When you start building a business, you either use your savings or reach out to the people you know for capital. Your acquaintances (Friends, Family, Ex-Colleagues, etc.) are most likely to be your first investors. They would back you because they know you and want you to succeed.
Their motives behind investing are both financial and personal.
In Venture Capital, raising money from people in your network is called an F&F (Friends and Family) round. Raising capital from your friends and acquaintances can be a double-edged sword. It's easy because you know them and don't need to convince them for a meeting. You can talk to them whenever you want. They are more likely to support you because they know your strengths.
It is challenging because it can sour your relationships if the startup doesn't do well. No one likes losing money. It's a cognitive bias called loss aversion. It's ingrained in humans. Thus, many founders hesitate to ask their friends for money because they fear it might ruin their relationship.
But remember, this is different. You are not asking for a loan or charity. You are asking them to invest in your business. If your startup does well, they will get a great return on their investment. Early-stage investors make the most return on their investment when the startup does well.
The best way to mitigate this risk is to educate your investors about the risks of investing in startups. You have to be honest from the beginning to avoid future turmoil. Investing in startups is risky. And this risk is even more in the early stages. As a founder, it's your task to educate the people who can invest in your business about the potential risks. You must be brutally honest about it.
F&F is the surest and most common way of raising capital in the early stages for most founders because it's easiest. But F&F rounds can also be tricky and cumbersome.
Let's say you want to raise Rs 2 Cr, and 20 people have committed an average of Rs 10 Lakhs. When you raise capital, you sign a term sheet with all your investors. Once your company has received the money, it issues share certificates to these investors. The company also has to do a few regulatory filings.
Most individual investors don't know about it. It's the company's responsibility to do all the filings.
In our example, the company will have to do the necessary paperwork for 20 people. It can be time-consuming. Hence, a more efficient way is to pool the capital of all investors into an entity (investment company) and then invest through this entity. In this scenario, this entity becomes your new shareholder, and these 20 individuals become shareholders in this entity. It reduces the paperwork because you have only one shareholder (the new entity) now.
But you can't simply create an LLP or a company to invest in a startup. There are rules around it. Creating a company only for investment purposes requires regulatory licenses in India. No founder does it. They use the services of SEBI-registered Venture capital funds called AIFs.
AL (Angel List) is one such company. AL has a product called RUV (Roll-Up Vehicles) that allows founders to legally merge all their investors into a new entity. AL charges 2% for entity formation, KYC, accreditation, collection of funds, tax documents, signatures, and distributions. This one-time fee (2%) also covers all filings, tax documents, and distribution management for the lifetime of the RUV. It reduces your admin costs.
Source: Angel List
Other angel-investing Indian platforms offer similar products. You can read about them on their websites. If you are a founder raising tiny sums from many individuals, RUV or similar structures are better than issuing shares to all these individuals. It saves a lot of time, effort and money in the long run. It frees up your time to build your startup.
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