Friends and Family Funding and Why I'm Dreading Thanksgiving

http://datodaily.tumblr.com/post/68087290627/friends-and-family-funding-and-why-im-dreading

by bscordato • 13 years ago

121 84 13 years ago

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rayiner3• 13 years ago

Relevant: http://thinkprogress.org/election/2012/04/27/473096/romney-b....

Although it is a weird dichotomy if you think about it. People let parents pay for their college to the tune of $100k+ and don't feel any obligation to justify or defend the investment.

fiatmoney• 13 years ago

"College" is in this case a proxy for "entrance to the socially-defined middle class". Parents in general (or at least the middle-class ones that would have money to lend/give for college) want their children to be at least as high in the social hierarchy as they are.

Financing someone's business is much more of a mercenary decision; "do you run your own business" isn't really a social class marker in the way "did you go to college" is. It's strictly for the money (or for some, a kind of consumption in the form of a "hobby business" that doesn't actually make money).

001sky4• 13 years ago

The purpose of borrowing from your parents is different, though. The transfer of wealth from parent to sybling via "paying for" college is (as you rightly point out) not really a loan, but a type of "grant". More specifically, its one that is both socially acceptable and tax beneficial[1].

The logic of Romney's positin on borrowing is that it is <market efficient>. That is to say, the parent has more information on the borrower than a bank, and therefore is in a better position to measure risk and avoid the typical market failures that correlate with the type of non-stochastic uncertainty that cling to first-time founders with no track record[2]. Your parents have much lower information gathering costs and monitoring costs than a bank, in other words. Also, since the return on the investment can be higher than what that money would otherwise get in a normal debt investment, the idea would be a win/win also in theory for the parents. This is, even with a true debt structure (ie, repayment with interest) which is again different from the way many parents 'pay' for college.

[1] Gifts over 10k are taxable.

[2] This is not technology risk, which is a different ball of wax. This is the risk that would keep a bank lending you money for a low-tech business, like a lemonade stand.

ef42• 13 years ago

Maybe there are some families where a parent funding their child's business is in it "strictly for the money", but I've never seen one.

Why would you believe that parents who would selflessly spend $100k+ on college without expecting any personal monetary ROI wouldn't offer money on the same terms for their kid to start a business?

In either case you're buying experiences and trying to create opportunities for your kid. Even from a purely educational perspective, launching a business can be far more educational than lots of college programs.

mikeash• 13 years ago

One big difference is that there's way less uncertainty in college. If you're reasonably intelligent and don't goof off, you can turn the money into a college degree almost guaranteed. Business, on the other hand, is inherently a crapshoot, and you can do everything right and still spend all of the money and have nothing to show for it at the end.

snoldak924• 13 years ago

I think it depends on the difference between an "investment" and a "gift." Similar to loan vs. grant.

segmondy• 13 years ago

Well, next time, don't raise money from Friends and Family. Raise it yourself. Work for a few years, gain experience, live frugally and save. Then bootstrap with your own money, starting with your own money will really have you think harder than with other people's money.

socialist_coder2• 13 years ago

I've always suggested this as well. But the truth is, almost everyone is too lazy and doesn't have enough financial discipline to do this.

FWIW I've been bootstrapping my startup for the past year and we're finally making a profit.

a8i• 13 years ago

If you're a single, early 20s engineer in silicon valley, it's nigh on trivial to sock away ~40 k$ in a year.

That's easily a year's runway for yourself, or half a year with a cofounder.

gohrt4• 13 years ago

That's similar to saying "don't get a mortgage, save up and pay cash for a house when you can afford". It is an inefficient way to allocate capital.

Proof: Nearly every large (and many/most small!) business in the world started with a loan or investment.

dlnovell• 13 years ago

TL;DR - "This rule is so underrated, keep ya family and business complete separated"

sbank2• 13 years ago

Commandment one, two, six, as well as number ten (when translated to the current context) is also solid advice.

7Figures2Commas2• 13 years ago

I’m deep into my second pivot, and haven’t yet delivered an exit two years after that initial money.

Haven't delivered an exit after two years?!? What's wrong with you?!?

