Congratulations! Your startup idea passed validation with flying colors and is deemed worthy of pursuit. Your business model? On point. Margin potential? Stratospheric. Timing? Couldn't be better. But you need money. Without the money, your little sparkle with dreams of one day growing into a full-blown unicorn is as good as dead. So, you leap into action…
VCs won't even look at you. To them, you're too early. For a moment, you think about angel investors, but you're not quite ready to relinquish control of your empire. So, you make what I deem to be an ill-advised move in capital raising: you go to family and friends…
Your good intentions could be disastrous
You must have thought that by getting friends and family involved in your business venture early enough, they'd be able to reap the benefits of being a seed investor in such an enterprise. Here's the thing…
Shareholders can get emotional. And when your shareholders – all family and friends – get emotional, for whatever reason, you'll subconsciously factor those sentiments into business decisions. That, dear reader, is no way to steer your ship to safe harbor.
As a startup founder, you need to be calm, collected and focused on your goals. You need to stay serene while maintaining a high-risk tolerance. It's hard to be scrappy and foster a high-risk appetite if you feel you're managing your father-in-law's retirement funds; or if you're constantly faced with nervously excited investors from sunrise to sunset.
"But I told them to invest ONLY what they could afford to lose..." Sure. Did you also tell them to abandon all hope of success? Their belief in you, although flattering, could be your worst enemy.
Four reasons why going to family and friends is a bad idea
1. Your professional and social lives will be set on a collision course
That much-needed and highly sought-after respite for a startup founder will be hard to come by.
Although you might be interested in spending quality time with your friends and family to escape the pressure and demands of work, it may not be easy when you are winding down around your investor(s).
Take it from me. I once ignored my own advice and got friends involved in a capital raise. Not only was it stressful (the company executed poorly, and shareholder capital plummeted), but it ported my professional life into my personal life when I needed them to be as far apart as possible.
How can you look forward to Thanksgiving if it means going into full IR (investor relations) mode around the dinner table?
2. It is always a touchy subject
If things are coming along as planned and your venture continues to grow into a success, the opportunity for a liquidity event might arise. Rest assured, your "investors" will be interested in knowing whether or not you think 'selling now' might be a good idea.
How on earth are you supposed to answer that?
They're obviously thinking about maximizing the return on what they put in, but you… you're trying to build a legacy. So from your point of view, whatever might have sparked the liquidity event is only the beginning. Of course, you'd like them to cash in some profit, but if your venture goes public or some other liquidity event occurs within 18 months (at a higher valuation), you might feel responsible for them missing out on "the big score".
Now, what happens if the venture fails (which, make no mistake, happens ALL the time in the startup world)?
Your friends will most certainly forgive — after all they knew the risks involved, and this time it didn't work out. Such is life. But will they ever forget? You definitely won't.
A failed venture usually places a significant emotional burden on its founder. Imagine how heavy that burden could be if family and friends lost all THEIR investment in YOUR enterprise.
3. You will be a less clinical decision-maker
I already brought this up, but it's worth elaborating.
If your business venture's primary source of capital is from family and friends, you may hesitate to swing big. Your risk appetite with money sourced from close personal ties diminishes compared to what it could have been had you raised capital from exclusively professional relationships.
Startup founders are regularly called upon to take significant risks, even to the point of 'betting the farm' to hit the company's targets. Elon Musk's Tesla was about one month away from bankruptcy during the Model 3 ramp-up, sometime between 2017 and 2019.
4. Your business could be erroneously valued
One major test you'll face as a founder chasing capital is how 'the market' considers your valuation.
Professional investors won't hesitate to question your valuation, but family and friends will take your word for it. Sure, they'd like to see a profit on their investment in your startup, but they may overlook your valuation because they trust you and want to support you. Besides, unlike VCs, many of your friends and family won't know how to determine what fair valuation is for your company.
Leave Seed Capital to Founders and Professionals
In the early stages of your endeavor, you'll likely be on the lookout for supportive and patient investors. Although family and friends might fit the description, that is definitely not the time to bring them on as investors. In my opinion, there is never a good time for that.
It's natural to wish success on those we love, and what better way than building a business which could make them wealthier. I get it. However…
Think it through. Remember, founders need to be calm and focused at all times; they must take big and small risks; and perhaps most importantly, they need a break from time to time.