If you just started a company and are looking to raise your first round of financing, you’ve likely heard of a ‘friends and family round’. This type of fundraising has become increasingly popular in the startup and venture capital world, as it’s a low-risk, low-cost way to raise capital quickly. In this guide, we explore the ins and outs of friends and family rounds and dive into some of the common pitfalls to avoid.
What is a friends and family round?
Friends and family rounds are a type of fundraising used by founders to grow their businesses. Founders ask their closest friends, family, and connections for investments in their business, in exchange for equity in the company. It’s typically the first outside capital that founders raise when starting their business, as it is typically not subject to the rigors of traditional venture capital.
How do friends and family rounds work?
Friends and family rounds work similarly to other rounds including the pre seed, seed, and Series A, though they are typically less rigorous. Founders outline the amount of capital they are looking to raise, the valuation they are looking to raise at, and the basic terms of the agreement. Then founders leverage their network to identify people who may be interested in the opportunity and make the ask.
How do you structure a friends and family round?
When structuring a friends and family round, it is important to consider the amount of capital that you are looking to raise, the amount of equity that you are willing to give up, and the terms of the investment.
The amount of capital that you are looking to raise will depend on the size of your business and the stage of your business. For example, if you’re just starting and you don’t have a product or a team, the amount you’re looking for should be smaller than if you have a product, have generated revenue, and have a founding team in place.
Similarly, the amount of equity you are willing to give up will vary based on your stage and the quality of investors you attract. For example let’s say your Dad’s friend has deep expertise in your space and is willing to coach you, while your Cousin’s wife has connections to individuals in your target market, and your Uncle just has money. Your Dad’s friend and your Cousin’s wife should hypothetically receive more equity because they have a higher intrinsic value.
Who should you avoid when raising a friends and family round?
When raising friends and family rounds, it is important to be selective to who you reach out to. Avoid people who are not financially able, those who do not have experience with or knowledge of the associated risks, and those who have a history of not following through with their commitments.
How much capital can you raise from a friends and family round?
The amount of capital that you can raise from a friends and family round will depend on the size of your business and the stage of your business. It also varies based on the number of investors that you can attract. Generally, friends and family rounds are used to raise a small amount of capital, usually between $50,000 and $500,000.
How much equity to give up in a friends and family round?
Generally, the founders should not give up more than 10-15% of the company’s equity in friends and family rounds. This is because the investors in a friends and family round are typically not professional investors and they may not be willing to take on a large amount of risk.
Friends and family round vs seed round?
Generally speaking, friends and family rounds are used to raise a small amount of capital, usually between $50,000 and $500,000, whereas a seed round involves a larger amount, usually between $1 million and $3 million. In a friends and family round founders give up 10-15% of the company’s equity, compared to 20-30% in a seed round. The terms of friends and family rounds are typically more flexible, whereas investors in a seed round may ask for more structured provisions such as most favored nations clauses, pro rata rights, or anti-dilution protection.
Benefits of friends and family rounds?
Raising capital through friends and family rounds can be a great way to get your business off the ground. Here are some of the key benefits associated with this type of fundraising:
- Quicker fundraising process: Friends and family rounds are typically quicker than traditional venture capital fundraising, as you don’t have to go through the lengthy diligence process.
- Lower cost: Since you don’t have to negotiate complex term sheets, you can avoid paying the exorbitant costs associated with traditional venture capital or venture debt.
- Low barrier to entry: You don’t need to have the perfect business plan or pitch deck to raise capital through friends and family rounds.
Drawbacks of friends and family rounds?
There are some drawbacks of friends and family rounds that you should be aware of.
- It is not a substitute for venture capital or a seed round. Friends and family rounds are typically only used to raise a small amount of capital, whereas venture capital or a seed round is used to raise larger amounts of capital.
- It can end friendships and cause friction in your family. Ultimately, investing in startups comes with an element of risk. If your startup goes under and your friends or family lose money it can cause problems.
- It might not be the “best” money. Ultimately you need backers who understand what you’re trying to build and can support you through introductions or mentorship, your friends and family might not be able to offer this.
Tips following successful friends and family rounds?
First off, congratulations—raising a friends and family round is no simple feat! Here are some general tips to set yourself up for success in future rounds.
- Keep your investors updated: Make sure to keep your investors updated on the progress of your business. Let them know when you hit certain milestones and when you’re launching new products or services.
- Send regular financial reports: Make sure to provide your investors with regular financial reports so that they can keep track of how your business is performing.
- Be respectful: Realize that they trusted you enough to give you their hard-earned money, don’t take this for granted or make them feel like their money isn’t appreciated.
Alternatives to Friends and Family Rounds
If you’re not comfortable with the idea of asking your friends or family for an investment, there are other options you can explore. One option is to pursue funding from an angel group or angel syndicate in your area. These investors are usually less risk-averse than your friends and family and may be willing to invest larger amounts of money. Another alternative would be SBA funding through the government, though this is typically only for businesses that have a proven track record or are asset-based (e.g. coffee shops, clothing retailers…etc.). Finally, if you’re revenue-generating and looking to raise capital, revenue-based financing may be a fit.
Our thoughts on friends and family rounds?
Friends and family rounds are an effective way to raise capital for your business, but they come with their own set of risks and rewards. It’s important to make sure that you understand the legal implications of this type of fundraising and to make sure that you come prepared with a detailed business plan, pitch deck, and term sheet. Additionally, make sure to give your friends and family plenty of time to make their decisions, and recognize that it may cause strain on your relationships should the business fail.
