By Louis Lehot, business lawyer and partner at Foley & Lardner LLP in Silicon Valley, and formerly the founder of L2 Counsel, P.C.
When it comes to financing a startup, many entrepreneurs think of venture capital. While a venture capital fundraising round is critical to securing funds for an emerging company, there are other options to consider when a company is still in the early stages of its life cycle. This article will cover the friends and family round and the angel investment round of early-stage financing.
The “friends and family” financing round
Your company’s first source of capital is likely your personal savings or an investment from those in your close network. A company can expect to receive an investment anywhere from $10 000 to $150 000 in this round, with investors providing their own money due to their personal connection with the founder of the startup. Because this round comprises investments from those primarily in your close personal network, it is commonly referred to as the friends and family financing round. To prevent future conflicts and to maintain a lasting investment relationship with the investors of this round, you should ensure to retain some level of formality to the documentation process, much like you would for a corporate investment.
The angel financing round
Angel investors are often wealthy individuals that have experience working with and investing in early-stage companies. Angel investors can also belong to angel investing groups, small firms created for investment purposes. Angel investors are interested in companies that are still considered early-stage, however they have a developed and deliverable product. An angel investment can range anywhere from $50 000 to $2 million, with angel investors focused on the return they will receive.
Key differences between these financing rounds
The investor:
The investor in the friends and family round is just that, a close personal connection of the entrepreneur. Their choice to invest in the company is based on their loyalty to and relationship with the founder. An angel investor typically does not know the entrepreneur and sees the investment in terms of the return and the opportunity to share their industry knowledge.
The size of the investment:
The capital raised from an angel round will typically be larger than that from a friends and family round. This is because angel investors or angel investor groups typically have greater personal wealth to invest in a startup. The average capital raised from a friends and family round is just over $20 000, whereas the average angel investment is more than three times that.
The valuation of the startup:
As friends and family round is one of the first sources of financing for a startup, the company often has a valuation no greater than $1 million. Angel investors typically invest in startups with a valuation between $1 and $3 million.
The time taken to secure the investment:
A friends and family investment is a quick solution to the immediate financial needs of the startup, as it usually takes no longer than two months to close the deal. An angel investment will take between three and six months to close, though if an angel group has a structured pitch and review process, it may take longer than six months to close the deal.
The chance of a repeat investment:
Investors in a friends and family round have a close relationship with the founder so they are more likely to support the idea of continuous or long-term support. An angel investor is concerned with their investment returns so they prefer diverse portfolios, making it unlikely for a company to receive repeated funding.
The cost of the round:
Being that the friends and family round is informal, without strict procedures in place, a company will save on transaction, documentation, and legal fees. The costs associated with an angel round will be greater, but this round also provides industry knowledge and advice from the experienced investors to the entrepreneur, making the fees worthwhile.
Companies should pursue these early-stage financing rounds to secure capital before they are ready to enter a formal round of venture capital fundraising.
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