How Much Stock to Give Friends and Family in Startups

When you're trying to start a new business, friends and family are generally the first people you turn to for funding.

Friends and family investors are essentially a type of crowdfunding and the people you would go to in order to present the presentation that you crafted on top of one of the best pitch decks from startups that you got for inspiration. To raise a more considerable sum, you could collect small amounts of money from various family members or close friends.

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Friends and family members may be prepared to invest in your startup without charging interest. Alternatively, you may make an investment arrangement with your friends and family that guarantees interest, an ownership position by giving them stock, or some other sort of compensation in exchange for loaning you the funds that you require.

The Stages of Startup Funding Rounds

Regardless of the nature or size of its activities, every startup requires funding to turn its unique ideas into reality. The bulk of startups fail because they are unable to raise adequate financing. You'll need money or capital to keep your company running and growing at all times.

Stage One: Pre-Seed and Self-Funding

An entrepreneur should figure out how much money they can put in from their own pocket. Examine all of your investments and money spread over numerous accounts, and talk to your friends and family about it. There are fewer hassles and documents at this stage, and your friends and relatives may be willing to lend at a lower rate. If your startup requires a small initial investment, self-funding or bootstrapping is a good option.

Stage Two: Seed Capital

Seed capital is a type of investment made in the early stages of a startup. This aids the company in determining and implementing the best course of action for their venture. The funds raised at this stage are used to learn about clients' preferences, demands, and tastes and then create a product or service that meets their needs. It’s about getting started. Self-funding, friends and family, angel investors and some institutional investors may participate at this stage.

Stage Three: Venture Capital Funding

Venture capital funding typically enters the picture after the company has gained some traction and has some proof points. Regardless of the profitability of the products, almost every company considers adopting outside financing at this stage. Which may entail many rounds of funding.

Round One: Series A

Because a Series A investment is often the first institutional round of capital, investors are usually looking for something tangible. Startups have developed a clear plan for their product or service at this point. It is mainly utilized for optimizing, marketing and brand reputation, and assisting with corporate growth.

Round Two: Series B

When a company relies on Series B funding, it shows that the product is promoted well and customers are purchasing the product or service as planned. Such investment enables a company to pay salaries, hire new employees, improve infrastructure, and establish itself as a worldwide player.

Round Three: Series C

At this point the company has nailed down its unit economics and is really ready to scale. There are no constraints as to how many investment rounds a startup can receive. It has become more common to even see a Series D or beyond. The more investment rounds there are, the more equity in the company gets released.

The Friends and Family Round

Founders generally get early funding from their own savings and networks of friends and family to meet their cash demands. Usually, these investors are prepared to put up $10,000 to $150,000 of their own money into a startup because they have a strong bond with the founders, or are inspired by their business idea. A "friends and family" round is a common term for this type of early-stage investment.

Friends or family members who have a close personal connection to the founder are an excellent source of initial funding. Because of this closeness, entrepreneurs may get persuaded to accept money from them without going through the formality that institutional investors require. That might be a mistake.

Entrepreneurs should always meticulously document each investment, even if it comes from friends and family closest to them. This will help avoid future disagreements while establishing a solid foundation for future investment.

Friends and Family – The Risks

At this point, it's essential to be completely honest with yourself and your family/friends: statistically, the most likely outcome is that your startup will not generate a profit for investors. The most likely scenario is often that the return is zero.

Experienced startup investors are aware of these chances, which is why they diversify their portfolios, anticipating that the majority of their bets on startups will fail. However, when investing in your startup, your friends and family may not have this plan in mind, so keep that in mind over the next Christmas dinner. You should talk with them ahead of time, where you discuss all the risks involved.

Another primary consideration for novice startup investors is the illiquid nature of the investment. Your friends and family need to be aware that a return of capital can take 7-15 years. In the interim, selling the stock isn't as simple as it is with public equities. Make sure the people who give you money are aware of this.

You run the danger of losing friends and strained family relationships. If half the people at your next holiday party believe you scammed them on a failed business venture or are unhappy because you left on vacation before repaying their money, it won't be as much fun.

As a result, it's best not to grow too casual in your business transactions. Be honest about the risks, set out the business plan that the money will support, and spell out the investment details in writing.

Consider a Standard Loan Structure

Even if your brother and best friend realize the dangers, they may be prepared to lend you $10k-$20k (or more). A good approach may be a typical loan structure with interest and regular installment payments, regardless of how successful your startup succeeds. This permits you to avoid selling shares of your startup to someone who isn't an accredited investor.

If you're taking out a loan, whether interest-free or with interest, you'll need to come up with a repayment plan that both parties can agree on. You lessen the possibility of your personal connections being jeopardized because everyone understands and agrees on when the money will get repaid. Having a repayment strategy in place might also help you qualify for more milestone based loans.
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