The perils of raising money from family and friends (Oversubscribed Weekly #34)

August 15, 2019 by Max

Max here. Today we’re responding to some reader email, so let’s dive right in!

Julian Luca of TRAVA Travel, asks: “If the investment landscape is unclear to me, then it would be even more unclear for the family and friends that people are seeking to raise from.” What’s your take on raising money from family and friends?

We discuss friends and family in our book, but only very briefly. The book doesn’t really do anything more than mention them as a possible funding source, clarify that they have to be rich to be accredited investors, and disclaim that it’s very possible to close a successful round without any investment from friends or family.

I told Julian that I recommend avoiding raising from family and friends entirely unless at least one of the following two conditions apply:

  1. The family member/friend is already somewhat familiar with the startup ecosystem and understands, at least in a loose sense, how startup investing works.
  2. You’re incredibly desperate and have explored all other options, and your startup will fail if you don’t take their money.

Otherwise, the risk of the investor losing their money, and that harming your relationship with them, is usually too great to be worth it.

I’m talking specifically here about close family and friends who wouldn’t normally invest in startups. People who are more familiar with startups are fine: for example, in my angel round, we got $50k from the father of a guy one of my cofounders had known in college. But that man had made a couple other startup investments before, so although he wasn’t the most experienced investor, he wasn’t brand new to the game either.

If you do take money from family and friends, I would describe the investment as a lottery ticket and make sure they are completely comfortable with the likely outcome of losing all their money. I would be very explicit about this, and literally say something like, “95% of all early-stage startup investments result in the investor losing all of the money they put in. Before I take your money, I want to make sure you’re comfortable with those odds.”

I might also add that even in the worst-case scenario, they’d still be helping you make a run at your dream, a motivation that’s more likely to be meaningful to someone you have a close personal relationship with.

Unlike with a normal investor, you do not want to try to convince family and friends that your company is a “good” investment. Real investors understand that even a good investment has an incredibly high likelihood of failure, but friends and family may not have this context and could easily end up feeling misled.

Especially now, with so many angel investors and other sources of capital out there, it’s easier than ever to avoid taking money from family and friends. But if you do want to do so, be extremely careful not to damage your relationships. It’s rarely worth it.

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