Fundraising · Sports

What's the best way to structure a friends and family round?

Patrick Caulfield Managing Partner at Plugin Group

December 30th, 2014

After a few encouraging meetings, I'm creating a prototype for afantasy sports-related app. The plan is to launch it and accumulate enough users to demonstrate market acceptance. In addition to showing that I can move past the idea stage, my thinking is that it'll be easier to get investors/partners involved if I give them a product they can demo for themselves.

I interviewed several designers/developers and have settled on a bid to create an MVP in the 65K range (for breathing room, I plan on raising closer to 80-90K). I have 15K of my money to start and will raise the rest, I hope, through family and friends.

In my pitch I'll outline the worst-case scenario: this is far from a sure thing and nobody should put up money they can't afford to never see again, i.e., if this project loses money, we all lose money (including my 15K). In the mid-range outcome, if the app generates any sort of income all investors will be repaid in full before I pay myself.

My question is how to approach the payback structure in the event the app does well and leads to bigger things. I plan to share the wealth, so what sort of return is more than fair and how do I present it to early investors?

Cory Rosenfield Serial Entrepeneur, CPG, Retail & Media | Advertising | Data | Analytics | Ecommerce, Co-founder of Qoints

December 30th, 2014

I'd consider a convertible debenture with a healthy discount. 

That let's you focus on building your business and not on legal/corporate setup. The convertible debt (note) will convert in the future based on a number of pre-set triggers or a period of time.

Let the future investors set the valuation and the early investors that participated in your note, get a discount to that valuation. 15%-25% discount is standard. 

Remember to include a cap (maximum future valuation) as well (usually 2-5 million early on) so the investor has some level of security.

So, let's say you raise 100K at a $3 million Cap with a 20% discount. Note, you should also offer interest on the debt that will convert to shares later. In the future, you raise money at a $4mil valuation. Your early investor is secured at the cap of $3mil. With a discount of 20%, their debt converts to shares at a valuation of $2.4mil (approx. 4.2% total equity).

Arthur Veytsman Founder at Immerss, 6x Entrepreneur & Angel Investor. Building relationships with Angel Investors worldwide.

January 2nd, 2015

Completely agree with Cory Rosenfield, but please do yourself as well as your friends and family a huge favor and completely outline how your app will start getting user  traction without relying on viral effect.  

Think about what it would be like to deliver a bad news to your friends and family members.  You only get one chance to raise money from people that are close to you.  Use it wisely. 

Skip Weeks President & COO at InTouch, LLC

December 30th, 2014

Patrick: I don't know if you have considered having your app developed offshore, but if not, you should. You might also consider developing the core of the application for the $15K that you have and adding additional functionality later after you have demonstrated some initial interest and viability. I can introduce you to some reliable offshore groups that you could consider using. I believe that you could develop some pretty impressive initial functionality for $15K. I've been involved in startups and software development for 30 years. If I can help you get started, let me know. Best Regards, Skip Weeks (801) 369-2225 Skip@SkipWeeks.com www.SkipWeeks.com

Anonymous

December 30th, 2014

I would normally strongly disagree with Skips posting but over the last year, I have changed my mind.

After hiring a dozen developers in San Francisco (I've been a developer of over 30 years myself) and dealing with the crap, I think your money is better spent getting a solid UX/UI of that you want (Visual Designs) and then having someone build it for you.

Remember that there are two parts to an app, the handset code and the server code, nothing says the same company must build both but normally this is the case.

Arlen MBA Co-Founder,President and CEO, Society of Physician Entrepreneurs at ceo@sopenet.net

January 2nd, 2015

Suggest you focus on customers, not investors at this point, and create and validate a customer funded business model
Read John Mullins's book, Customer Funded Businesses

Scott Williford Founder and CEO of vLink Solutions, Video Marketing Pioneer, Serial Entrepreneur, B2B Marketer

January 2nd, 2015

A unique way is to offer a Convertible Note at a fixed interest rate which accrues interest for a set period then start making payments and a balloon payment at the end.  The Note holder has an option to convert at a set multiple of actual top line revenues at 12, 24 or 36 months where the multiplier is lowered each of the respective conversion dates. 

The idea is that the Note holder is guaranteed (assuming you'll be able to pay) some interest and the principle back whether they convert or not.  The conversion valuation is set by a multiple of actual revenue rather than some guess of the value of the company in the future.  The multiple is lowered over time because the risk is less each year the start up survives.

You will want to include a change of control conversion and perhaps a discounted conversion clause should a larger round of funding come before the note holders convert.

We did this and it worked out quite well.

Anonymous

December 30th, 2014

I always enjoy people being positive about new projects. Its fun to work with startups until one of two things happen, you make money or close the doors. ,

They say, you can have fun at any business without customers and employees, this may just be a hobby :)

Once there is money coming in and you have enough to pay investors (this might be a long time out) then make sure that you have the exact arrangement up front.

If they put in one dollar, do you just pay them back the dollar, maybe with interest, then this is a loan. 

If they put in one dollar and they get stock then they are an investor for good or bad, if it fails you owe them nothing, if it succeeds then they share in the success.

Then there is reality where all the fancy paper work comes in, if they give you one dollar but you become successful you can pay them back the dollar plus interest plus other fees, you then have a purchase price to buy them out, this is what you really want anyway if you do not share forever.

An investor relationship is like being married, it does not last forever!

Make sure there is an out for both parties.

They might want their money back an you might want them out of your hair.

All that being said, if I invest 25% of you capital I would expect 25% of your profits, its pretty simple. The hard math comes from calculating what your profit is. Are you going to take a salary? is that part of your profit, etc, etc.

Istvan Jonyer VC at NexStar Partners

December 30th, 2014

I had a fantasy startup before. I'd be happy to share insights if you like. Reach out directly if interested.

Jeff Dennis Entrepreneur in Residence at Fasken Martineau DuMoulin

December 30th, 2014

My approach would be to determine a value for your idea. Then apply a simple calculation (ie. $10K investment with a $100K valuation would result in a 10% interest). A simple equity deal with a simple shareholders agreement is a good approach 

Kerry Davis

December 30th, 2014

I don't have any association with these guys at all, but i like their concept for developing apps, especially if you are nontechnical yourself and are starting from scratch. They are in your price range which is admittedly high compared to other offshore dev houses, but they seem to take more ownership of the development. I am technical and believe me, you can really get into trouble by trusting an offshore dev house (even if you know what you are doing). Draw lots of pictures and regression test with every intermediate release!

More to your original question. Wait for the first real seed investment/valuation to set a value for this initial investment from friends and family. Setting a value at this stage is futile. Let a third party do it (aka your first real investor) and it will be easier for your current investors to grasp. Setting a value now and percentages this early only opens up unneeded drama when it doesn't matter because right now you have nothing. You could also offer a discount to apply to the original investors at the future valuation to sweeten things.

Yes, as Cory said above as I was writing my comment, convertible debt with a discount is the way to go.