, Advice
23 July 2015

Fundraising Explained: Implementing Your Early-Stage Financing Needs

Friends, Family and Fools:

The FF or FFF round, (the acronyms origin stemming from the hindsight revelation that a failed startup played you as the fool) is a startups original source of capital, excluding those monies flowing out of founders pockets or a bank loan. Typically, in order to keep a companys capital structure as basic as possible from the outset, founders will issue common stock in this round, though a convertible note or even plain vanilla debt are common as well. While dollar amounts vary based on ones personal connections, the Friends & Family round is generally used to raise $25K-150K with some unusual rounds upwards of 500K. This first informal round is very useful as a means of turning a concept into a tangible business model though its implementation can be tricky from a legal perspective. Tips here.

Grainy but useful tidbit: Regulation D of the Securities Act of 1933 details certain exemptions pertaining to registration of private placement security offerings (Friends & Family rounds can be exempted from SEC registration); one of these exemptions allows companies to bypass the traditional rule that securities can only be offered to accredited investors. Despite this very useful exemption, startups should be conscientious of the fact that accepting a check from a close personal contact is a dangerous proposition due to the extreme risk of the investment class. Full disclosure of risk factors, including loss of principal and a no information clauses, is critical as no founder wants to deal with the double-whammy burden of lost relationships AND lawsuits if the investment sours. Helpful guide here.

Though an FF round will presumably include non-accredited investors who believe in your vision, many founders have emphasized that accredited investors should be included in this round whenever possible for their experience and relative financial security. The reasoning here is that the potential loss of a 10K check will be partially mitigated by the fact that these investors will not have to sell the farm to make ends meet. Sweetening your term sheet in regards to a favorable equity stake, interest rate on a loan or discount on a convertible note is a logical way of making this first capital raise more attractive to close contacts who might otherwise be wary of investing in an idea. Remember, friends and family are investing in YOU first and your idea second, as there are no tangible metrics to gauge the viability of your product at this point. In summary, heed the warning that friends and family members must be fully aware of the risk/reward relationship inherent in an extremely early-stage investment opportunity and craft your term sheet in an equitable, transparent manner.

The Pre-Seed Round:

The differences between the FF round and the Pre-Seed--or what is sometimes called an Angel or Genesis round--are murky, to say the least. What generally sets these very early rounds apart is that the Pre-Seed round, if and when raised, will typically include individual angel investors for the first time and will most likely be used to transition from idea stage to pre-product or prototype stage. A general rule of thumb is that if a startup raises a Pre-Seed, it should not be much more than $500K, or more importantly, it should not interfere with raising a traditional Seed round down the road in terms of $ value, proposed use of funds or strategic roadmap. Interesting blogs on this round here and here.

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