How about friends and family financing ?

Quite a bit of discussion took place in the comments and offline following my post on accredited investors, especially as it relates to friends and family financing. These investors will typically be “easier” to convince to support and finance your idea, but at the same time they might not qualify for the accreditation as defined by the law.

So what can you do as a young entrepreneur/team needing some cash? First order: can your savings and credit cards get you anywhere meaningful? Second: in order to avoid being stuck between a rock and a hard place, a loan that will be re-imbursed as opposed to converting into the next round of equity financing might be a temporary solution. Unfortunately for the unaccredited lender, he/she will not be able to benefit from that early support through the perks angels typically get: discount to Series A, warrant coverage, etc. because only accredited investors can acquire equity. And once again, you want to make sure that this is a solution that works legally (for the nth time - I am no lawyer).

Coming back to this set of rules and regulations: they have put in place ages ago to protect investors, and make sure they do not end up involved in highly risky illiquid investments like... financing startups. Not only is this exercise not for the faint of heart - because of the ups and downs startups go through during the initial 2 to 3 years - but probabilistically most of the investments angels will make will end up hitting the wall.

Of course, everyone's goal is to beat the odds, it just does not always happen. Quite the contrary.

Comments

[Bruce Boston]

Jeff: "Coming back to this set of rules and regulations: they have put in place ages ago to protect investors, and make sure they do not end up involved in highly risky illiquid investments like... financing startups.

They were set-up ages ago, but the world is different today. The internet has changed everything, and we now have the ability to work together like never before. If anyone thinks that a single person with $5M is smarter at making investments than a group of 3,000 people, I'd love to hear the reasoning behind that thought.

-bruce
QuidStreet.net

[Jeff Clavier]

Bruce> Thanks for your two comments on the topic. I don't disagree with you that these rules might have come of age, however their spirit of protecting the *individual* investor is still valid IMHO. It is very easy to get trapped in the current hype (2.0) and therefore imposing minimums on NAV is not a bad proxy.
In you other comment, you are referring to a pooled source of capital (multiple smaller investors getting together to create a "mutual fund"). This might be solving the issues of thresholds (once again I am not a lawyer so won't take a position on that) but from the standpoint of the startup receiving that finaning, you want to make sure that this pool of money is acting as a sole entity and not a multitude of investors.

[Bruce Boston]

"however their spirit of protecting the *individual* investor is still valid IMHO"

Totally agree. Then again, we as a society seem to trust these same people when they get on a plane for Las Vegas, or when they want to buy $100 worth of State Lottery tickets. I'm not saying that early stage investments are as risky as Vegas, but start-ups are much more important for our economy to figure out, and we should be even more open to people taking risk with them. If we were half as smart about start-ups as we were about blackjack, we wouldn't be nearly as worried about were all the jobs our kids will need are going to come from.

On the mutual fund idea, basically, MeVC (see http://www.internetnews.com/bus-news/article.php/417761) did just that and raised $330M at the start. They later had problems with the crash, but seem to be doing well today.

"It is very easy to get trapped in the current hype (2.0)"

Again totally agree. But this was the same logic that kept the general public off the stock market for so long. The logic is still valid today, but the value of having the everyday investor in these markets far outweighs the risk involved.

"you want to make sure that this pool of money is acting as a sole entity and not a multitude of investors"

I think you are talking technique before talking ideal. I can't see why we wouldn't want a method for investors to be in complete control of their own money with the added flexibility to invest in the projects and companies that will drive our economy for the next 100 years. Too many ideas, teams, companies drop off into the abyss because we haven't figured this out, and again, I'd take the opinion of 3,000 investors over 1 any day.

-bruce
QuidStreet.net

[Jeff Clavier]

Bruce> On your last point, I was merely pointing out that as a startup, I don't want to have to deal with 3,000 individual investors if this is what the constituency of you "fund" is, I just want to deal with the fund.

[Bruce Boston]

Hi Jeff,

Jeff: "you want to make sure that this pool of money is acting as a sole entity and not a multitude of investors"
Jeff: "I don't want to have to deal with 3,000 individual investors if this is what the constituency of you "fund" is, I just want to deal with the fund."

Ok, agreed.

