Recently Rob Delman, a colleague of mine at Golden Seeds, and I were discussing the best ways to structure an investment in an entrepreneurial venture started by your children. As we both have “twenty-something” children who have been exposed over the years to our work in angel investing, it is only natural that they approach us as potential funders of the next great thing!
There are many ways to structure the “friends and family” round ranging from a pure “gift” to a priced equity round. For me, the key is striking the balance between encouraging that entrepreneurial spirit and drive, while at the same time making sure that your child understands that taking in outside funding, even if it is from mom and dad, has implications for the way you run your business.
Doing a priced round, especially when your budding entrepreneur is only at the idea or concept stage can be tricky. If you put too low a price on the venture, you end up potentially requiring too much of an equity stake. Conversely, putting too high a valuation on the venture can be problematic in seeking the next round of funding. We have all seen early stage companies that suffer from very unrealistic valuations based on earlier rounds that were priced too high.
So as Rob and I continued to think about what made sense, we came up with the concept of “Love Notes“, a subset of the convertible notes used in many very early stage ventures. What is different? In structuring this note, perhaps you can provide a longer maturity than a typical note to give your child a bit more runway to get the concept fully-baked. Do you really need a 20% discount into the first priced round or can you live with 10%. Consider not having a cap…. Basically construct an investment that is a bit more entrepreneur friendly but still incentivizes your child to really make a go of the venture.
Although we would hope that all of these great ideas from our offspring morph into successful businesses and enjoy a great exit, the reality is that the risk of failure in startups is quite high. One of the most important aspects of the “Love Note” is a concept borrowed from that iconic 1970 romance novel by Erich Segal:
Make sure that your relationship with your child will not be jeopardized by a failed startup. It is November, so you do want to make sure that your kids can come home for Thanksgiving!!!