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Ask HN: Raising a friends And family round?
29 points by jnovek on Nov 2, 2009 | hide | past | web | favorite | 36 comments
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.

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.

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&F round on HN could give us some insight. We are currently incorporated as an S-Corp.

How did you determine your valuation before a F&F round? This is one of our biggest concerns.

Because a F&F round is pretty small, how did you minimize legal costs?

What did you tell potential F&F investors about the opportunity? Is there anything that you're REQUIRED to tell them?

How much of your company did you give up in your F&F round?

Feel free to include any resources that you found useful when you were doing your F&F round.

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.

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.

In most cases, yes, you can - most jurisdictions in the U.S. permit stock sales in such cases.

For example, in California, you have a "limited offering exemption" (technically, under 25102(f) of the Corporations Code) by which you generally can sell stock to up to 35 non-accredited investors in any given round provided they have a pre-existing relationship with the startup or its founders and that they represent that they are buying as an investment and not for immediate resale.

These exemptions are very easy to comply with, though you should use a lawyer to make sure you cover any technical points (the costs are minimal).

Hi, jnovek's co-founder here.

RMS below shared a link pointing this out. It warned that "Non-Accredited Investors Trigger a Larger Disclosure of Information" . . . do you know much about this or have any experience in using Non-Accredited investors? I'm wondering how much of a legal pain it is.

This may vary somewhat from one jurisdiction to another but, in practical terms, the disclosure issue does not really prove burdensome (I have substantial experience with this in Silicon Valley, having specialized in early-stage startups for many years now).

Years ago (back in the 1980s), the conventional practice concerning disclosure was to prepare a private placement memorandum (PPM) in connection with most offerings involving outside investors, even "friends." The PPM was involved and expensive, amounting to a mini-version of the registration statement companies file when they go public.

Since at least the mid-1990s, this practice has changed in Silicon Valley to the point where, very often, a "2-pager" (fairly high level executive summary) would be used to meet disclosure requirements, coupled with an invitation to the prospective investors to ask questions, etc. of company management. This revised practice has proved to be fairly easy to comply with for most companies.

Of course, this assumes you are dealing with people who are true "friends and family" - that is, people with whom you have existing relationships prior to the offering. If you do, both the legal and practical risks associated with this sort of early-stage offering are so minimal as to be in the "remote" category and the compliance costs/burdens are very small, at least in Silicon Valley (I believe this is true in most other locations as well and this has been consistently confirmed via our "blue-sky" practice, i.e., where we need to make sure that a California-based issuer meets the local securities law requirements of other states in which its investors reside).

By the way, later-stage investors usually don't like to see too many unaccredited investors in a company (working rule of thumb: best avoided if possible, no more than 10 if it can't be avoided). See also http://www.grellas.com/faq_business_startup_012.html.

Wait. Can you sell unregistered stock to non-accredited investors, even if they're "friends and family"?

The rules vary by jurisdiction. My understanding is that in the US, the rules are quite restrictive here; in contrast, Canadian securities regulators allow essentially unrestricted sales to family and friends.

But as Thomas says: Talk to a lawyer, especially if you plan on raising any future rounds.

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 $$$.

"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.


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.

Here's a link describing the sort of "convertible note" that gtm mentioned: http://www.entrepreneur.com/money/financing/startupfinancing...

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.

"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.

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.

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.

You think you're working two full time jobs now, just wait until you go to work full time for a startup!

Ten months is not a long time.

Can you make arrangements with your current employer? Work 4 ten hour days, and one on the startup ( they don't have to know what you do on your day off of course). Take a sick day or some vacation? Test out your productivity on a dedicated day or week or two. Work a saturday instead of a wednesday.

I know I'm not answering your question, others are, which is good.

My concern is, what if you take the money and it doesn't work out like you expect? You have lost a job and your friends and family.

Currently working about 40 hours @ work and 40-60 on startup per week--so when I say I'm working two jobs I'm not exaggerating. My hobby is working. Problem is businesses are closed during my free time, and I can't sell while at work.

