Raising Capital: Friends, Family, and Conventional Debt in the Early Stages
In the last post, we covered raising cash by selling common stock to friends and family (F&F). This week, we’ll cover raising early-stage capital by taking a loan from this group and what that means for your business.
Early Stage As previously discussed, most investors in follow-on rounds expect that you used your own money plus sweat equity to fund your business. If you’re savvy, you’ll already know from your detailed financial plan what your cash needs will be going forward. You’ll also understand that you’ll reach a point where your cash needs exceed the cash flow available from the business, requiring you to obtain outside funding.
Many founders consider taking a loan from F&F to raise capital. Money can be loaned to the founder personally or to the corporation, and is usually accompanied by a promissory note or a loan contract, both of which are legal lending documents if properly written and signed. Just like a loan from a bank, both require repayment of the loan and contain terms regarding interest rate, repayment timeline, and consequences if you fail to repay the loan.
F&F Raise Options: Why Not to Raise Debt If you’re going to need additional money for your start-up in the future, we don’t usually recommend taking a loan from F&F at this early stage. There are a few reasons that this isn’t a good idea, namely:
The loan will have to be repaid, usually when you need more capital and can least afford to repay it.
Failure to repay the loan may cause personal breakdowns with your F&F or even cause you to have to file personal or business bankruptcy.
You may find it impossible to raise your next equity round, as equity investors don’t want their money used to pay off existing debts.
If you need to modify the terms of your loan agreement to raise future capital from other investors, this may trigger significant tax issues for you or your company.
Summary Raising capital using debt from F&F at an early stage may be a good option if you won’t need additional funding in the future. However, since most startups will need additional funding, we don’t usually recommend conventional debt financing to early-stage companies.
So what do you do if you’re an early stage company, have run out of personal resources, and need to raise your first round of fund? Over the coming weeks, we’ll cover three other capital raise options for the early stage that are much better choices.
Are you considering how to raise your first round of money from F&F? Have you explored all of your options and are confident that you’re making the best choice for long-term growth and value? To learn more and how we may be able to help, schedule a one-hour call with us here.
Until next week! All the best,
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