The single most frequent question that I receive about raising capital is to raise capital from friends and family. Of course, people want to know where to get big money too — but you have to learn to walk before you run, so I have put together a beginner’s guide to successfully raising the money that you need to launch or grow your business from people who are close to you.

The Bad News

Access to capital in the United States is not a constitutional right. Unfortunately, many people will simply not get any.

The Good News

If you do it right, money will flow your way. But do you want to know the $64,000 question? Here it is: What does it mean to “do it right”? Follow the comments below for an overview of how the fundraising process works.

Seed Capital

The very first money that you put into your deal is called seed capital. I get numerous requests for seed capital because someone has an idea that could be great if they just get some money. Only someone who knows you — and who actually knows you very well — is likely to give you seed capital. Strangers and outside investors need to see proof that you have a good concept that merits their investment. You still need a plan for your “insiders” but the requirements are diminished by how well they know you and yet again by how much they love you. Outsiders are not your target for seed money.

The Golden Rule

At all times, treat your friends & family with the same level of respect that you would treat any outside investors. That means you want to have a strong business purpose, have a good plan, ask for an appropriate amount of money and offer a fair return in exchange for any investment.

Plan your Business

It’s critical that you plan your business concept before you speak to anyone about asking them for money. That doesn’t mean that you have to create an investment grade business plan complete with financial statements, documents and details, but you do have to have a good outline of what you’re going to accomplish and how you plan to do it. You’ll need this because it creates credibility with the people who you’re calling on. Even though these people will not “rake you over the coals” in the same way that a stranger would, they still want to know (and they deserve to know) that you are thinking clearly about exactly what you want to accomplish.

Use of Funds

One of the most important questions that any investor wants to know is “what will you use this money for?” You have to be able to demonstrate that you have a serious business purpose for using the money. And by the way, taking a salary for yourself can be only a small part of the business purpose that they expect to hear you articulate. They may find it appropriate for you to take a small amount of money while you’re developing your project, but they do not want to know that 80%, 90% or 100% of the money is going to fund your lifestyle instead of going into growing the business. You have to be able to document that you will use the money for the purpose of growing the business and getting it to a place where either it can be self-sufficient, or where you can raise even more money from outsiders in the future.

Profits and Payback

The primary reason that an investor puts money into a business is so that they get that money back, plus more. A person who does not have an arms-length relationship with you may not have exactly the same expectation as a stranger, but they still expect you to make a serious effort to return their capital plus more. It’s critical for an entrepreneur to demonstrate that the plan for the business that they have will produce more money than the amount that was invested. The business plan has to demonstrate all of the mechanisms that are critical to make this happen.

What’s the Problem?

It’s not critical to provide a tremendous amount of detail to friends & family investors with regard to your business plan at this level. However, you do have to demonstrate that the community has a problem and that you have a solution that will address this problem in a significant way. All businesses are based on solving problems that people have, and being paid for those solutions. Your job is to demonstrate that you have great control of this area.

Valuation

The hardest question to answer is also the one that comes up the most. Entrepreneurs and investors want to know what share of the company the investor gets for his or her money. Since the company is usually new at this point and very little value has been created beyond the idea itself, establishing a value is hardly scientific. It is more about how well you can sell and get others to put up money. The bottom line is that you want to raise the least amount when the company is worth very little. Conversely, later, you will want to raise more when the company is worth a lot because that makes the money less expensive.

How Much is Enough

For a Friends & Family round, the amount that the entrepreneur should ask for will vary based on the needs of the business, but the goal is to take as little as is necessary because when the business is worth the least, you have to give up the most. I usually see first round raises in the amounts ranging from $250,000 to $600,000. Although, sometimes for smaller deals the first raise can be as small as $75,000.

Purpose of the Money

In the earliest stages of business building you have to focus all of your energy to get your business to the “next level.” That means that you are organized to raise enough money to move your business to a place where it is self-sufficient and generating cash flow. There are many ways to define this but the bottom line is that you have to spend money “thinking” about your project. You will have to get others who are experts in thinking about start up businesses also. You need perfect strategy. You need expert documentation. You need great financial projections. You need legal materials. All of this is expensive so in addition to whatever financial requirements you have identified for your new “baby,” make sure that you put some aside for these overhead items. Good planning and documentation now will make it possible to get into the long run.

The Four Questions

If you want to create a brilliant business plan – for a real business that will make real money, ask a few questions and carefully document the answers to them:

What is your vision for the project? What do you want the business to become?

What problem does your business solve? Describe the problem in very careful detail. Who has the problem? How big is the problem? What happens if they don’t solve the problem? Who else can solve the problem?

How does your product, service or invention address the problems that you have identified?

Does the world need this product, service or invention?

Creating Momentum

The art to getting a start up off the ground is to create momentum out of thin air. It’s tricky but mandatory if the business is going to get off the ground. Start small. Accomplish something. Parlay your success. Accomplish something else. Parlay that second success. Set another goal. Accomplish that. Continue to parlay each success no matter how small because it will eventually add up to a success that is surprisingly big.

Can a Stranger Raise Capital For You?

I am regularly asked to raise money for start ups that have very little track record and very little accomplishment under their belts. It is a rare situation that a stranger – or an outside investor – will put money into your deal until you have a string of accomplishments that they can review and validate. That is why creating momentum is so important. If you set a goal and then accomplish the goal – no matter how small – it creates confidence in the investors that the entrepreneur can and will actually accomplish what he or she says they have set out to do. That is a healthy pattern that will begin to set you up for raising big money. But that is a sequence of events for another day.