When Jeff Bezos first decided to sell books online, he was fortunate enough to have financial support from his parents. As Bezos recalls:
"The first initial start-up capital for Amazon.com came primarily from my parents, and they invested a large fraction of their life savings in what became Amazon.com. And you know, that was a very bold and trusting thing for them to do because they didn't know. My dad's first question was, "What's the Internet?" Okay. So he wasn't making a bet on this company or this concept. He was making a bet on his son, as was my mother."
In fact this is a common story in startup funding both within Australia and around the world. Keen business founders with a big idea often turn to friends and family as their initial investors. Of course, this worked out well for Bezos' parents. Thanks in part to their support, their son is now one of the richest people in the world, and their initial investment is estimated to be worth tens of billions of dollars.
But of course we hear about the success stories. We do not hear so much about the parents who have lost their life savings on their child's failed business, or the friendships that have been shattered when promised riches did not arrive. And there are plenty of these.
So this is a delicate topic. If someone you care about invites you to invest in their startup, how do you handle it? You might want to show your support. But how do you do this while looking out for your own financial situation?
Although friends and family are a major source of startup finance in Australia, there are many pitfalls to watch out for, including:
This is an obvious point but it helps to take a moment and remind ourselves of this. It is absolutely ok for you to say "No".
Remember - you do not have to provide any money. And if you still want to help, there may be other ways you can do so.
Even if the founder is someone you care deeply about, if, after considering their proposal, you are not comfortable investing, then the best thing you can do is to politely turn them down.
There are many other ways for you to offer your support, such as promoting them on social media, offering some of your services, pre-ordering some of their products, or putting them in contact with people who you think can help them. You most likely have your own financial responsibilities, which the founder is not aware of. But perhaps you know someone else who is looking for a new project to get involved with. See "Other forms of support", below, for further discussion about other ways you might show your support.
If you allow yourself to be pressured to invest your money when you are not comfortable doing so, then this can lead to resentment or friction in the relationship which can be difficult to overcome. Furthermore there are the financial consequences if the business fails.
Therefore, it is important for all parties to take some time to assess the situation before finalising any finance terms. If necessary, the parties can engage professionals such as lawyers, accountants, financial advisors or business consultants to assist at this stage.
If the parties want to discuss the proposal, but are not ready to finalise the terms of the funding, then there are a number of preliminary steps they can take.
Firstly, the founder might ask prospective investors to sign a Confidentiality Agreement (also known as a Non-Disclosure Agreement). This is very normal in relation to startups, and it allows the founder to protect their business ideas, intellectual property and other confidential information, while discussing their business with a variety of potential investors. This is discussed further in our guide Do I Need to Sign a Confidentiality Agreement?
Secondly, if the parties come to some kind of "in principle" agreement, with further details to be finalised at a later date, then they may choose to sign a Memorandum of Understanding. This document is generally non-binding, and sets out some basic terms that the parties have discussed. It is intended as a starting point for the parties, as it enables them to set out the preliminary understanding between one another, and can help them to work towards a more formal agreement. For further information about this matter, see our guide What is a Memorandum of Understanding and is it Legally Binding?
In some cases, if the business is just starting out, and if the investor is going to own part of the business, then an Agreement Between Co-Founders (Non-Binding) might be appropriate. This is another document which is generally non-binding and it is designed as a quick and easy solution for business founders. It helps them to address a number of important preliminary issues and to avoid disputes down the track.
Broadly speaking, you are going to need to make a decision about the potential risks and rewards of this investment, so that you can determine whether or not to hand your money over.
Of course, you can choose not to assess the investment, and to just hand your money over. But if you do so, you leave a lot to fate, and you really should consider the money a "gift" rather than an "investment". Some people (such as wealthy parents) might choose to do this if they are happy to lose the money, and just want to show a bit of support. But this does put you at much greater risk of losing your money, and it also does not help the founder to develop responsible business practices.
Doing your due diligence means reviewing the business proposal, the terms of the investment, and the founder(s), to determine the worth of the investment. Depending on the complexity of the proposal, it might be necessary to engage professionals such as lawyers, accountants, financial advisors or business consultants, to help you make this decision. For smaller investments or more simple proposals you might make the decision on your own.
In relation to the business, there are many things to consider, including:
These are only some of the questions that you might need to ask about the business. So take your time, and if in doubt, seek advice from professionals such as lawyers, accountants, financial advisors or business consultants.
It is worth remembering that the terms of funding are entirely negotiable. The founder might have presented a proposal to you, but it is normal, and reasonable, for you negotiate some changes to those terms if you require them.
In relation to the terms of the funding, there are many things to consider, including:
Some of the most common ways for friends and family to provide startup funding in Australia are by providing a loan, or by buying shares in the business.
This is one of the most common ways that friends and family members choose to fund startups in Australia. If providing a loan, then there are a number of things to consider, such as:
We have a Loan Agreement available for this purpose. We also discuss loans in more detail in our guide Should I Lend Money to Friends or Family?
Another common way that friends and family members choose to fund startups in Australia is by buying shares in the company. If the investor does this, then they become an owner of the company, which comes with various rights and obligations. The Australian Securities and Investments Commission provides further information about the rights and obligations of shareholders.
When the investor purchases shares in the company, they should be issued with a Share Certificate.
The rights and obligations of the shareholders in the company can also be set out in a Shareholders Agreement. This is a contract which is signed between the shareholders. Alternatively, if there is a pre-existing Shareholders Agreement, and the investor wants to become a party to it, then they can sign a Deed of Accession.
In any case, if the investor is planning to buy shares in the business then they should conduct their due diligence on the company and should carefully review the Shareholders Agreement to see what their rights and responsibilities will be.
Aside from providing a loan or investing in the business, there may be other ways for you to provide support. For example:
It is very common for Australian startup founders to seek funding from friends and family members. When it works out, it can be a great result for all involved. The founder gets the support they need to get their business off the ground, and the investor gets to share in the financial success of the business. But unfortunately, it does not always work out.
This means it is essential for the parties to take some time getting their ducks in a row. The investor needs to conduct their due diligence on the business and the investment proposal. Both parties need to consider the terms of the funding, to make sure they are happy with how it will proceed.
To avoid any confusion or disagreement down the track, it is also important that the terms of the agreement be set out in writing. There are a number of different documents which may be used along the way, many of which are available on our website.
As with any legal matters, if the parties have any concerns, then they should seek legal advice.