What are 'Friends and Family Shares'

Friends and family shares are often regarded as the very first sources of capital for a young business entity. Entrepreneurs, issuers and bankers may offer "friends and family shares" to business associates, family members or friends, prior to the stock's launch to the public, allowing them a stake in the future success of the company. These shares may represent a small percentage of an offering, typically less than 5%, but can create significant gains for the holder.

These securities may also be called directed shares.

BREAKING DOWN 'Friends and Family Shares'

The lead underwriter for the IPO typically agrees to administer the friends and family shares as a service to the issuer. In the U.S., the Securities and Exchange Commission (SEC) has paid close attention to the effects of friends and family shares. Some of these shares are "flipped" during the IPO, creating large profits for the friends and family shares holders.

Often, even before a new business entity reaches the "angel" stage of raising capital, they must call on friends and family for the additional funds to push through to more traditional forms of financing. In theory, because friends and family are more understanding, they may be more willing to provide capital for speculative purposes. Friends and family rounds of financing are not without their drawbacks, as the use of friends and family monies creates the potential for strained relationships. But at times, friends and family may be the best option available.

Banks won't lend debt capital to young business without a history of revenue or assets. And seed money or private equity often comes at too high a cost, such as giving up significant equity ownership.

Unfortunately, the idea of friends and family seed money is largely an issue for those individuals with considerable financial resources. Entrepreneurs without excess to friends and family in higher socioeconomic positions are effectively locked out from this form of financing.

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