The “Founding with Friends, Founding with Strangers?” post suggested that starting a company with friends can introduced big risks, an assertion that was echoed and amplified by many of the comments, experiences, and insights that people posted in response. Among the risks: losing a great friendship when the friend underperforms, or making suboptimal business decisions because of emotional complications (hence, losing the company).
Is the same thing true with your investors?
Whether you’re trying to avoid raising venture capital or just waiting until your venture gets big enough for it, one of the most common early sources of funding is good old “friends and family.” As the people most closely connected to you, friends and family members can be accessed much more easily than strangers. However, are there risks introduced by taking their money?
Given the recent holiday, let’s consider a couple of “Thanksgiving Dinner scenarios“:
- Your favorite Uncle Fred tapped his retirement fund to give you seed money to start your company. Then your company went out of business. Are you prepared to go to your family’s Thanksgiving Dinner and face him and his wrath? (In possibly a related vein, Paul Graham says that, “The reason I didn’t take money from my parents was that I didn’t want them to lose it.”)
- Or, taking the investor side of the scenario, as you’re starting to eat your turkey and cranberry sauce, your dear nephew Johnny outlines his grand plans to quit his job and start a company, and really wants you to provide some of the funding. You’ve always liked Johnny and enjoyed giving him small cash gifts to buy himself a birthday present each year, but a $25,000 Seed Round would be quite a different gift altogether. However, you don’t have the heart to turn him down. (Oh well, you didn’t need the $25,000 anyway….)
Risking the loss of a close relationship. Emotional entanglements leading to bad business decisions. Seems like déjà vu.
Do the problems of “founding with friends and family” also apply to “funding from friends and family“? Does this source of funding introduce other problems? How have you managed those problems?
<>In case you have trouble accessing the link, here is Chris Marino's input (thanks for the great thoughts, Chris!):<>Noam Wasserman a professor at HBS has a < HREF="http://founderresearch.blogspot.com/" REL="nofollow">blog<> with a ton of great info. I haven’t read it all, but I will eventually.Today he asked about taking money from a family member and if you would be prepared to face them at a Thanksgiving dinner after you had lost their investment.I think that’s a great question.When I faced this exact dilemma, I consulted a good friend (and entrepreneur) and he gave me some great advice: This should be a litmus test for your endeavor.You should take the money if <><>only<><> you are sure you’re not going to lose it. This might sound too simplistic, but what it means is that if you think there is a real possibility that you might lose their investment, maybe you haven’t addressed all the risks.On the other hand, if you know that you <><>won’t<><> lose their money, you should take it.The reality of the situation is that there is always the chance that the investment will be lost, and the rational mind acknowledges this. But often, success is based on confidence and attitude as much as execution. Successful entrepreneurs are often blessed (cursed?) with an abundance of confidence, some of it irrational.If the entrepreneur hasn’t progressed to the point of certainty, they shouldn’t take the money.Once the money is in, a whole new dynamic is involved. With the relationship at risk, the entrepreneur (the good ones anyway) will move heaven and earth to not lose the investment. And moving heaven and earth is often what it takes. Being on the hook for a family investment is < HREF="http://archives.tcm.ie/carlownationalist/2020/06/23/story21173.asp" REL="nofollow">burning the boats<>.The next bit of advice I got from my friend was ‘<><>always<><> take the money’. You have to start somewhere.In hindsight, this was the best advice I ever got. I took the money, and it turned out OK
Noam, lots of great info here. Haven’t read it all, but I will eventually.My comments < HREF="http://tumblingduke.blogspot.com/" REL="nofollow">here<>.CM
You should never rely only on friends and family. If you can’t convince someone more objective than your friends and family to invest in you, there’s probably a flaw with your business, which will result in them losing their money and you feeling terrible. Even if you have a dozen rich uncles, I would suggest you find someone outside that circle who believes in you and your idea. Conversely, I wouldn’t want to invest in any business backed by just friends and family. I might do it, but I would regard it as a gift, not an investment.
An entrepreneur once told me he was asked all the time by friends to invest in his company. He would tell his friends no and if he was very successful he’d write them a check. This way, he’d always have his friends whether it worked or not.the “friends and family” money is often a term used broadly. If this group represents experienced entrepreneurs and successful business people in your business network who have good business judgement and can be helpful in you building your business, then this can work well. If it is literally your best friends and your extended family, I’d resist.One of the most important things for an entrepreneur is their time. Getting market savvy feedback on your idea early is important to make sure you are headed down the right path. The opportunity cost for a smart and capable entrepreneur is quite large. With the wealth of investment vehicles that exist from angels to VCs, a good idea shouldn’t have to resort to capital from Uncle Larry.
I think that Intuit provides an example both of how VCs can miss some of the very best investment opportunities and how “personal” money (i.e., cash from those close to you) can be a real motivator. As he tells the story at < HREF="http://www.hbs.edu/entrepreneurs/scottcook.html" REL="nofollow">http://www.hbs.edu/entrepreneurs/scottcook.html<>,Scott Cook was unable to raise a dime of venture capital and thus had to borrow from his parents’ retirement savings and also from his cofounder’s friends. During one particularly difficult period, he said that “what kept me going was just fear that I didn’t know how I’d ever payback the money.” That’s not to say that people who raise VC$ quit easily, but it does serve as a reminder that you shouldn’t take a failure to raise VC$ as an indicator that your startup is doomed.
