The right way to raise capital from friends and family
By Pauline Muindi
| May 26th 2021
Every entrepreneur who has ever built something of note will tell you that perhaps the hardest part about starting a venture is raising the initial capital. It is particularly hard to convince investors such as venture capitalists and banks to believe in your idea as much as you do.
However, even before turning to funding institutions for help, many entrepreneurs turn to family and friends for that early boost that will get the wheels on their promising ventures rolling.
The simplicity of raising funds from your kith and kin is a major upside. Unlike banks and other financiers who will definitely put you through a gruelling probe before acquiescing to your requests, your loved ones are likely to be less demanding and more understanding. Furthermore, venture capitalists, angel investors and other secondary financiers are more likely to fund you later in your entrepreneurial journey if you demonstrate to them that the people who know you well are willing to bet on your idea.
However, convincing the people close to you to trust you with their money and resources is still no walk in the park. It involves taking your personal relationships to a business level and if this is not done carefully, it can lead to soiled rapports and burnt bridges. Below are tips to guide you through the process of imploring your close ones to invest in you with as little friction as possible.
1.Show belief in your idea by betting on yourself first
People are more likely to risk their hard-earned cash if they see that you have gone all in. Before asking your friend to forgo upgrading their car for your sake, why not sell your own car first to get the business started? If you do not go to great lengths to ensure that your enterprise is funded at the cost of a personal sacrifice, do not expect others to put their necks on the line for your sake.
While imploring your kinfolk to lend you the initial seed, be sure to tell them how much money you have put into the business so far. They will be more at ease if they see you are heavily invested too, and that you will do all you can to ensure your fortune does not sink.
2. Formalise your business as an LLC
If you are considering taking on investments from your social circle, it will behoove you to register your business as a corporation, a limited partnership or a limited liability company. This will be beneficial as people are more likely to back a formally registered company compared to a business that only exists abstractly as figments in your brain.
Forming an LLC also has another advantage—it will insulate your funders from any liability and debts associated with the business as it runs. Say, for instance, that your venture fails to pick up as expected and instead ends up with it getting sued or under a lot of debt. Having an LLC in place will make it so that your debtors and accusers do not come after your close friends and relatives when things do go south.
3.Focus on friends with appropriate business connections and experience
While selecting which kith or kin to approach, the amount of money they can shell out should not be the only consideration. The personal connections and work experience should be regarded highly as well. If you are starting a medical supplies business, for example, your cousin who is a pharmacist but can only afford to put in as seed Sh200,000 shillings is a much better bet than your uncle, the rich farmer who could loan you Sh1 million.
4.Only take what they can afford to lose
Even though you might be in need of a lot of money to spend, you do not want to put the people you care about in a rough patch financially. Your personal relationships, after all, should count for more than the amount you get to start your venture. Avoid being greedy, and do not pressure anyone into giving you more than they can reasonably afford to.
If someone tells you that they do not have any money to offer, or if they flat out decline to invest, do not take it personally and let it sour your cordial relations.
5. Clearly communicate the risks
While it will be rewarding to you and your loved ones if your venture succeeds, it is bad to only extol the upsides of your venture while understating potential downsides. You do not want to appear overly optimistic, as this can leave your backers feeling cheated and shortchanged should the venture fail to pan out.
6.Use contracts to document commitments
While people that know and trust you can give you money without the need for excessive documentation, it is generally a good idea to give friends and family the same contract and terms that you would give a sophisticated investor. Advise them to have the contract looked at by their lawyers before signing.
Let the contract clearly state whether their money is a gift, a loan, or money that will convert to equity once the business gets off the ground.
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