

Ask HN: Raising a friends And family round? - jnovek

We started developing our product about 10 months ago, and have seen steadily increasing monthly revenue since we took on our first paying customer in June.  We made about $2500 in recurring revenue last month, but we would like my co-founder to be able to quit his job and come on full-time.<p>Our model is based on direct sales with large customers.  My partner is company's salesman and he believes that if he were selling full-time (he sells only on his lunches at the day job right now) we would be profitable with both of us working full-time in three months.<p>We have applied for an SBA loan to cover part of our costs for six months of operation and have decided to raise a "friends and family" round for the rest of it.  We've never raised any funding of any kind, so we're hoping that those who have experienced a F&#38;F round on HN could give us some insight.  We are currently incorporated as an S-Corp.<p>How did you determine your valuation before a F&#38;F round?  This is one of our biggest concerns.<p>Because a F&#38;F round is pretty small, how did you minimize legal costs?<p>What did you tell potential F&#38;F investors about the opportunity?  Is there anything that you're REQUIRED to tell them?<p>How much of your company did you give up in your F&#38;F round?<p>Feel free to include any resources that you found useful when you were doing your F&#38;F round.
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patio11
The stock piece of advice we gave at the technology incubator I used to work
at is to consider giving them debt rather than equity. There is a minimum of
legal fuss associated with this -- for many friends & family, you can
literally proceed on a handshake ("$10,000 loan, 5% APR, 3 year term work for
you? Thanks Uncle Jim. My bookkeeper will cut the checks.") and if you want to
contractualize it you can have loan docs drawn up very, very reasonably.

Personally, if I were to do it, I'd have somebody like Prosper (but not
Prosper) involved in the middle to handle the loan payments/collection/etc. It
costs a little extra money but saves on you actually having to calculate loan
payments and may well prevent you and Uncle Jim from ever having to have an
unpleasant discussion about the tardiness of your check.

Particularly for a concern with actual revenue, loans are a great alternative
to equity: they won't entangle any of your activities going forward, there is
a built-in way to sever the relationship with both parties leaving on amicable
terms with each other (repayment), and they're very, very easy to understand
for people who are not in your business, in a way that an equity position in
your company is not.

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tptacek
Wait. Can you sell unregistered stock to non-accredited investors, even if
they're "friends and family"? Unless your friends and family are millionaires,
you need to talk to a lawyer.

~~~
jnovek
That's a great question. Certainly, we're not the first company to receive
investment from F&F -- how do "normal" small businesses do it? As loans? We
want to give our friends who choose to help us out some kind of return on
their investment.

Before we do anything we'll talk to our lawyer, but we would like to get a
sense for how people normally do this before spend big lawyer $$$.

~~~
rms
"Normal" small businesses just take the money from the F&F and don't worry
about selling securities to non-accredited investors. But presumably you're
not a normal small business, you're trying to build a billion dollar company.
It's certainly not illegal to sell shares in your company to non-accredited
investors, but it can be a problem for due diligence that can happen when
raising money, selling the company, or going public. Loans are definitely
easier.

[http://www.thestartuplawyer.com/seed-funding/life-is-too-
sho...](http://www.thestartuplawyer.com/seed-funding/life-is-too-short-to-
deal-with-non-accredited-investors)

------
gtm
One approach is to raise the funds in the form a "convertible note", which is
basically a loan that converts to equity when you raise your first round of
financing. Rather than interest, you give investors a discount (20% is
typical) on the conversion. (e.g. If your price per share is $1.00 when you
raise your next round, the notes convert by paying on $.80 per share).

One other comment is that, if you can, it's better if your friends and family
investors are experienced investors (not necessarily with angel experience).
It makes things easier if they understand the risks and have the means so that
if they lose their investment, it won't be a hardship for them.

Good luck.

~~~
BobbyH
Here's a link describing the sort of "convertible note" that gtm mentioned:
[http://www.entrepreneur.com/money/financing/startupfinancing...](http://www.entrepreneur.com/money/financing/startupfinancingcolumnistasheeshadvani/article159520.html)

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BobbyH
An SBA loan must be personally guaranteed by the borrower, so I don't really
see a difference between an SBA loan and running up credit cards, except for
the interest rate.

Personally, I would try to suffer through the Valley of Death. Here are some
ideas I would try:

* Can lloydarmbrust sell for an extra hour by taking a two hour lunch and spending an extra hour at work?

* Can lloydarmbrust sell via email during the workday (assuming he can stay on top of his regular job)?

* Can jnovek can do some of lloydarmbrust's work so that lloyd can get more time to sell and/or survive at his current job?

* Can jnovek learn to sell, at least to the point of identifying prospects? For instance, a lot of lloyd's time may be spent trying to find out the decision maker at, say, the NYTimes. jnovek might be able to offload some of that "find the client" work, even if he weren't comfortable enough to "sell" the prospect he finds.

Finally, $2.5k in monthly recurring sales sounds extremely low for a b2b sale
that can add 5-8% to the bottom line. Have you considered raising prices by
10x? If your customer has $1 MM in revs, saving them 8% is $80k a year! You
should be capturing a big chunk of that.

Forgive my forwardness, but it's my sense that you don't have a financing
problem, but rather, a pricing problem.