It’s not just at HBS that that’s true, Amir. The most interesting questions <>in life<> are often “depends” questions…. :->Thanks for your reflections on this!
All questions asked by an HBS prof have the same answer, it seems: it depends.I’d rather not have friends & family money in a deal as an investor or an entrepreneur, but the reason people usually go to those sources is that they don’t have other choices (or more likely, they don’t know they have other choices).Does it make an entrepreneur more comitted to success? I dunno. My experience is that when an entrepreneur has all of their own personal wealth or their family’s wealth tied up in a deal, they are more likely to be risk averse and more likely to sell out at a smaller number. So I think there might be some downside mitigation in that scenario and I’m fairly certain there’s some upside mitigation too.Several venture deals of late have included shareholder liquidity for founders. The thought is, take some money off the table so that you can be secure. But let the rest ride, and shoot for something really big. It’s counter-intuitive, but there’s some wisdom in that approach.AG
out of principle, i do not include family into business/financial transactions or pursuits. the fact is, money stands to be the very thing that can dissolve strongest of relationships. added with the prospect of “family drama” (of which everyone seems to have plenty) it’s not worth it. on the other hand, if your family comes from a business background and are well-informed about finances, AND they know to keep business and friendship strictly apart (too many and/or/if’s here), you should utilize them. good blog!
If I borrowed money from my relatives or friends, I would also expect them to participate in my business. Being more precise, I would involve them in the management or operational activities, or would make them responsible for some marketing or distribution parts of the business. I would leverage the responsibility over their stake in the business to my relatives/friends - let’s call them partners after transaction occured.Business owners shouldn’t rely on benevolence of their relatives/friends, but be more business-like and apply exactly the same principles as they would borrow money from bank or solicit funding from venture capitalists.I am talking about significant amounts of money. In another case, if it is couple of times of “pocket money” - up to $500, then it would be OK to manage money by yourself, and if the business is lost, then it wouldn’t be that painful for your small investors to lose money they borrowed to you (I am not 100% sure about this).So my advice to business owners, who want to borrow money from relatives/friends, would be: get them more involved in your business. They should care about their money a little bit more than usually. Set the benchmarks of returns on investments and deadlines when the money should be paid out.Otherwise, to avoid any problems, just ask them to close their eyes and donate money to you.
Should entrepreneurs “burn their boats”?Short answer: In my opinion, no.The long answer: Cortez is said to have burned his boats to motivate his men to conquer the Incas and plunder their riches. (Historically inaccurate but that’s beside the point.) Burning the boats may be a motivational technique that is effective in motivating others (although not consider to be good 21st century mgt practice) but when one applies it to oneself, it is more akin to entrepreneurial suicide. If one sets oneself up in situations where you must “succeed or die”, then you’re fundamental motivation must be called into question, i.e. “Are you just doing it for the rush?”. Instead of minimizing(marginalizing) and taking prudent risks to maximize your chance for succeeding, you live constantly on the edge in a world of “possible success”. If this is the case, then the business is your “crack habit” that you’re asking your friends & family to support. Ever wonder why it’s called <>OP<>IU<>M<>, i.e. <>O<>ther <>P<>eople’s <>M<>oney. This situation is no different from the character Tom Hulce plays in the movie “Parenthood”, but there I go with the movie analogies again.Further, founders and entrepreneurs must have a “safe haven” if they hare to have any hope to survive the rigors of the startup company lifestyle. Where do you go for physical/psychic nourishment and comfort when the world is crashing in on you. Family serves this purpose often and best. “Burning your boats” undermines this support structure and thus is setting oneself up for failure.Why do people take such a risk when there’s plenty of other money out there. Because F,F&F{ools) money is too easy to obtain which encourages people to start marginal businesses. Beyond that, F,F&F’s do little diligence, have no real objective judgment, and can’t advise/prevent you against doing something completely stupid. Think about how many restaurants are started with well intended F,F&F money? How many survive the first year of operation?If you go into business with money from F&F, then you will either lose the business, lose your family and have a very good chance of losing both.It’s a shame to lose friends or family because they invested their savings in the business and lost it all. It becomes a tragedy when the business concept was flawed from the beginning.If you’re on the other side of the table and approached by a friend or a family member seeking an investment in their new business idea and there’s no “smart money” around the table, then do what Nancy Reagan taught you, “Just Say No!”.
……is anything more important than money?……or is wealth the highest of noble goals?……will greed and fear control our destinies forever?
I would say that there is no “black and white” rule for this sort of thing. Each situation is different. Having said that, when I am approached about business ideas (which happens on a regular basis), I will almost always counsel people to avoid going into business with family. “Better safe than sorry” is my vague and nebulous reasoning for it. I also suggest the same concerning friends, although not so vehemently. Perhaps I am shooting myself in the foot by saying this, but I recently started up a business with several friends (and investors on a friendly level) that has been showing great potential for success (< HREF="http://www.degreeme.com/" REL="nofollow">http://www.degreeme.com/<>). So far we haven’t had any conflicts and I have actually quite enjoyed doing business with those whom I trust and consider friends.So I guess my conclusion is that it really does depend on the situation (to avoid being hypocritical), but that I would typically suggest staying on the “safe side” by avoiding business relationships with friends and family.