This is the season when we gather our loved ones around us and think cozy thoughts about our friends and family. We’ll lucky to have them in our lives! They support us during the rough times and they share our joy when things go well…and sometimes they provide the financial backing necessary to get a company off the ground before opening the process to the complexity of institutional investors (or an eventual public offering).
But pitching your business to friends and family may not be as simple—or as cozy and risk-free—as it seems on the surface. Here are a few things to keep in mind as you structure your friends-and-family pitch.
Comply with securities laws
Securities laws are put in place to protect people from making bad investment decisions and being caught up in investment hype or froth that has no sound business case. Before you approach your friends and family for investment, make sure you’ve vetted the investment opportunity by legal counsel. There is no “friends-and-family” exception to the securities laws, and you need to make sure that the deal you’ve put together and its terms are consistent and compliant with both state and federal rules. This is really important! Failure to comply with securities rules can make future financings a lot more difficult and also expose the company to civil and criminal proceedings for breaking securities rules.
Be honest about the offering.
Your potential backers need to be sophisticated enough to understand that they may lose everything they put up. With friends and family, you have to be honest with them and they have to understand that success is absolutely not guaranteed. So-called “accredited investors” are presumed to be sophisticated and able to handle their own financial affairs, but state securities rules may have other tests they use, and your investment deal and offering materials that you prepare for your investors may need to include significant disclosures of risks. Also, be clear about your own risk exposure; if your idea generates income, will you pay them back before paying yourself? If your business struggles, will you accept a level of loss or risk that reflects what you’re asking from them?
Think about the investment opportunity
At the friends and family stage, many early stage ventures elect to offer convertible notes as their first securities offering. But there are other ways to structure investment deals, and some companies forego this traditional path and issue Series Seed stock or other forms of equity to friends and family. With the rise of ICOs, some companies are even considering offering coin to friends and family. Make sure you’ve thought through what the investment opportunity is, and how it will fit into the larger vision for the company.
Invest some sweat equity before making your case.
From a practical perspective, your friends and family will have more confidence in your plans if they’ve seen you at work—literally—for at least a few months before you turn to them for backing. If they recognize your commitment, they’ve heard you talk about your plans for a while, they see you toiling away in the garage, or they can hold and interact with a prototype you’ve designed and built, they’ll gain a clearer sense of your level of determination and business savvy. This is also important from a securities perspective as it helps show the bona fides of the venture. Again, disclosure will be important here, but it’s important to have operating history before you approach friends and family.
Keep your request specific and goal focused.
Instead of simply holding out your hands and letting your investors decide how much to offer, share a clear goal, and explain how you arrived at that number. Break down how this investment will be applied and share the amount you plan to contribute on your own. Make sure your investors understand that there’s a roof on what you’re asking for, but no clear roof on potential returns if your product does well in the marketplace. This is important both from a practical as well as from a compliance point of view.
Invest in legal support.
At this stage, engaging with an attorney might feel premature, but think of legal guidance as an investment that will pay off quickly if it can clear the path to capital while protecting your relationships with the people you care about the most, and very importantly, ensuring proper compliance with securities rules. Take the right steps at the start, and your family and friends will still be with you as the years pass and your business grows.