The most common funding sources for a startup are friends and family and fools. It can be the easiest and least time-consuming fund-raising source around.
However, for the many pros in raising funds from your immediate circle, there are as many cons to consider as well, which I list below so that you can consider whether it really is worthwhile.
Pros
1. Funding can be quick due to existing relationship – there is no bureaucracy and far less hassles than dealing with professional investors and VCs’. Cash comes in quick.
2. Returns can be more flexible – you can negotiate flexible terms and take out loans rather than equity, which means you keep control and ownership in the early stages.
3. Business models that are less mainstream can be funded – institutions like banks and VCs’ like mainstream business models so the less mainstream model may not get funded.
4. It can be more fun – family and friends will be more encouraging and probably go out of their way to help you succeed. You probably will have more supporters than you need!
5. Everyone benefits – if you do well, everyone benefits and there’s nothing like sharing success.
Cons
1. Limited experience – the more questions asked about your business model, the more refined it can be, increasing the chance of success in the long-term. Professional investors will have more experience than family and friends.
2. Get less funding – your immediate circle may not be able to fund you fully and this may affect the success of the business.
3. Relationships may suffer – if you don’t succeed, your relationships may suffer.
4. Too many cooks can spoil the broth – as the saying goes, all your loved ones will give you ongoing advice due to their involvement and that’s the last thing you need!
5. Later stages could get complicated – if you’ve given equity to family and friends, taking on board new professional investors at a later growth stage can get complex.
So there are many pitfalls to consider but funding from family and friends can be a great way to start and I would give any entrepreneur the following advice:
- Don’t ask if you think they can’t afford it
- Make sure you inform them about the risks of losing their money
- Agree the details of the ‘deal’ and be fair to them
- Finally, try to make it loans rather than equity to avoid complications later.
[Contributed by Asoka, Independent Finance Director and Management Consultant based in London. He works with growing companies as their part time Finance Director and is the Founder of AKCA Consulting, which helps companies improve their financial health.]