Sarcasm aside, while taking money from friends and family may not always be desirable for a variety of good reasons, the problems that arise from it are usually the result of unrealistic expectations.

Most companies never achieve an "exit", the average time to a liquidity event for companies that do is well more than a couple of years and most liquidity events don't produce Hamptons money for everyone involved.

If you have raised capital from friends and family and are sweating bullets after two years because you haven't made yourself and your investors wealthy, the expectations you set for yourself and your investors were way, way off.

wdewind2• 13 years ago

I don't think he means exit in the sense of IPO or sale to PE. I think he means exit for his initial f&f investors. It's not entirely unreasonable to expect a larger seed round or even a series A after 2 years.

7Figures2Commas2• 13 years ago

A professional investor (or group of investors) providing a seed or Series A after a couple of years is realistically going to have little interest in cashing out existing friends and family investors at a gain. At that stage, you're investing to grow a nascent business, not to buy the founder's mom and dad a deluxe new kitchen.

Domenic_S• 13 years ago

I've always heard it as f,f&f -- friends, family, and fools.

;)

gohrt4• 13 years ago

A company that is successful enough to still be a going concern 5-7 years later is generally in good enough shape to either pay off the original investment (not converting the "convertible loan"), or make interest payments, or raise new money to buy out the original investors[].

[] In a case like this, buying out the founder's mother is less of a red-flag than buying out the Angel investor.

albedo2• 13 years ago

This is part of what we were trying to avoid while starting Lambda (http://getlambda.com). Do contract work to bootstrap your company, especially for technical founders. It's very much worth it to take 1-3 months off to freelance, make ~$20-50k, and keep your entire company.

ereckers• 13 years ago

I'd say making $20-50k for 1-3 months of freelancing may be just enough to make me want to ditch the startup altogether.

albedo2• 13 years ago

Yes, freelancing is very lucrative, if you're a good developer with the right skillset. People are generally willing to give up a lot of money in exchange for a steady income guarantee.

angersock• 13 years ago

If you're young and not in an area where people are used to paying market rates for development work (read: the midwest), doing contracting work is not a silver bullet.

outworlder• 13 years ago

Only do this if you expect to make an amount which will get you a few months of runway.

If it is just enough to cover your operating expenses plus a small surplus, it will be very easy to fall into the trap of doing consulting and then creating the product "on the side".

sbank2• 13 years ago

I would never take funding from friends or family. Hard rule. More aspiring entrepreneurs should listen to Ten Crack Commandments by Notorious B.I.G. at least once.

aestra• 13 years ago

Good advice from the Notorious B.I.G. minus the homophobia.

Seven: this rule is so underrated Keep your family and business completely seperated Money and blood don't mix like two dicks and no bitch Find yourself in serious shit

macspoofing2• 13 years ago

I’m deep into my second pivot, and haven’t yet delivered an exit two years after that initial money ...
I’m confident I will (deliver an exit) - I bust my ass every day - but I haven’t yet.

That confident are we?

bscordato• 13 years ago

If I wasn't I wouldn't be doing it :)

macspoofing2• 13 years ago

I'm sure you are.

... but maybe you should consider scaling your expectations.

the_derelict• 13 years ago

I’m confident I will - I bust my ass every day - but I haven’t yet.

Busting your ass isn't going to make a bad idea any better. I took a look at your lobster schtick and think you need to go back to the drawing board.

beat3• 13 years ago

Two years isn't enough to judge whether an idea is bad or not, either.

bowlofpetunias• 13 years ago

There's a reason why this kind of funding is generally referred to as "Friends, Family and Fools".

emhart3• 13 years ago

This is an anecdote, not a great insight, so feel free to skip:

When I was starting a small theater company in NYC with some friends we raised money for our first off-off-broadway ("broadway", "off" & "off-off" are a definition of seating capacity, btw, not geography) show, we turned to friends and family for our funding. This was very much the norm when you were just starting out. Usually these were small amounts, aiming to raise maybe 5-7 thousand dollars total, often even less, all depending on location & run of the show.