~~~
jnovek
"Can jnovek can do some of lloydarmbrust's work so that lloyd can get more
time to sell and/or survive at his current job?"

This is a discussion that we haven't had and should. There may be things that
I can do to optimize Lloyd's lunch-hour selling.

As far as me doing sales, I am an awful salesman and Lloyd is a very skilled
and accomplished salesman. The difference between us is like night and day.

"Forgive my forwardness, but it's my sense that you don't have a financing
problem, but rather, a pricing problem."

Keep in mind that we haven't yet developed a novel product -- we are still
entering spaces that are occupied by other providers. We have big plans for
some novel stuff, but right now we need to cover a few salaries.

While we ARE competing on product quality, most of what makes us competitive
is price. Low-price alternatives are very attractive to newspapers right now
as their ad revenue continues to decrease steadily. We try to negotiate the
maximum price that we think a publication will bear.

------
fnid
My first thought is, if he believes that, why doesn't he quit and go full time
selling the product? Three months isn't that long, but imagine the opportunity
to work full time on your own product. With $2k+ already in recurring revenue,
that's enough to eat on.

You may not need that F&F round, no dilution, no investor's expectations, no
F&F asking where their money is...

Much fewer risks if you don't need it and you may not.

~~~
lloydarmbrust
I'm jnovek's co-founder. Unfortunately for the startup I have two kids and a
WAF to deal with. Honestly you're right that bootstrapping would be easier,
but we've been at this for 10 months and working two jobs is really starting
take its toll.

~~~
izak30
Your credit limit is probably around the amount of money you would need in the
short term though.

~~~
teej
Suggesting that someone live off of credit cards for a startup is wrong. Given
that he has a wife and kids? It's gravely irresponsible. I cannot emphasize
how bad that advice is.

~~~
kylecordes
> Suggesting that someone live off of credit cards...

In one sense, this is obviously correct.

However, the poster/partner is also about to go ask their friends and family
to put money at risk to grow this business; yet the poster/partner isn't
willing to put N months of living expenses (small N) at risk for it? It could
be a hard sell.

------
skmurphy
I would continue as you are and find a way to close deals part time until you
hit break even. I would think your co-founder could take some vacation days
over the next six months and get you to break even (figuring that a partial
sales effort will take perhaps twice as long as a full time one). This is not
a bad outcome.

The problem with F&F is that neither--unless they are qualified investors or
have experience in early stage investing--are normally prepared to lose their
investment. You will be relying on them for emotional support as well: it can
become difficult to talk about setbacks because their focus shifts from
supporting you to worrying about losing their investment.

You don't say what your product is but normally an SBA loan will require "hard
assets" that a software startup won't have (compared to a restaurant or a
bakery or other small retail/industrial business).

If you really want to raise a round I would talk to Angels and other qualified
investors who are used to risky investments and who may also be able to
contribute expertise and advice along with funds.

~~~
lloydarmbrust
I'm jnovek's co-founder. The company has about $10k in cash and about $7k in
computer equipment--also, they include your incoming receipts as assets. We
are only asking for $20k-$30k and I have a CR above 860.

Unfortunately to get to this point I have maxed my vacation and sick days. Our
sales cycle in this mode is about 3-4 months because we are B2B sales right
now (this will change down the road).

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albertsun
My start up is in a similar place right now and I've been trying to come up
with a valuation.

The problem is that so many of the normal methods taught for valuing a company
break down for an early stage start up. How do you predict your free cash flow
in the future without pulling a number out of nowhere? How do you come up with
a meaningful weighted average cost of capital when you have little debt or
equity on your balance sheet.

I think what we'll be doing is looking at our earnings and then setting our
valuation at a simple multiple of earnings plus assets.

Very interesting to see you guys on here as my start up is very similar. We're
focused on selling editorial side products to help college newspaper websites
succeed. The plan though is to eventually expand to all local news sites.

~~~
lloydarmbrust
Wow. Going up against College Publisher? Nice--I wish you well. Maybe there's
something we can do together. We hate about 90% of the CMSs that we have to
implement our products in and have contemplated building a CMS that we give
away just to avoid the hassle.

Currently we are only working with small daily and weekly papers, but
obviously college papers would work too.

------
Travis
My (bootstrapping) startup took a smallish f&f round. We took the money in the
form of a convertible loan, which means that it can be converted to stock or
repaid (as a normal loan would) at a certain date.

This got us the money easily, and left it more flexible for us to maneuver in
the future.

Yes, it's a little less advantageous to the lender. But the f&f rounds are
usually b/c your f&f want to see you succeed, not because they are actually
shrewd business deals (although they certainly can be).

~~~
lloydarmbrust
May I ask the terms? How long ago was it, and how has it served you?

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thorax
Check with your lawyer, but the SEC has some overviews here:

<http://www.sec.gov/info/smallbus/qasbsec.htm#eod6>

Sounds like a lot of hassle for those 35 non-accredited investors you get with
Rule 505/506. I'd also be interested if anyone else used that mode for non-
loan investments.

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vaksel
Why not just get one of those 0% apr for 12 months credit card offers and use
that?

~~~
lloydarmbrust
Co-founder here. Did something similar for start-up costs (about $18k).

