Friends and Family Financing is the means of receiving initial investment funds from close confidants – this means friends, family members, or co-workers. Funding from friends and family is often limited and not the sole form of initial investment, although it is known as the most common startup financing route. According to a survey in the 2004 Inc. 500, half of the CEOs of the nation’s fastest growing companies stated that family was involved in regards to start-up capital. With Equity Investments, you are selling stakes of ownership to your friends and family, integrating them into your business. This is not to be confused with loans from Friends and Family and Debt Financing.
Handling an Equity Investment
1. Hire an attorney
All equity investments must be formally documented; because you and your investors have a lot of money and ownership shares at stake, it is important to clearly define boundaries and responsibilities. The key document for selling shares is a Stock Purchase Agreement. This agreement form includes the terms of purchase, such as date, conditions, and purchase price, as well as conditions and statements about the business that both parties verify as true.
Your attorney will also help you comply with specific laws that deal with shares. The law refers to Corporate Shares as “securities” and your attorney will register you with the Securities and Exchange Commission (SEC) so that you may begin to sell them securely and legally.
Because things can easily get complicated with paperwork and legal issues, it is important to protect your family and friends, as well as your relationships with them by treating them with the same business respect and guidelines you would give to any other investor.
2. Know that you are Sharing Ownership
When you sell equity to your company, remember that you are giving your friends and family shared ownership and shared decision making in your company. Choose your investors wisely because while some people can offer valuable advice and input, some investors can choose to be nitpicky with their financial updates or vote casting. Be sure to include family and friends that can offer the right kinds of services and attitude for your management needs.
3. Know what your Investor is looking for
With equity financing, there is a high risk for investors because if your company goes bankrupt, so do they. Equity investors do not get paid back because they invest into the ownership of the company and thus the company’s failure is their failure as well. Because of this high risk, equity investors look for an attractive return on investment, or “ROI.” Be able to offer your friends and family an attractive return rate that makes up for the high risk they incur by giving you capital.
For example, let’s say your father-in-law decides to buy 10% of your company’s shares into your business valued at $50,000. If in three years, your business has grown to be worth $200,000, your father-in-law’s original $5,000 investment in the company would now be worth $20,000. It was a high risk to completely lose his $5,000 if your company went bankrupt, but the investment was made in the hopes of a high ROI.
Delivering the Kitchen Table Pitch
Compared to an elevator pitch, the Kitchen Table Pitch is an investment pitch that adapts to the pre-established relationships with potential investors. These pitches are geared towards informing family and friends of your business idea and opening the door to discussion on official deals and loans.
Read tips on preserving relationships at our entry discussing Family and Friends Loans