Why family money should be avoided

There are examples of wildly successful startups that used money taken from parents, friends and extended family, but this approach is not recommended and to be avoided if at all possible. Beyond the first few thousand dollars that might be gifted to a young entrepreneur, it behooves startups to approach professional channels, either through bank/private loans or angel investors. The most desirable source of capital for your startup is always going to be sales revenue. Sales trump all, and it is important to remember that outside capital for pre-revenue companies is very expensive and often provided under terms that turn out to be onerous later. Many entrepreneurs have lost control of their startup over it.

However, since most startups don’t have the luxury of launching or growing via sales, the next best thing is to bring on experienced angel investors who are not related to you. It is important to be realistic about the damage a founder can do to personal relationships by coaxing family and friends into investing in a startup. If your mother is in her 50s or 60s and of middling resources, she should have as risk-averse a portfolio as possible. Startups don’t qualify.

In addition, the reasons to avoid family money go beyond the highly speculative nature of venture investing. From a purely business perspective, relying on financial backing from family as you start your company will deprive you of the advisory capabilities and critical pushback experienced investors bring to companies. Investor guidance is typically more important in the long-run than the seed capital they bring. Quality backers will keep a startup focused amid the noise and many distractions of building a company. They provide important connections to later-stage funding and offer a laser-like focus on target markets, since such markets, after all, are where the investment returns live.

Most importantly, these early investors/advisors will be able to shoot down bad ideas that can kill a young company. Mom and Dad often won’t.

On a practical level, too much reliance on family funding could scare away follow-on investors. Professionals want to deal with other professionals when growing a startup. A company funded by the founders’ parents raises red flags for two reasons: 1) It brings up the question of why the startup was unable to attract seed capital on the open market and; 2) it brings up the possibility of having to deal with a group of protective family members whose judgment could be clouded by emotion or lack of experience building companies. In other words, angel investors and venture funds often see family controlled startups as a potential pain.



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