3F’s, Angel Investors and Venture Capitalist

You have heard the term “bootstrap” and if you ever started a business you are well aware of the concept of using every bit of money you can find to get a new venture going. Let’s talk about what happens when your company requires funding beyond bootstrapping.

The first round is usually what is sometimes called FFF’s (Friends Family & Fools). These are the people close to you who believe in you or at least you have convinced to believe in you and your concept. Typically FFF’s come into a new business at the riskiest stage, with the highest chance of loosing the money they invest. Many times these are also the folks who can least afford to loose that money. But, don’t hesitate to use FFF’s, because there are three possible outcomes and two of the three are good.

One-you are a huge success, everyone gets their money and more back and maybe even a good paying job for your nephew. They also get to say they always knew you would succeed and that’s why they entrusted you with the family’s life savings.

Two-you survive and everyone gets their money back or at least most of it. Pretty much everything in situation one applies, because truthfully they thought they would never see their savings again and are happy you paid them back. You still probably need to hire your deadbeat nephew.

Three-you fail and everyone looses. Believe me Christmas just got a lot more uncomfortable and not just because your nephew is still living in your sister’s basement.

The good thing about funding from FFF’s is these people know you and everything can be handled informally, without having to put together financial projections and a detailed business plan. The bad thing about funding from FFF’s is these people know you, be prepared to answer how you can afford to buy your husband a new suit or your wife a new dress. Why are you not plowing that money back into the business?

Even though you have a personal relationship with your new investors, make the effort to treat them like partners when it comes to the business. Draw up an agreement that outlines the financial plans and expectations and have everyone sign it. If your FFF’s put a significant amount of capital into your venture, make the effort to sit down with them on a regular basis and share the income statement and discuss what your plans are. This does not have to be a formal board of directors, but buy them diner and listen to their input. These folks have a horse in the race, and they just might have some good ideas. One benefit, the meal becomes a 50% deductible business expense. (Put it under meal and entertainment category when you enter the expense into Outright)

Unless you were born into the right family, it can be difficult to raise more than a couple hundred thousand dollars from friends and family. The second round of funding for a startup frequently comes from Angel Investors. Angel investors will typically invest their own funds; although, there is a growing trend where investors organize into angel networks. Angel investors will certainly expect you to have good accounting records and well a developed business plan and financial projections. They will also expect to either take an equity ownership of your business or possibly want you to issue debt convertible to equity. Angel investors will always need to have an exit strategy where you help them get their money back out of the venture either through a sale, an IPO or another round of investors. These types of investors are looking for a 5 to 7 year exit resulting in a 20-30% return on their investment. Angel investors may contribute a few thousand dollars to several million depending on the unique circumstances. Besides looking for investment opportunities, angel investors may have other motivations for taking an interest in your business. Often angel investors are successful retired former executives who are looking for opportunities to “stay in the game” and will tend to focus on businesses and markets where they have experience. You should definitely take advantage of that experience and bring these folks into your inner circle as advisers and mentors.

The last stage of outside investors will be venture capitalist (VC’s). VC money most often comes from institutional investors (insurance companies, university endowments, etc.) or extremely high net worth individuals. VC’s are frequently pooled funds managed by investment firms. These are professional investors and will expect a high level of professionalism from you. Like angel investors, VC’s will expect to take an equity stake in your business with a definite exit strategy. VC’s are looking for deals in the tens to hundreds of millions of dollars that are going to give them a strong return similar to what angel investors expect. VC’s will also expect to know what goes on with your business. Some firms will even specialize in specific markets because they plan to essentially embed their people into your business to keep watch over their investment. Before you get to the point of seeking funds from VC’s, you should have already established your own circle of trusted, experienced bankers, business advisers and accountants that help you run your business.

Start from the beginning by treating your business like a business. Make the extra effort to be organized, keep good accounting records, utilize the resources, like Outright, that are available to you, so that when you when you do go looking for that $50M funding, you will already have the successful and professional businessperson act down.

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