How to let Friends + Family Invest
Once your personal life and professional life start colliding, you need to apply clear boundaries to keep them separate.
The same applies to when your friends or family members want to invest in your business.
They say that friends and family mix with the business like oil and water, and for good reason. When you put a part of their financial futures in your hands, there’s a lot of pressure for you to not fail. Additionally, early investors can hold up later investing and blow up a deal unless you have them agree to certain conditions at the start.
Get it in writing
There’s nothing more awkward than running into a surly relative at a family gathering who’s demanding his money back. Because now you’re thinking, wasn’t the money he gave you a gift? Or was it a loan? And since when did you agree to a deadline to pay up?
This is a perfect opportunity to revisit why it’s of utmost importance for you to have a formal investment and documentation process, even with your family and friends. Even though it can be awkward to have a family member or friend sign a contract instead of just shaking hands and calling it a day, you want to legally protect your reputation and your business.
A couple of important documents for your investors to sign or look at include:
- A formal business plan: While your family or friends might be more than happy to support you in blind faith, you owe it to them to share the important details of your business. This includes how you are structuring your business, what your product or service is, and ultimately how you aim to earn profit.
- A purchase agreement or promissory note: As tempting as it is for you to not look a gift horse in the mouth, let’s face it. People get touchy about the subject of money, and you can never be sure if the donor intended for it to be a gift, loan, or a purchase for equity. If that’s the case, you should hit up your lawyer and draw up a contract outlining the terms of investment and purchasing stock. This way, your donors will be made aware that they are risking their money and may or may not be able to recoup payment.
- A partnership agreement: If your family or friends are willing to throw money behind your business and offer advice, they are effectively demonstrating an interest in becoming your business partner. If you choose to accept more than just the occasional monetary gift from a specific relative or friend, it might be in your best interest to draw up a partnership agreement. This will help define the boundary between your personal and professional relationship with said friend/ relative.
How to protect your family, friends, and yourself
When drawing up those documents, your lawyer will want to incorporate what appears to look like jargon but is actually important for the legal protection of every party involved. Important provisions you will want to clarify in your documents are:
- Right of First Refusal: This right serves as a nifty insurance policy, as it puts you at the front of the line to purchase these shares from your partners before anyone else can.
- Right of First Offer: Similar to the right of first refusal, the right of first offer is the contractual obligation that you have to negotiate the cost of an asset with your partner before you try to sell the asset to other parties. However, the seller is only in a stronger position if there is a third party that is willing to purchase the asset at a higher price than the prospective buyer is willing to pay.
- Tag Along Rights: Tag along rights, or “co-sale” rights, protect minority shareholders (your relatives and friends) and give them the right to sell their minority stakes in the case that a majority shareholder (you) decides to sell his or her stake.
- Drag Along Rights: In the case that the majority shareholder (you) is planning to sell their stakes, they can invoke drag along rights to ensure that minority shareholders sell their stakes in the same deal.
At some point, you will have to address the elephant in the room: “How well is my company performing?” The performance and profitability of your company will inevitably affect the valuation of your shares, and the last thing you want to do is make empty promises about how your ventures will earn enormous wealth for your family and friends.
Instead, offer to schedule monthly or quarterly briefings on your company performance. That way, your family, and friends will be able to hear about your company’s wins and losses firsthand, ask questions about your future strategy, and provide valuable feedback.
In exchange, they will appreciate your efforts at transparency and integrity and will be much more willing to support your company for the long-term.