What do I tell my friends and family who want to invest in my company?

TLDR: Confirm they are accredited investors and weigh heavily the decision of receiving investment from friends and family.

You’re at coffee with a close friend. You mention that you’re working on a start-up. After listening to the idea, your friend wants in and offers to invest. How should you react? Remember, to a future investor, a family or friend investment signals more than a dollar amount. It acts as an endorsement, a stamp of approval. Therefore, a friend’s investment offer should not be taken lightly. 

Before answering your friend, you should reflect. Do you have sufficient skin in the game? Have you invested sweat equity in getting your company off the ground? If you haven’t, you’re likely not in a place to be taking an investment from a friend.

Next, evaluate where the company stands in its lifecycle. Does the company need additional investment at its current stage? More investors equate to more opinions, external pressures, and expectations that may not align with the company’s interests. In other words, accepting investments from friends may distract your focus from growing the business.

Fundamentally, it’s essential that your friend understands the risks of start-up investing or, more specifically, that most start-ups fail. If you receive any inclination that your friend is not in a financial position to lose his or her entire investment, it’s best to decline. When considering fundraising from friends, remember the proverb, “Before borrowing from a friend decide which you need most.”

Proceed with Caution

In addition to the practical considerations, entrepreneurs must be cautious not to run afoul of securities laws. The general rule is that a company that offers or sells its securities must register the securities with the SEC or find an exemption. The most common exemption is when a company sells its securities to “accredited investors.”

There are a few categories under which you can qualify as an accredited investor, but the most applicable to family and friends are: (i) individuals whose net worth, or joint net worth with that person’s spouse, exceeds $1 million, excluding the value of the person’s primary residence, and (ii); individuals who had an income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of the two most recent years and has a reasonable expectation of reaching the same income level in the current year. To summarize, before accepting any investment, ask the relevant questions. The time to begin protecting your company starts at the first invested dollar.

The Response

The decision to accept a family member’s or friend’s offer to invest in your company requires close analysis, including practical considerations stemming from the existing relationship and determining whether your family member or friend qualifies as an accredited investor.

Although family and friends rounds are commonplace, they may not be the right path for everyone. However, if you decide to accept an investment from your family or friend to help get to your next goal as you grow your company, remember to clearly communicate risks, expectations, and do your homework. Begin the process at the first invested dollar.

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