Anyway, we raised a few thousand, put on a great show of original one acts from writers and directors in our own company and it was shockingly well received. In the end, we actually managed to turn a few thousand dollars profit, which was less typical. In the meetings we had afterward with what to do with the money, everyone but myself and one other partner were blatantly treating it like a lottery win. A completely unencumbered windfall with which we could just buy beer for a year if we wanted. It was infuriating.

For me, and the other partner (who both left the company due to these and related issues soon after) we felt that while we may not owe that money back to the family that supported us, we at least owed it to them to keep it rolling. Instead, we rented out office space on 42nd street for ~6 months and never did anything more than use it as a storage unit. Most expensive storage unit you could find in the city.

Finally, the time had come to put up our next show, a full-length new work by one of our best writers, and with absolutely 0 compunction 7 of the partners enthusiastically recommended we return to the friends and family well. There was nothing left of our profit and no one cared. After the first show we had enough to mount the second, had we just set it aside for that purpose.

That was my first real experience in small business and unfortunately I was too young and angry to properly learn those lessons at the time. Took me another 8 years to really comprehend what we had done.

Edit: Faulty memory, updated for accuracy.

mcv• 13 years ago

Family and friends gave you that money without expecting it back? And what happened the second time your group asked for money after wasting the first profit?

emhart3• 13 years ago

That's precisely right, it was handled more as a gift/grant and no one was ever (to my knowledge) given the impression that there would be any return.

I do not know the specifics of the 2nd round of begging, but I do know the show they launched had a shorter run in the same theatre, so the amount raised must have been significantly less. They folded entirely very soon after that production closed.

gohrt4• 13 years ago

Did you repay 0% of investment, or 100% of principal with 0% interest? The former is awful, the latter is a bit less awful.

emhart3• 13 years ago

0% it is awful, but at that scale, it is very frequently how things are done. The other common off-off-scale money raising method is to make your actors agree to take responsibility for N# of tickets per performance, so they either sell them, or it comes out of their pay if they can't. Lot of pestering friends to buy tickets to your shows. I was never willing to work for a production that did that, as I wasn't comfortable mixing the work with sales in that way, but in asking for money from friends and family, I don't know that investment was the proper word.

In addition to asking for money from family, I also filed grant applications, and both were treated similarly. None of the people giving had any expectation of a return, but I think they similarly had no expectation that they would ever be asked again, or that we would squander profits as we did.

PhasmaFelis5• 13 years ago

I'm still trying to wrap my head around the idea that there's a world out there where you can just casually hit up Grammaw and Uncle Barry for twenty grand apiece.

It doesn't really favor the notion that the startup world is an egalitarian meritocracy.

beat3• 13 years ago

It depends on the family. Hell, I drop a couple thou a year helping my retired mother financially, as she has zero money and zero sense with whatever little money she gets. My family has always been dirt poor (and those who are still dirt poor look enviously and somewhat resentfully on me and my one sister who also achieved a comfortable middle class life).

My wife's family, on the other hand, is solidly upper middle class all around. Her grandfather worked from a Kansas dust bowl Depression childhood to a Harvard MBA and probably several million in net worth. Several of them are "qualified investors" in the legal sense and could angel-fund a startup.

But I won't ask them for a cent, not even take it if it was offered. Why? Because they're family, and not blood family at that. If I took investment money from them and it failed, I would be paying for it in non-financial ways for the rest of my life, and my wife would be paying even worse. Even asking would be a tremendous misstep of the delicate dance of family.

So yeah, even if Grammaw and Uncle Barry have twenty grand to invest doesn't mean there's anything "casual" about it.

beat3• 13 years ago

I should add that I've been "Uncle Barry" too. One of my poor sisters and her daughter tried to get me to loan them ten grand to help start a business, and I refused. Why? Because their plan was nonsense. I think they have a good $20-30k/year idea, which is great, but they were absolutely convinced that it's a $100k business - something I consider impossible upon running various numbers and the limitations of hands-on work. If they're not willing to be realistic about their scope, I'm not going to hand them money to pour down a hole.

dsugarman• 13 years ago

It is obviously not an egalitarian meritocracy, but there are serious opportunities for anyone with access to the internet. The less fortunate will face a lot more adversity to find success, which makes it that much sweeter.

rayiner3• 13 years ago

"Egalitarian meritocracy" is relative.