The desire to not have to deal with 3,000 separate people is a concern that I hear a lot, and I think this basic issue is included in the QuidStreet concept.

One of the complexities of early stage investing today is that you have a 'Many (investors) to Many (Start-ups)' relationship. People who do this for a living probably understand the paperwork volume that this creates better than anyone else.

Database people know how to simplify a 'many to many' relationship, you just split it into two relationships, a 'many to one' and a 'one to many', and you get a 'many to one to many'. In this case, Many (companies) to One (QuidStreet) to Many (Investors). Now each company only has to deal with One Entity, and each Investor has the same luxury of dealing with just One Entity.

Imagine the reduction of paperwork that companies would have while retaining the ability to harness the power of large crowds, and then imagine the simplicity that investors would have receiving a single summary report of all their investments, and the resulting tax information, etc, etc. Not to mention that this whole area could use a little more standardization, professionalism, etc.

Again, this isn't the main goal of QuidStreet, just a nice side perk.

me: "I think you are talking technique before talking ideal."
Too often I hear software producers talking technology before they fully document what it is that they actually want to do, and in so doing they often limit the idea flow. After talking with many, many people about QuidStreet there have been too many people that have done the same by suggesting one legal entity or another before really discussing what we would do, or what we want to do, with a system that really opened up the capital markets to both investors and investees. Just wanted to make sure that we separated the two, as I think the ideal would really be a market where investors where in complete control of their resources, had access to thousands of opportunities, had liquidity and yet had the simplicity of dealing with a single entity.

-bruce

QuidStreet.net

[Eric]

Since I don't speak legalize, I assume that in the following:

"a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase;"

a "natural person" = a person? So, if a relative/friend/acquaintance had over $1 million in net worth then they would be an accredited investor?

[Jeff]

Eric> "Natural person" does imply a human being, to oppose to a group or a corporation. So yes, a friend/relative/acquaintance with over $1M in NAV (net asset value) is qualifying.

[Kevin Jones]

There are other people working on how individual small investors, investing outside of the public capital markets, can act on their own interests, yet not, by acting seperately make the transaction cost of their money too high for the entrepreneur. One startup is www.microplace.com, which, working with eBay to enable people to invest as little as $100 in a microfinance institution providing micro loans in the developing world. The problem is never the structural banking plumbing, in my experience. It's figuring out how to make the deal make sense to buyer and seller. I don't know if Quidstreet will work or not. But i think the relationship of capital to enterprise it is reaching for makes sense in context of current techology and the reality of the waysocial networks can work offline and the way they are starting to work online.

[Govind Agrawal]

An Indian Technology Business Incubator, has a solution for seed fund - it funds even freshers! (on zero liability)

NirmaLabs, Ahmedabad, India is a technology business incubator, involved in promoting Techno entrepreneurship in India. At NirmaLabs, one gets groomed to identify an idea, understand hi-tech markets and emerging technologies, gain insights of high-growth businesses, form a team and create a business plan, develop value proposition during incubation, interact with mentors and venture capitalists and spin-off to start your venture. Its an attempt to create Slicon Valley Ecosystem here in India.

Each incubated project gets seed funding up to Rs. 2 Million (Approx. $ 50,000) (and each team member gets sustenance of Rs. 8000/- per month. All this on zero liability. Apart from this you get lot of support & access to high profile network. More Details are on www.nirmalabs.org

Regards,

Govind Agrawal
Incubatee, NirmaLabs
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[Basil Peters]

As an angel investor, I often see Friends and Family financings that have gone horribly wrong. In every case I can think of, both the entrepreneurs and investors were well intentioned, but nobody involved had the experience to incorporate all of the elements in a successful transaction.

The most common way entrepreneurs treat their friends and family unfairly is by over-valuation. This causes serious structural problems that must be rectified before the next round of financing.

The entrepreneurs don’t do this intentionally - it’s most often just a by-product of entrepreneurial enthusiasm.

I have been working on a series of posts on how entrepreneurs can avoid the pitfalls of Friends and Family financings at http://www.angelblog.net/Startup_Funding_the_Friends_and_Family_Round.html

I hope this information helps some entrepreneurs maintain good relationships with their friends and family.

Thanks,

Basil