Briar L. McNutt

Article Summary:

Raising capital from family and friends has many advantages over other types of financing.

Raising Capital from Your Family and Friends

Raising capital from family and friends has many advantages over other types of financing. Venture capitalists are typically unwilling to invest at the initial financing stage and generally demand hefty concessions in exchange for their investments, e.g., seats on the board or veto authority over business decisions. Family members, friends and acquaintances, however, will often invest early on and without insisting on control provisions.

Federal and state securities laws generally allow startup businesses to raise capital from small groups of investors without registering the securities sold to those investors - a time-consuming and expensive process - as long they comply with certain conditions, i.e., conducting no public solicitation or advertising.

One disadvantage of soliciting investments from family and friends is the risk of hard feelings if your business hits hard times. The best way to reduce the likelihood that hard feelings will lead to dispute, and dispute to litigation - and to put your business in a better legal position if it does -- is to create an "arm's length" relationship between your business and friendly investors. That means making sure that your investors understand and acknowledge the risks involved in investing in your business and adhering to all the formalities that a private securities offering to outside investors entails:

  • Be realistic about your prospects. Avoid making overly optimistic predictions to potential investors or the public about the prospects of your business.
  • Screen your investors. Be reasonably certain that potential investors have some business sophistication. At least make certain that they can afford to lose whatever money they are investing in your business.
  • Provide full disclosure to investors. "Full disclosure" means providing investors with written materials describing your business's operations, assets, liabilities and risks - all information they need to make an informed decision about investing in the business. The materials should describe investors' rights (if any) to have a say in management and the possibility that they may lose their investment entirely.
  • Your business should enter into written agreements with all investors. Investors should acknowledge in writing that they have received and read the disclosure materials. The written agreements should also contain representations from investors that they have sufficient business sophistication to evaluate the risks of their investment and that they have sufficient net worth or annual income to sustain a loss of their investment.

Briar McNutt is an attorney at Eckert Seamans Cherin & Mellott, where she represents clients in public and private securities offerings and assists public companies with proxy materials and required reports filed with the Securities and Exchange Commission. She also works with clients to form and reorganize business entities.

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