of Friends and Family Financing
When we’re young, we often think of the “Bank of Mom and Dad” when we get into financial difficulty. However, once we reach adulthood, that “banking window” usually “closes”. As adults, we are expected to “fend for ourselves”s. This is how it should be for us as adults. However, when we start a business, we are creating an “investment opportunity” and not “asking for a hand out”.
If you have started a business, you’ve been talking with your friends and family about it. You most likely started when it was still in the “Idea Stage”. You talked about the business idea, the business opportunity, the marketing strategy. For consumer facing ideas, hopefully your friends and family said “Gosh, I love to be able to buy that!”. They may have even said “If there’s a way I can help, reach out to me”.
Investing in your business during the “Build Stage” of the business is a great way to help you. It also gives them a chance to make a financial investment “on the ground floor”. Investment dollars can be in the form of a “Loan” with the ability to convert the loan into company stock. This is known as a “Convertible Note“. You could also just sell them “stock” in your company in return for their “investment”. Neither case is a “gift” of monies from the Bank of Mom and Dad. It is a legitimate financial investment.
If you do well, then your Friends and Family, at a minimum, get back all their “invested money plus interest”. If they converted the loan to equity (stock) or bought stock directly, then they get back all their investment dollars plus a nice profit when your company is sold.
Cons of Friends and Family Financing
However, like any financial investment, that investment carries “Financial Risk“. The “loan” or “equity” (stock) that your Friends and Family invest in your company value could change – in a negative direction.
It often takes longer to get a company profitable than planned. If you have to raise more monies, the new lender may require that the prior lenders are “subordinate” to the new loan. This means that the new investor gets paid in full “before” the original “Friends and Family” investors get paid back.
Your company could “go bust”. The majority of all new business fail in their first 5 years. The odds are that yours will be one that fails. This is why Friends and Family need to clearly understand that they could “lose it all”. Ask them how they would feel about you if that happened. If they say “I’ll likely hate your guts” or “I’ll disown you”, then don’t take their money. Friends and family are irreplaceable. Don’t let money invested in a business idea impact you for 50+ years.
What If My Company Goes Under?
In a study by Statistic Brain, Startup Business Failure Rate by Industry, the failure rate of all U.S. companies after five years was over 50 percent, and over 70 percent after 10 years. (Feb 18, 2017).
Yep, business life is hard. Friends and Family monies is likely going to add some real psychological pressure to most founders. In some respects, that kind of pressure can help. Many will look at every dollar they spend much closer. This can help you from making poor choices. But, it can also result in “analysis paralysis”. This means you spend too much time making decisions.
Communication and honesty is the best policy. When things get tough, let you Friends and Family know earlier rather than later. Nobody likes surprises. If you’ve been openly sharing that “things aren’t going to plan” regularly, then you announcing that “you’re closing your doors” will be a disappointment, but not a “shock”. You’ll sometimes find that one of your investors might offer to step up and help in ways you didn’t expect.
Planning For Success!
I strongly believe in “Planning for Success” as well as “Preparing for Failure”. By doing both, I find a make a better business plan.
I recommend when you decide to consider taking money from Friends and Family, you start a monthly Newsletter. Publish it on the first of every month like clockwork. One page in length. Start with “A Message from the CEO” (You). Have a paragraph that talks about new clients. Include a paragraph that addresses revenue in broad terms. Have a paragraph that introduces new or planned employees. Include a paragraph on Marketing. That’s all. Email it out to every investor, employee, newspaper, blog, customer list – everyone you know. This helps them feel like they know what’s going on with their “investment”. You’ll also find a Newsletter is great for bringing in new clients and employee’s.
I hope I have educated you on the Pros and Cons of Friends and Family Financing. If you decide to do Friends and Family Financing, you will not be alone. Some 38% of company funding comes from Friends and Family Financing.
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Next time …
In the next blog post, I will write about “Do You Need a Mentor or a Coach?“.
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