Friends/Family Start Up Funding

advice?

[ItsAllBallBearings]

some background:

looking to start up website #3 and i have been speaking with a friend about him investing in the business. I threw out the idea of an initial amount, which i could guarantee a return in 12 months (guarantee based on revenue from my existing biz's). My friend said he is interested in more of a long term investment.

my dilemma:

I need capital now to purchase inventory but once the new biz is up and running it will be largely self sufficient (barring expansion needs). My friend will not be very involved in the operations, so his input will be limited beyond the investment itself. I don't want to indefinitely give away future profits just to secure start up money. But, at the same time i understand how my friend wants more of a long term investment. How can i structure his investment/return such that we both win (he gets long term and i dont sacrifice my profits for start up $$)? Do i ask for both an A round and B round from him? Do i tie the success of the company directly to his return?

Sorry, but i began my business now with my own capital and have no experience with this sort of funding. This new biz is significantly more involved and expensive than my existing ones, so using my own capital is not an option.

[edited by: ItsAllBallBearings at 10:57 pm (utc) on Jan. 24, 2007]

[andye]

How can i structure his investment/return such that we both win (he gets long term and i dont sacrifice my profits for start up $$)?

Maybe other people will have some better ideas here, but personally I'm not sure that you can.

The normal deal with funding is either:

1) Debt. You have collateral - the bank provides you with a loan, you pay it back plus interest. If you don't pay then they seize the collateral. Low risk for the investor.

or

2) Equity. An investor buys shares in your company. This entitles them to a share in future profits (this is the value of the equity). If there are no profits (e.g. the business goes bust) then they lose their money. High risk for the investor, therefore higher return in the case of success.

I guess another option you could think about is profit-sharing for a limited period of time? This isn't a good deal for the investor... they get all the risk of equity but not all the return.

HTH, a.

PS you could also think about issuing the investor with a class of shares with different rights to your shares... you need to be upfront about what you're doing though, make sure they understand what they're getting in return for their money, otherwise you're basically defrauding them by making them think they're getting normal equity when they're not really.

[ItsAllBallBearings]

Thanks A - i spoke with my friend last night and i think we're going with 2 rounds of funding. The first will be a smaller, short term "loan" with a guaranteed return. If the biz goes well and takes off, he'll add a B Round in which he is entitled to a % (small) of gross revenue for a fixed period of time. This allows him to limit his risk by seeing that biz is viable before committing the significant portion of the investment. This also allows me to limit my exposure by having a finite period of payout time on his investment. Once that time is up, all revenue is back to me.

See any fatal flaws?

[Sharpseo]

"The first will be a smaller, short term "loan" with a guaranteed return. If the biz goes well and takes off, he'll add a B Round in which he is entitled to a % (small) of gross revenue for a fixed period of time."

The problem I see is this: if your business takes off, where is your motivation to allow him to buy part of it? As someone else mentioned, he's taking a lot of risk by putting money up front.

The second round may or may not happen, and without pre-determinted terms, it will probably be hard to come to an agreement after the business is already been proven.

[Essex_boy]

Never use friends or family in any business - it wont work out.

You wont push hard enough against them when it comes to the crunch.

[LifeinAsia]

I almost agree with Essex_boy's comments. However, I will say that it does work sometimes.

My wife and I had just decided to start a business together and I was meeting with an old friend who ran a consulting business with his wife. His advice was to never going into business with a spouse because he had just started divorce proceedings with his wife. We also attended a business seminar for startups and the first thing we were told was to never go into business with your spouse.

Well, it's more than 7 years later, and we've almost gotten divorced only 53 times. :) Seriously though, it's been rough at times, but we somehow managed to survive the low points and rough times. But I agree- in general, it is not a good idea to go into business with your spouse or family members.

We also had to kick my brother-in-law out of the company. Twice.

[edited by: LifeinAsia at 7:02 pm (utc) on Feb. 6, 2007]

[aspdaddy]

If its just cash you need then you will get much lower rates off banks even in the Uk but worldwide even better - as low as 0.2%

As an investor people are going to want 10% ROI or why take the risk?

[rfung]

I had a friend who wanted to start an online business. It doesn't really require that much in terms of capital (maybe $5-$10k). I believe in her idea, and wish no real involvement in the way she runs her business - but, at the same time, I realize that sure $5k might be small potatoes, but I have the high risk of losing it (and of course, I'm prepared to accept it if that were the case). But, given that risk, I would not accept anything short of 10-20% of equity, and definitely would balk down on any limitation of terms for the return.

It's not so much the money that's at stake here - but also the implicit trust that your idea can take off the ground when you're using someone else's money to fund it. As others pointed out, one can always get a loan from a bank or charge it up to credit cards, but perhaps you are not willing to risk your own money(to the amount required) on the venture. That's why a lot of angels or VCs require you to put your money where your mouth is and very few will ever fund you 100%.

Would you rather be the owner of a $100 million company where you have to share 20-30% of the company with your investor, or have a 9-5 working your regular job?...