Asking for love money
Family funding has its rewards and challenges
Raising funding is typically the hardest part of launching a business, especially for a first-time entrepreneur.
Entrepreneurs looking for early-stage capital have several sources to turn to: angel investors, high-net-worth individuals who typically invest less than $1 million; loans from traditional banks or entrepreneur-focused banks such as BDC; government grants; startup accelerators such as FounderFuel, which typically offer funding and mentorship in return for a small equity stake; and crowdfunding sites.
Another source is what is sometimes called love money — funds raised through an entrepreneur’s personal network of family members, friends, or business associates.
Daniel Eberhard, co-founder and chief executive at Koho, a Vancouver-based financial tech company that is launching a mobile and web-based alternative to a traditional bank account, raised $100,000 in friends and family funding for his first venture, and he said going to friends and family was the most efficient way to raise money, especially because they were selling a complicated concept with no real experience.
“When you are unproven, you have to do what you can to get your vision off the ground,” Eberhard said. “Often, family money is the best way to do that.”
Friends and family funding isn’t just for first-time founders, though. Paul Teshima was on the founding team at marketing automation company Eloqua, which raised $92 million through its IPO in 2012. Now, as co-founder of Nudge, a social selling platform, he decided to raise money through family and friends to stay in control of growth.
“We still have taken on big responsibilities and commitments by taking their money, but (co-founder) Steve and I call all the shots at this phase,” Teshima said.
Approaching family and friends may be easier because they’re willing to listen, and you don’t need to hustle to get in the door like you would with a traditional venture capital investor. But taking money from people you know can present challenges, from the stress associated with returning their money, to whether you have to talk about balance sheets at Thanksgiving dinner.
Eberhard said being clear about expectations and the risks involved is key. He warned his contacts that they shouldn’t participate if they couldn’t afford to lose the money and, once invested, they should treat the money as if it were gone.
“A really high percentage of startups don’t return money to the investors, and we made sure everyone knew that,” Eberhard said. Likewise, he said he set rules for discussing the venture at family events and social gatherings.
There are also legal considerations when taking money from friends and family. Having a clear idea of the terms and type of investment (loan, convertible note, or equity) is key to making sure everyone is on the same page.
Rubsun Ho, a partner at Cognition LLP, which specializes in working with startups, said it’s key to have “a pre-nup for investors.” That should include a clear subscription agreement outlining the terms of the investment and what securities and rights an investor is getting in return, and a shareholders’ agreement to further define the rights and obligations of the company and its investors.
He also recommends entrepreneurs look at the provincial regulations that govern who is considered friends and family, and make sure their investors sign a prescribed form acknowledging the risky nature of the investment.
Eberhard just raised $1 million in funding for Koho, with only a minimal amount from family members, all of whom approached him. He says entrepreneurs considering this funding route should take the time to figure out exactly how much money they need, and only ask for that much. He also recommends they be clear about the opportunity and keep investors updated, regardless of whether the news is good or bad.
Nudge’s Teshima recommends tying your business idea to a trend and explaining the big challenge associated with that trend, and how you’re going to solve that challenge in a unique way. He also recommends outlining what you bring to the table as founder beyond your idea. Finally, he says, you need to give a sense of what you’ll use the funding for, and target milestones.
While there are risks involved, successfully growing a company built on money from your personal network has its rewards. “Despite all the complexities, it’s a really great feeling if you ask for your family’s trust and are able to create a great return for them,” Eberhard said.
Teshima agrees. “When it does work out, it is very gratifying to see those people who took a big chance on you at the start get rewarded. And the fact they are your friends and family makes it all the better.”