Friends and family or venture capital?

Negotiating the gap between relatives support and institutional firepower in business funding.

I was asked recently for some help thinking through first stage funding and I came across an interesting trend.

Of my friends who have started businesses over the years, one of only a handful of things on which they all agree on is that it was a significant challenge to decide how much, and for how long, to seek financing from family and friends versus a more ‘professional’ source.

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Where they have come out on that decision is of course partly driven by the type of business they have been growing, but more fundamentally by the type of person they are. It is a very different type of pressure/pleasure to put at risk the money of loved ones, with very different benefits and compromises.

There is no question that friends and family provide a critical role in the funding of new ideas. Very often the starting point for a new business is such that more funding is required in the early stages than the personal resources of the entrepreneur allow, but the business has not evolved to a stage where the venture capitalists are likely to commit funds.

At this initial stage, there is perhaps little choice for the way forward. However, many entrepreneurs choose to continue seeking to fund that way long after the possibility exists for more institutional funding, and it is that decision that is interesting to reflect upon.

Some of the advantages of friends and family funding are clear: limited time commitment required to raise the capital; in all probability lower dilution for a given amount of capital raised; little need to adapt any current methodologies and certainly the attractive prospect of delivering handsome profits to those people to whom you are close.

But there are some challenges also that need careful consideration and planning. A desire to be helpful and/or inexperience in evaluating early stage risk may lead people to invest more than they could comfortably afford to lose.

This can lead to uncomfortable strains on close relationships if things go less well than forecast. If developments take longer than expected and more capital is required that can often compound the problem.

If the group is disparate, working out an effective way to provide information without consuming significant time can be challenging; quite understandably if it is a relatively large investment by those parties’ standards, they might expect more access/information than is straightforward to provide.

In addition, there may be an opportunity cost deriving from the fact that often family and friends will have little or no relevant experience so are unable to assist with the development of the business.

So, whilst friends and family may well be the best starting point, as the business develops taking more formal finance is certainly something an entrepreneur should consider.

There is no defined point that such a decision should be taken but if some of the above concerns are arising and/or there is assistance that it is believed might accelerate the growth of the business, it is likely time to consider an alternative type of funding.

As I have written before, all investors are not created equal so to garner the optimal benefit from going down that route, a commitment of time will be required to find the right investor.

However, if such an investor is found, not only should it avoid some of the potential stresses above but also provide valuable assistance in taking the business forward both strategically and operationally and in turn making the early stage investment of those friends and family more secure and more valuable.

Related Topics

Early Stage Funding