It used to be that going to Harvard was largely a measure of whether you had enough money to go to Harvard. In 1950, the acceptance rate at Harvard from elite preparatory schools was almost 90%.

Today, it's an "egalitarian meritocracy." The acceptance rate is around 5-6%. A quarter of students come from families that make below $80k, and 60% of students receive some financial aid. In other words, a household income of $80k, which is top 30% nationwide, puts you at the bottom 25% mark at Harvard. Further, 40% of students apparently come from households making over $180k (the point at which aid phases out), which puts them in the top 5% or so of households nationwide. The statistics at Princeton, Stanford, etc, aren't any different.

People in the start-up world talk about "egalitarian meritocracy" in the same breath as they say they give explicit preference to kids coming out of Stanford, a place where the median person is from the upper middle class. It's true in a purely relative sense. It's very meritocratic compared to how things were historically, and how things still are in many parts of the world.

That is not to say that these institutions could be appreciably more meritocratic by their own efforts. Rather, when talking about whether a field is "meritocratic" you can't ignore the fact that class and income-based sorting takes place at a much earlier stage in the pipeline.

natrius3• 13 years ago

If merit correlates with the ability to make money and merit is heritable, you'd expect those with merit to come from families with money. Top schools and our industry are probably far from pure meritocracies, but that data doesn't prove (or even strongly suggest) it.

foobarqux2• 13 years ago

Bezos's parents invested 300k into Amazon or whatever it was called at first.

SkyAtWork• 13 years ago

Though Jeff came out of a hedge fund (DE Shaw) and doesn't seem to have been struggling :)

phamilton3• 13 years ago

20 grand isn't that much. Go hang out on mrmoneymustache.com or earlyretirementextreme.com and you'll see plenty of people with twenty grand set aside for "risky investments".

It's especially true right now, as depression era children have all retired after a lifetime of deeply-ingrained frugal living.

PhasmaFelis5• 13 years ago

See, this is kind of what I'm talking about. There's a world out there in which people can say "20 grand isn't that much" with a straight face. I guess it's nice that that world exists, but it really doesn't represent the experiences of most Americans.

Crito• 13 years ago

Some families have little money, but are willing to lend what little they have among each other. Some families have plenty of money and are willing to lend to each other. Some families have plenty of money, and think that it is poor form to lend to family.

People in my extended family go out of their way to help family members when they are down; for instance covering a few college loan payments or providing a bed to sleep on for a few weeks, but going to them for a business loan? That is not done, even with comparably small amounts of money. I kind of always assumed that was the common attitude, but I guess not.

sturgill• 13 years ago

I turned down friends who wanted to join our raise at Goalee for this exact reason. That, and I wasn't convinced that they were fully aware that you only invest in a small start-up what you can afford to lose. They guy was getting a doctorate in piano performance, and I didn't get the sense that they had a lot of extra in their lives (especially considering their three kids).

Best decision I ever made.

robodale• 13 years ago

That smelled like a sales letter.

sejje• 13 years ago

I didn't catch a whiff of that.

I have no idea what business he's in, after reading the article.

jliptzin• 13 years ago

On the flip side I've seen close family and friends angered at not being given the opportunity to invest in a successful startup, the opportunity instead handed over to "strangers."

rajbala• 13 years ago

You don't have to raise money from friends and family to have Thanksgiving become "Thanksgiving plus a 20 minute board meeting."

All that's required is that your family know you're in the throes of starting a company and suddenly you'll get lots of questions some perhaps hard to answer.

vertis• 13 years ago

There are hard questions: Are you sure this is going to work?

And then there are hard questions: Am I going to get my money back?

jheriko• 13 years ago

thank you.

I'm constantly bugged by the level of privilege amongst the startup crowd. Not even just being able to borrow from family, but being able to rely on them, or friends as something to fallback on when it all goes wrong.

There are a lot who seem to be seeking investment and I really don't get it. If your idea needs money then go make money... or don't be so selfish and take the risk and illuminate someone who does have the money. (hint, how dare you ever complain about patents when this is your attitude)

For me not having money rules things out. Borrowing that money to take a risk /is stupid/ it just is - even if it pays off - success is nothing to do with intelligence, sensibility or even doing anything right necessarily. I simply never enter into such an arrangement, nor does the thought realistically warrant consideration - I might lose my home and the few meagre possessions I have - along with an enjoyable lifestyle - if I screw up.

xrd• 13 years ago

I took money from friends and family. I would not do it again.

