Can Your Family & Friends Help Your Business? Part 2

Make sure that your friends-and-family round includes organizations of which you are a member.

As de Tocqueville remarked, the United States is built on voluntary associations. For example, some of the premiere American life insurance companies started as benevolent organizations of individuals and families in a given geographical location or specific line of work. The founders pooled their resources to help the members through occasional catastrophes ‘” burial societies are one example.

Make sure that you understand all the organizations that you and your family belong to.

Some alumni associations have small seed funds designed for providing graduates with very early stage capital. In recent years, this form of giving has become a favorite pastime for rich alumni, particularly those who made their money through venture-capital-backed enterprises. They put up some seed capital, cut the university in for a portion (or all) of the investment, and make capital available to graduates ‘” potentially a win-win situation for all involved.

Also, don’t neglect your high school and college reunions. Seek out the individual who was the biggest “go-getter” when you were in school together and try to coordinate your reunion plans with him or her. You may be surprised how your classmates turned out ‘” just as they may be surprised how you e turned out!

If, as entrepreneurs often do, you fly coast to coast, you will find yourself sitting next to a total stranger for six or eight hours ‘” with about 2 inches separating you. If you’re looking for capital, our advice is to strike up a conversation. No fooling, folks. Any number of enterprising people have been able to either raise money directly or develop contacts provided by a seatmate with whom they’ve been trapped on an extended airline trip. You can start with the usual: cursing the airline. After you’ve become blood brothers in that regard, you can start talking about your proposition.

Submitting an over-the-transom (unsolicited) plan to a venture firm is not likely to get you very far. Most venture firms make their investment decisions on the basis of plans that they helped develop or that sources they know and respect forwarded to them. The trick, therefore, is obtaining an introduction.

If you don’t have access to a placement agent (a professional hired to find investors for your opportunity), consider employing your professional associates ‘” that is, your law or accounting firm. A savvy partner can showcase your opportunity to his or her associates ‘” many of whom may be interested in a piece of the action ‘” and sometimes they invest themselves (the lawyers, anyway).

So, what does a family and friends deal look like? In reality, no one single model exists for investments made by family and friends, and company owners historically used a variety of different investment vehicles. As in other kinds of financing, however, family and friends investments break down into to major categories:

  • Debt financing. In some cases, investments by family and friends are made as straight loans of cash to a company’s owners. The debt is paid back to the investors by way of regular payments (often monthly) with interest added to compensate the investors for the risk they bear in making the investment. Debt financing confers no ownership stake (equity) to the investors ‘” the owners retain full control of the company.
  • Equity financing. In other cases, investments by family and friends are made through the purchase of securities such as stock. In this way, investors become part owners of the company ‘” proportionate to the amount of money that they invest ‘” and the original owners give up some amount of control over the company.

Regardless of the many different investment alternatives available, the family and friends round is likely to be a straight common stock issuance. There isn’t enough money to construct an elaborate securities structure, including a convertible preferred. Accordingly, the notion is that everybody is generally pari passu ‘” holders of a single class of common stock.

One of the worst things you can do in the early stages of your company’s existence is to give out stock promiscuously. By the time you have finished the journey from embryo to IPO, you’ll find yourself personally owning only a trivial percentage of the company. You may have created a $100 million company, but if your percentage is down in the 1 percent or 2 percent range when you sell, you’ll find that you’ve been working like a slave at a substandard wage for no reason. Given enormous opportunity costs, your outcome would have been better had you taken up basket weaving as a profession.