A business starts as nothing more than an idea. No matter what industry or geography, founders and entrepreneurs start out with a problem to solve and a customer to serve. However, every idea needs to grow capital and most people just don’t know where to find it. With a limited network and understanding of the market, most turn to the people who are closest to them and who they trust the most: family and friends (F&F).
This is a good way to raise some of the early capital you may need, depending on the needs of your business and what you are trying to accomplish. Like any capital raise, the F&F approach comes with its own set of risks and benefits. Here are three that should be near top the of your list:
1. Less legal documentation could increase future risk. Passionate founders and entrepreneurs are excited to get their ideas funded. Focused on building their business, most will take the first money they can get and typically from unsophisticated investors. This leads to very little documentation around the structure of the investment, the equity provided to the investor, etc. This can be detrimental down the road should you need more capital from more experienced, institutional money that might not trust the terms (or lack thereof) of the initial F&F round. Also, if you do get more sophisticated money, your F&F may end up with worse terms than they expected when they gave you their initial investment.
2. Lack of structure could lead to underfunding your business. Most business owners/founders focus on serving their customers and solving a problem. The majority do not understand the best way to incorporate their business, the right amount of equity to give up, or the total amount of capital needed to get started. Without the right amount of capital, your business can run into serious problems like being unable to fulfill customer orders, an inability to hold inventory on your books, etc. However, the biggest danger in underfunding your company is that you don’t make it to the next round of financing and your business ultimately goes bankrupt. Ensure you raise the right amount in order to get to profitability or to the milestones that will allow you to raise another round of funding.
3. Limiting your options can hurt your business down the road. Angel investors, VCs, and other institutional investors help build companies for a living. They analyze business models and innovative ideas across a wide range of industries and geographies daily. Their job inevitably builds a knowledge base and network. This is a dense web of knowledge that are well beyond the reach of most entrepreneurs who are just getting started. As a founder considering whether to raise capital from F&F, one of your top considerations should be whether or not you should be networking with some of the top minds and firms in your space, attending industry specific events, or even joining networks in your local geography. While not mutually exclusive, focusing on raising an institutional round from “smart money” can at least help you move the right direction, even if you end up taking some of your early capital from F&F.
The business owner drives the economy. No matter how much or how little, founders and owners should consider accessing outside networks, like Axial, to get a better concept of other sources of capital and business insight before jumping straight into friends and family money. You never know who you’ll meet or how they’ll change your business.