Most of my investors were well meaning. And, their expectations were often set by what they read in the media. I had one investor dream that he was a millionaire, and was initially very upset when we sold for a lower valuation than his investment valuation, and did not understand why he was not receiving all of the purchase funds rather than an amount based on his ownership share. There was a generally poor understanding of investment and this was hard to explain to a friend. Angels, supposedly, know that they will probably lose their entire investment, while F&F almost never think that, nor can they afford to.

Of course there are pros and cons of each type of investor.

The thing that would have me hold off from taking investment from friends & family would be that they often cannot to bring anything other than money to the table. If you read about Ron Conway, for example, you'll see he brings money and his whole being (connections, advocacy, etc.) when he invests. This is a big deal. F&F investors intend to do this, but they are as different in this way from "real" investors as growth hackers are from government workers. They don't know how to build businesses, and don't have much other than more opinions, generally.

And, if you have a family member that does not fit this bill, then by all means, take them as an investor.

Aloha• 13 years ago

Don't ask your family for money, ever. You'll pay for it in grief 1000 fold over every time you see them in perpetuity.

kumarski• 13 years ago

My dad came to the states with 8 bucks in his pocket and not speaking English. He was nearly deported twice and went to Mexico and then Canada finding random agricultural work before returning.

When I started my small business, even with customers in the queue, I didn't have the heart to ask him or anyone else in my family for funding.

I remember hearing stories about 'Patels' who came to the USA. The small but robust tribes of Indian(not Native American) families in each community would then each fork over $1000 to the new family for the purpose of starting a business(hotel or convenient store). One of the older families would then coordinate payments and ensure the new family made payments back to the loaners. It was a zero interest loan.

I'd rather eat macaroni and eat canned food for a month than consider asking mom and dad for money.

goggles99• 13 years ago

WOW, really?

Startups come and startups go, but family you will always have (unless you blow all their money in a failed startup)

This is a very bad idea.

asah• 13 years ago

Thanksgiving wouldn't rank on my top 100 considerations in starting or not starting a company.

-adam (6 startups, 3 IPOs, #7 on the way, bbfdirect.com, ask me about killer snacks for your office)

ef42• 13 years ago

I'm going to disagree and point out that all the horror stories always include people also breaking the regular old cardinal rules of investing. Whether or not they're friends & families has very little to do with it.

Don't raise a bunch of money from a crazy person with unrealistic expectations. Don't fund a business you don't understand. Don't invest money you can't afford to lose. Don't do business with people whose character you can't count on in good times and bad.

Now, obviously you need to not let your emotions blind your judgement so you can actually follow these rules, but that's always true, whether or not its family. And there's a very good reason to consider family deals: you have deep insight into the psyches of the people involved. (Or if you don't, you're probably not cut out for this kind of investing in the first place.)

I have a lot of friends and family I would never do business with, because they don't fit the criteria. But I also have people I would fund in a heartbeat, and I've done it happily.

If you're the investor, it comes down to accurately judging yourself. Can you really put relationships ahead of money?

If you're the startup, you need to judge the investor by that standard. Are they truly mature enough (and wealthy enough) to honestly not give a fuck about that money if they never see it again?

ansontl• 13 years ago

Friends and family funding is indeed very common in startups and small businesses. Over 40% of businesses started from borrowing money from friends and family. The rules are very simple: 1) make sure they can afford to lose the money; 2) have a formal agreement and make it professional, set the right expectation, and communicate the risks upfront; 3) keep them informed on your business status, give them regular updates regardless whether it's a good or bad news. Even though this sounds easy, the actual fundraising process can be very tedious. You can get a lawyer to help you but that will cost you a lot of money. The best way is get use the tools online, like http://kickstarter.com, or this one http://trustleaf.com which is specialized in friends and family funding.

Friends and Family Funding and Why I'm Dreading Thanksgiving

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