This is it! You’ve found the entrepreneurial opportunity of a lifetime. You’ve validated product-market fit, are solving a long-standing industry problem, and have the business model to execute on this once-in-a-lifetime, high-margin business opportunity. The only thing left is to raise the $2 million seed capital to get this idea off the ground and running.

Ah yes, that first funding round… it’s too small to take to VCs. Perfect for angel investors, but you don’t want them to have too much control so early on. So, you decide to go to family and friends.

What a mistake.

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I Know You Want to Share in Your Future Success, But…

Sharing in your entrepreneurial success is fantastic, especially with those you love and care about.

You build a business, become wealthy, and so do your family and friends because they invested early. At least that’s the intention behind getting them involved as shareholders in your venture. I understand that completely.

Unfortunately, when family and friends become shareholders, things can get emotional. You will likely put unnecessary pressure on yourself, among other negative behaviours.

As the founder of an early-stage venture, you need to be devoid of emotion for the sake of your business. You need to be level-headed, focused on execution, and a high-risk tolerance is required. It’s hard to be a scrappy, risk-taking entrepreneur (willing to consistently make calculated gambles) if you feel you’re managing some of Mom’s retirement funds or part of cousin Sally’s inheritance…

Although you told friends and family to ONLY invest what they can 100% afford to lose, the more they believe in your ability as an entrepreneur, the less likely uncle Bill is to listen.

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Why You Should Never Raise Capital from Family and Friends

Merging of two worlds

That precious downtime with friends and family may never be the same.

Like it or not, the investment will inevitably come up the more time you spend with friends and family, and likely at a time when you just want to relax and shoot the breeze.

I’m speaking from experience. One time I broke my own rule and got friends involved in a capital raise. It was not only stressful (the company didn’t execute well, and shareholder capital diminished), but it merged my two worlds (personal and professional life) when I needed them to be as far apart as possible.

The last thing you want to be doing on Thanksgiving is going into full investor relations mode around the dinner table with your family.

There is no win

If your venture succeeds and your family and friends have the opportunity for a liquidity event, they’ll ask you if ‘selling now’ may be a good idea.

What an impossible question to answer…

They’re thinking about ROI, and if they should try and squeeze out more profit by waiting a little longer. You’re trying to build an empire, and the early success that has enabled this liquidity event is merely the start of bigger things. Although you certainly want them to take some profit, if all goes according to your plan, they’ll be selling far too early. If you tell them to take profit, and the venture goes public or has another liquidity event in 18 months at a higher valuation due to successful business development on your part, you’ll feel responsible for them leaving money on the table.

You can’t win.

If the venture fails

Startups fail all the time. More fail than succeed. They’re one of the riskiest types of investments.

Those that love you will move on. Friends will accept it for what it was — a venture that didn’t work out, and they’ll most certainly forgive. But they’ll probably never forget… you definitely won’t.

There is a heavy emotional burden on founders when a venture fails. And it is heightened further if they get family and friends involved.

This guilt, or shame, let’s call it, negatively impacts your subconscious. It can even change how you operate as an entrepreneur for years to come.

Clouds judgement

I touched on this earlier. You will be as worried about your mom’s money invested as you are about the business succeeding.

Raising capital from family and friends may make you hesitant as an entrepreneur. You may be more reluctant to take risks with the money than had you raised the capital from professionals, who know and understand what’s required, and your relationship is exclusively professional.

As a startup founder, you need to consistently take risks and, in some cases, ‘bet the farm’ on a strategy/thesis to succeed. Harder to do when friends’ money is on the line.

It may not be a fair valuation

One of the first significant litmus tests you’ll face as a founder raising capital is whether or not ‘the market’ deems your valuation appropriate.

Industry professionals will not be afraid to critique your valuation, but family and friends won’t go there. Sure, they want to make a profit on their investment in your company, but they may overlook your valuation because they just want to support you. Or, they may not have enough understanding of the industry to know what a fair valuation is.

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Raising Seed Money Should Be a Professional Endeavour

When raising seed capital, you want to minimize dilution, bring on supportive and patient shareholders, and use the funds to rapidly grow your business. This may seem like the ideal funding round to bring on family and friends, but it isn’t…

In fact, I don’t think there is a good time to bring family and friends on as investors.

Although we all wish success on those we care for, and there may not seem like a better way than building a business which makes you and your loved ones wealthier, I’m telling you the cons greatly outweigh the pros.

Ignoring this advice may negatively impact you as an entrepreneur by clouding your judgment, making you less risk-tolerant (founders must take risks), and it can ruin what little downtime you’ll have during the building phase of your venture.

Stay hungry,

Aaron

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