Family and friends or rather your inner circle giving you a startup capital is a viable source if handled properly.
However, before acquiring the startup capital it is important to properly educate everyone involved about the risk involved, not just the return on interest.
Also, there should be a clear communication of the terms of the agreement binding their investment. This has to be written down and properly signed by every party involved, and everyone has to have adequate knowledge of probable situations that might arise.
There are benefits as well as challenges of having your inner circle fund a startup, here are some of the benefits.
Trust and Flexibility
Even as a sole founder, family, and friends would still readily fund the startup because they know you integrally unlike in external funding, where investors are wary of sole founders.
In cases where the startup needs additional funds. There are more favorable responses from family and friends under favorable terms, this gives the startup the flexibility in running the startup at its best capacity.
Reduced Pressure Zone
Family and friends are less likely to pressure the startup to seek an acquisition, going public, or other exit strategies, this helps the startup focus squarely on its business goals.
There is therefore reduced pressure from family and friends for payouts once they have understood the direction of the startup.
Increased Funding Speed
Once family and friends decide to fund a startup, it is done quickly as it doesn’t take a lot of time when compared to most external funds. This is because there’s no bureaucracy before the money is released.
No Equity Dilution
Unless in rare cases, there is usually no Equity dilution when family and friends fund a startup. This helps the founder remain in control and therefore able to make decisions for the startup with little or no interference.
Well-rounded support
The founding journey is not an easy one, having your family and friends fund can come with the added benefit of more than just financial support as they want the startup to succeed too, they can go all out supporting to ensure it does.
Pulling their network where necessary, providing advice, mentorship, and even emotional support. These things can go a long way to making a startup successful.
Lower interest rates
Family and friends are willing to fund at a lower interest rate than an external investor would. This helps in reducing the financial burden of the startup, as they can have more to put back into the business when revenue is generated.
No need for a formal pitch
The classic pitch party is set for external investors, Family and friends do not necessarily need all the formalities involved. This saves time and resources for the founder.
Having listed some of the benefits, Let’s take a look at the challenges of family and friends funding for startups.
Entangled Relationships
When family and friends fund a startup, it could be difficult to separate personal and professional lives. Whatever happens in the business has the potential to affect personal interactions.
Biased Objectivity and Expectations
Because the founder is family or friends, even the decision to fund is most likely to be biased. So will other decisions that should be taken about the startup, and the business failure, doesn’t care about who funded.
Legal and Valuation Challenges
When family and friends funds your startup capital, they are less likely to tow the legal route of putting into place proper documentation, stating terms and rights.
Hence, proper valuation of the startup could be a tedious task. The startup is at risk of either undervaluing or overvaluing the startup.
Limited Expertise
Unlike external investors who have access to a wide range of industries, family and friends have limited expertise except in rare cases, which makes it hard for them to provide the necessary support, contacts, and resources that would be beneficial to the startup.
Limited Growth rate and Diversification
Because the family and friends will not be pressured for a Return on their Investment, founders run a risk of falling into a rut, which leads to a reduced growth rate. When the growth rate is slow, it is hard to think of diversification.
In summary, while there can be benefits to having family and friends fund your startup capital, it is important to be aware of the risks and potential challenges involved, as well as have a clear understanding of the terms of the investment, and weighing the pros and cons before making a decision.
Your inner circle should also seek professional advice before investing in a startup. This will help them make more informed decisions while reducing the risk rate.
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