Why you shouldn’t raise a ‘friends and family’ round
Modern startup culture has painted a cliched image of the founder’s journey. It often starts with young friends who have some mix-and-match of these classic tropes:
- Dropping out of college.
- Taking crazy risks with their personal finances.
- Working in some wholly inappropriate location (and sleeping there if you’re really hardcore).
- Being rejected by early investors and instead scraping together cash from uncles, cousins, parents…anyone you can.
We idolize these stories because everyone loves an underdog. The eventual success is all the sweeter for the tough times, the doubts and all the people who said you couldn’t. But there’s a problem with these stories; the majority are cherry-picked PR bullshit. The truth is that most successful founders come from positions of considerable privilige, hence the over-representation of middle class white men, and the perceived risks were not as great as they may have seemed. For example, Bill Gates, Zuckerberg and Spiegel may have dropped out of university but they were also all from comfortable backgrounds and left at a point where their businesses had meaningful traction. In each case, I’d quite confidently say they would have still been more than fine even if their venture failed.
My concern with these half-truths is that they have seeped so much into the romanticized picture of startup culture that they can lead real founders to believe that’s its not just OK but expected that they behave recklessly. This is stupid. Your job as an entrepreneur is to take calculated risks, not as much risk as possible.
Most of the points in my earlier list could probably merit an individual article (here’s my co-founders on when to quit your job), but my focus in this article is that last example from my earlier list — raising your first round from friends and family (f&f). It’s my view that, in so far as it is reasonably possible, you should avoid this funding step and I outline my reasons below.
If you can’t raise at-arms-length, it’s probably for a good reason
As a startup, raising cash is more than fuelling your business; it’s also an important part of validating your concept and progress. When we founded Stasher we felt that raising money from investors who had no personal interest in us was a good test of whether we were on the right track. For this reason Jacob Wedderburn-Day and I decided that we would make a point of avoiding an f&f led round, despite the option being available.
So why is it so dangerous? Raising cash by leaning on people’s love and respect for you personally, rather than belief in your business, can skip important checks on: your business model and how it scales, your traction to date, maybe even your ability as an entrepreneur. This can have catastrophic outcomes when these checks should have surfaced serious issues.
Many people see this as a chicken and egg problem; how do they develop the traction they need to raise money without an initial cash injection to build traction? Traction isn’t the only thing that can raise money (and traction is a loose term, traction can be customer/market validation, it doesn’t need to be money). However, if it’s really not possible to build at least some traction then you need to bring something else to the table that’s convincing. This ‘something else’ can be one (or a few) of many things: Deep domain expertise, relevant experience, a strong network within your target industry, really anything that helps make the case that you have a good reason to say the problem you’re solving exists and that you are going to be able to solve it.
If you can’t convince an investor on those 2 points then, as per this sections title, it’s probably for a good reason that they’re not investing. Without either of these, you have to consider whether you’re the right person to pursue this idea right now. We knew we weren’t the right people to pursue a deep tech or supe capital intensive business as young non-technical first time founders, for example.
Following closely from this point…
Investor feedback will help you identify and fix these problems (or let you know it’s time to walk away)
When someone you don’t know is thinking of giving you cash, they’re going to be much more skeptical in their approach to your business than a loved one. If they’re a seasoned investor then their feedback also comes laden with valuable experience. If they have negative feedback then it should make one of two things click in your head: ‘This is what I need to do to make this work’ or ‘this is not going to work’.
If your problems aren’t fixable, knowing to quit earlier can be a great benefit as you save yourself the time and stress and can prepare for your next venture if you’re so inclined. If your problems are fixable then the ‘no’s actually lead you closer to a ‘yes’ by guiding you along a path of improvement. That’s why it’s always recommended to start off pitching to the investors you’re least interested in, find out the negative feedback early (it’s often the same feedback) and have an answer ready when you do pitch the investors you really want on-board.
When I look back at our pitch materials from the first to last pitch within our first couple rounds it’s amazing how much progress we clearly make in developing our business model. The result is that our proposed strategies for scaling and overcoming key obstacles become more believable, and that’s because they are! For example, we realized we had to develop larger and more defensible demand-generating strategies as we scaled, identified where our team was weak and how to build credible financial models. That progress is all down to pitch feedback.
With the above in mind, the worst thing you can do is raise cash from investors who don’t challenge you thoroughly. Often such founders rest on their laurels, stubbornly doing exactly what they originally said they would (no one ever made them reassess this after all) which is the greatest mistake an early stage venture can make. It’s the equivalent of the student who never hands in their essays for feedback; how could they possibly hope to improve?
Fundraising is a skill set and needs practice
Fundraising is a process you manufacture with several steps and is most akin to a sales cycle. I say most akin…it’s literally a sales cycle, where equity in your business is what you’re selling! You’ll need to prep your materials, source and warm your leads, pitch, negotiate and close.
Nailing this process is a co-founder’s most important job. If you fail at this, it’s likely that nothing else will matter. Also, you’ll probably need to do it several times and it’s not going to get easier. In fact, if you become a successful business then the earliest rounds will probably be the easiest you raise (particularly due to tax incentives and angel investors) so they are the logical time to start developing this skill set. Become familiar with the questions you should expect to answer, learn what pitching styles and strategies work in different contexts and for you personally and learn how to build a compelling written and financial case for your business. Aside from helping future fundraising, I promise you’ll develop an even deeper understanding of your own business.
Hopefully, you found the above helpful and inspiring. Don’t be lazy and take the easy money, push yourself to go and pitch those angels and seed funds and find success. I promise you won’t regret it!
One small caveat on the above. Whilst I advocate against a f&f round, I’m not saying absolutely zero f&f cash should be allowed in an angel round. I suggest 2 clear rules:
1 — Investment terms should be set with experienced at-arms-length investors.
2 — The f&f stake shouldn’t be so large that the round’s success is contingent on their involvement.