I'm on borrowed time with my employer anyway--been pushing the limits of civility already (maxed out on sick/vacation). I doubt I have the political stock left to make new arrangements, but appreciate the ideas.

You are in the valley of despair. You are feeling the pain. It's normal. Don't give up. There's no magic genie, getting F&F money isn't going to make things better. In all likelihood, it will make things worse.

I love what you are doing. A lot of people talk a lot about the decline of newspapers and you are doing something great to rescue them! What are we going to do without local news? We say, "Think globally, act locally!" but there is no local news anymore. It's dying and you are helping to keep it alive.

And you too should stay alive. I feel the exhaustion in your words. Don't give up! Keep at it. Pull back on your hours if you have to. Don't burn yourself out. Don't jeopardize your children's future or your family. It's hard, you're in a really tough spot right now.

I have no advice to offer. I do have encouragement though. Keep at it. Keep giving it your all. You're doing a great thing. It can't be easy with your team all over the country. It's like you're all working alone, together. I've been there. I am there. It's not easy.

But, if it was easy, everyone would be doing it, right? You're insane. Admit that. It's true. You're outside the box.

I don't know what your future holds, but I want it to be great. F&F, Angel, lots of newspapers signing up for your services, whatever! I want you to get the money you need to keep your business alive. I think you can do it. I think the world will be better if you succeed!

Ha, you've been to my website. Thank you for your words--I do feel better.

This is just the start of a long emotional roller coaster.

Once you come on board full time you (and/or your wife) may find the uncertainty associated with income from a startup equally taxing. I do not say this to be discouraging but to get you to consider getting your financial affairs in order before coming on board full time (e.g. you may not be able to get any additional credit for several years once you are dependent on a new startup for income).

Anything you can do to lower your burn rate without compromising your obligations to your family is probably a good idea today. I think you would be much better served to continue part time and close enough business that you feel comfortable making the transition.

You must know my wife.

Our current clients have proven to be reliable. Once we launch them they directly profit from our product by adding about 5%-8% to their bottom line (our customers are newspapers, BTW). It's unlikely that they will pull out unless they close, and our current customer are all smaller newspapers which make this less likely.

Do you think it would serve us better to wait until we have the revenue to support me? What experiences bring you to this conclusion?

You are in an uncomfortable but probably sustainable position bootstrapping the business by "working two jobs." If you raise a small amount of money that doesn't allow you to "bridge the gap" (i.e. replace your salary for long enough to allow you to become sustainable) you now face some very hard choices.

This is a recurring topic of discussion at the bootstrapper breakfasts (http://www.bootstrapperbreakfasts.com). We have seen folks do better bootstrapping by "working two jobs" (or consulting and building a product).

If you come on board "full time" can you consult on projects with newspapers to replace your current income? That might be an alternative that would allow you to align all of your work efforts more closely than two unrelated jobs.

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

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.

> 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.

Well, they're already profitable. If you're looking at a year or more, I'd agree, it's crazy; but they're asking "how do I make the jump, and be profitable full-time".

Hopefully will be getting $20k-$30k in SBA loan. Already put $20k in (credit card). I need $5.5k/mo for mortgage, taxes, and childs/wife living--sub optimal for "ramen" profitability. Also, mortgage only two-years old so no room for second mortgage although I do have a CR above 860.

Cool. I wasn't suggesting that you be irresponsible with your credit, especially given that it's not just _you_ taking the risk. But clearly you've though through your options, that's all I was getting at. That what you'd make, even in your first month of not being under normal employment would more than cover the minimum payment (and hopefully cover most of your expenses).

CC isn't the best sort of debt, I understand that, but it's the one most readily accessible to most of us, especially when looking at small amounts and short terms.

Have you guys looked into things like kickstarter? I'd be interested to see how well that could/does work for a startup, and not an art project.

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.

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).

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.

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.

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).

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

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


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.

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

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

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