What kind of due diligence is necessary to begin raising money from family and friends?

Long story short, I’m ready to begin raising money from family and friends to begin building a product. But of course I’ve never raised money, and am not sure what kind of due diligence is necessary. Do I need to hire a lawyer? Can I outline an agreement myself promising a certian percentage on the company for their investment? Do I incorporate first, or raise the money first then incorporate and designate them as share holders?

I bootstrapped my first two companies with a partner, and never had to go through this process. This company will need some runway though, so I’m trying to figure out where to start.

  • First, I’d be sure to clearly express to family and friends the risky nature of their investment, that it is not only no guarantee but that it might be the first of several rounds of investment.

    The form is up to you – in general, to protect them and yourself, I’d definitely incorporate and set up an equity round. Some people like convertible notes – this is easier but does have both good and bad points.

    You clearly need to read up on the difference between equity and convertible.

    If equity, you need to decide on a valuation which is agreed upon by your investors. For convertible, the question is valuation cap.

    Given your apparent lack of familiarity, I’d strongly suggest retaining appropriate counsel. You’re looking for someone that has worked with startups, has a payment schedule you can live with (cash and/or equity). This individual will not only draft the various agreements, but more importantly will ideally give you access to information necessary to justify valuation decisions.

    There’s a lot there – don’t squander your friends/family with a poorly thought out and/or executed setup as this is probably not a well you can go to over and over.

    • Thank you, this is very helpful. And yes, I have zero familiarity with this process and the details. I’ll read up on the differences and do some more homework.

  • Are you confident that they can easily shrug it off when/if your company fails? Are they emotionally capable of making any (large) write-off? Or are they the sort of people who panic when the stock market drops 5%? Are your friends and family well off, so that they’re not investing their kids’ college funds into your venture or other money they can’t afford to lose? These are critical questions to ask yourself, and many people aren’t sufficiently introspective to make this judgement call for themselves.

    Either way, whenever you accept money from FF&F you’re jeopardizing your relationship with them. Sometimes it turns out great, of course. And there are certain advantages. For instance, family members are less likely to stab you in the back when you’re at your weakest.

    I don’t blur the line between business and family, and I suggest you think very carefully before you do. If you take their money then every family meetup will become in unofficial progress meeting, and you’ll have to keep your guard up and your game face on. This is hugely stressful, especially if your business isn’t going well.

    (PS: It’s especially dodgy if you’re trying to take money from friends and family because institutional investors won’t touch your business with a 10 foot pole.)

    • Great council.

      Yes, the list of friends I would go to can emotionally write-off $10k – $50k if the company fails.

      Your points about family though ring true, and it is probably best to keep family and business separate. I’d prefer family to be a respite from the demands of entrepreneurship, and I’d like their support to be untainted by any stress of losing their money.

      I’m more than confident angels and institutional investors will be excited about this venture, but I’d like to build an initial product before pursuing that route. It’s just that the gap between bootstrapping and getting serious seed funding is a bit too big to span myself.

    • This has come up before among friends, and it is an interesting idea. What platform have you seen the most success for this route? It looks like the top three most well-funded software projects on Kickstarter are from Great Britain. Even then it looks like only 208 have ever been successfully funded.

  • My recommendation is to avoid raising money from family and friends like the plague. If things go south? Those relationships become damaged. It’s much better to gamble with a stranger’s money who you don’t have to face every Thanksgiving and Christmas. Just saying…

  • “Practice safe crowdfunding” if you do intend to crowdfund. There is a whole world of inexpensive legal tech out there, just look for it. Find something like a questionnaire that identifies legal issues you have, and protect the intellectual property that you definitely have.

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