Why you should avoid funding from friends, family or yourself

beos

Millions of words have been written about fund raising for startups. So why am I adding to them? Because the received wisdom is that the place to start is with “friends and family” money. And I beg to differ with that wisdom. I’ve been told on more than one occasion that VCs in particular, but angels as well, respect founders who put their own money into their startups.

I’m a faithful reader of Monday Note , Jean-Louis Gassée’s weekly email newsletter.  Jean-Louis was an executive at Apple Computer and after leaving Apple he did his own startup, Be Inc. Be were developers of BeOS, originally developed to run on BeBox hardware. I never met Jean-Louis, but he was kind enough to send me a personal, hand written note when I applied for a job at Apple (though I never even got an interview). His latest post 50 Years In Tech Part 15. Be: From Concept To Near Deathabout starting Be, Inc., has some words of wisdom for founders seeking to raise money. Here’s one quote (Steve Sakoman was Jean-Louise partner.)

Early demos impressed visitors to Sakoman’s clean room, so much so that an early investor friend wrote a second check on the trunk of his rental car at the end of his visit. (I’ll write a separate Monday Note on the Don’ts of my dangerously naive fund raising efforts. In short: Skip Friends and Family, go for cynical Deep Pocketed Pros.)

And Jean-Louis held the very common prejudice against institutional investors:

I also told Sakoman I’d fund the project, perhaps with friends’ help so as not to fall prey to Vulture Capitalists. This proved severely misguided and almost lethal.

While we have to wait until next Monday to find out more about Jean-Louis’s funding efforts, here’s a few points about friends and family funding;

  • Funding from institutional investors, be they VCs or corporate venture funds, sends a strong credibility signal to potential customers and other investors. Funding from Friends and Family (FAFs) sends exactly the opposite signal.
  • Even worse than FAF funding is putting your own money into your venture. While I was trained that this was a mistake, I did run into numerous investors who told me that putting your own money in meant you had skin in the game. Don’t believe them! I made this mistake not once but twice! Those stories will be told in future posts.
  • Unless your friends and family are successful serial entrepreneurs or professional investors, don’t go to them for money. Not only can they not add any value to your venture, they may turn into back seat drivers. Worse yet, if your venture fails they will lose all their money, which can damage or even kill a friendship and hurt family relationships.
  • Raising capital should have one purpose: to grow your company. You need to build your product out of blood, sweat and tears – which far exceeds “having skin in the game.”
  • The best funding is customer revenue. Bootstrapping beats fund raising as the use of your valuable time – the only resource a founder has – though it lacks the glamour of raising money from wellknown angels or VCs. Better yet, if you successfully bootstrap your venture the odds are good that the angels and VCs will come to you, eager to invest. You then have leverage, which helps greatly in negotiating an investment.
  • Great VCs can be great partners. But as I’ve written previously, the VC way is the superhighway. If you aren’t prepared for the extreme measures needed to gain growth at virtually any cost then institutional funding is not for you. And be prepared to give up control, as is usual when companies raise multiple rounds to fund hyper growth and founders get diluted.

Jean-Louis wanted to sell BeOS to Apple, which badly needed a successor to the MacOS, but as those who follow Apple history know Apple bought Next, Steve Jobs’ company and got Steve Jobs along with a new OS. Jean-Louis ended up selling Be, Inc. to Palm, yet another extinct company.

Of course, there are exceptions to every rule of entrepreneurship and you may have very wealthy friends or family who are happy to support your vemtire and won’t bat an eye if you end up losing all their money. And if you are simply using FAF funds as a bridge loan between where you are and a term sheet and eventual funding from angels or VCs that’s a different story than trying to fund product development with FAF funds.

We will hear more from Jean-Louis about how he got Be funded and what happened to his startup. Which by the way, violates another one of my startup heuristics: build hardware or build software, but don’t try to take on both. It  will sap all your resources as you face divided yor priorities. Both Steve Jobs Next and Jean-Louis’ Be, Inc. both made this classic mistake.

Author: Mentorphile

Mentor, coach, and advisor to entrepreneurs, small businesses, and non-profit organizations. General manager with significant experience in both for-profit and non-profit organizations. Focus on media and information. On founding team of four venture-backed companies. Currently Chairman of Popsleuth, Inc., maker of the Endorfyn app for keeping fans updated on new stuff from their favorite artists.

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