Ought to You Elevate Cash From Mates And Household For Your Startup?

Raising money from friends and family is complicated, but it might be the only way to raise funds … [+] for a while. Before taking the leap of faith, make sure you understand the implications

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You have an idea, you have confirmed it and you are confident that it has potential. However, to really test it you need to start building – you need a prototype or a Minimum Viable Product. Often times, this requires at least some capital investment in your startup project.

Most new businesses are funded by the founders – either from their savings or from corporate loans. For traditional businesses with predictable cash flows, bank loans are a great source of funding because they give you leverage – you don’t dilute your stake in the business and you can make more money in the long run.

However, when you’re starting a startup, financing your business with credit is far too risky. You have to return the loan whether your idea works or not, and unfortunately, given the very high failure rates of startups (over 90%), this is the more likely outcome.

For this reason, most startups are booted by the founders in the very early stages. However, if you don’t have enough savings to cover the cost of developing your first versions of the product, you’ll need to raise funds.

However, raising funds from angel investors and venture capital funds at this early stage is not a viable option. Nowadays, professional startup investors are more demanding and know that startups are way too risky in the idea phase. Investors typically want to see solid evidence that the company is on the right track to get the product market fit. In other words, investors want to see some traction before risking their money. However, in order to gain traction, you will need money to make the first version of your product – a catch-22.

If you don’t have enough money to meet your new business needs and banks and startup investors are not an option, then your last hope is friends or family. If you are lucky enough to have people in your life ready to support your business, this seems like a win-win situation. Needless to say, taking the hard earned money of your loved ones at risk is not an easy decision to make.

The very first pre-seed investment round is often jokingly referred to as the FFF round in the startup community – fools, friends and family. Fools, you would only invest in an early stage project like this if you did not understand the level of risk involved. The expected return on such investments can be negative on average.

However, it doesn’t necessarily mean that your friends and family are stupid. Such an investment is of greater value to them than to an outside investor, as these people are already personally invested in your life and success. From the point of view of the founding parents, for example, even if the expected return on the investment is negative, this could be justified as an expense for the personal growth and development of the founder – the experience of build a startup would be valuable from the ground up for the professional future of the founder, even if the project fails.

In addition, the real benefit is greater, as parents are concerned not only with their own return, but with their child’s ability to nourish themselves from something they love. If, for example, the startup idea is not scalable and does not become a unicorn but a lifestyle business, an angel investor or venture capital fund would write it off as a failed investment. However, parents would likely want to help their child start a small family business, even if their investment doesn’t result in a 10x return on their investment.

This is the ideal scenario. However, if the investors’ friends and family do not fully understand the implications of their decision to give you money for your project, losing their money can cost you relationships. This is a terrible situation – a failed startup is very tough for founders, but if it comes with damaged relationships, the emotional cost would be even higher.

Hence, you shouldn’t be afraid of making an early investment from friends and family. However, you need to make sure they aren’t fools too. You need to have a good understanding of the implications of your investment – the likelihood that the money will be lost. If your friends and family cannot afford to invest in your project, it is better not to take their money and look for other options.