A good read from Forbes.com, written by former VXG client Mitch Free. -Chris Mangum
4/22/2013 @ 4:18PM | Forbes.com
Entrepreneurs: If You Love Your Family, Don’t Let Them Invest in Your Startup
The best case scenario is that all goes well, the business grows in value per your business plan and you make a lot of money for your family and friends. But the truth is, even the best businesses do not grow linearly as planned. It is reported that 3 out every 4 startups will fail. As entrepreneurs we are optimists, we tend to ignore those odds and think we will be the 1 out of 4 that succeeds. However, there is a 75% chance you will lose their money. In order to preserve your relationships with the people that matter to you most, it is important to make sure they are not investing money they can’t afford to lose.
Now, your goal should be to get the business profitable with just the initial investment. But if the business doesn’t go as planned, or even if it goes better than expected and you need capital to scale, the raising of that additional capital could have a negative effect on the initial investors. Ideally, your family and friends would have deep enough pockets to invest more cash if needed, provided they are happy with the progress you made with their initial investment. But if you have to turn to professional investors it can get messy for the family and friends that invested in your dream and believed in you from the start.
Professional investors, if brought on for a second round of funding, will invest with preferred terms that will give them priority and special treatment over your initial investors. This will often be very dilutive to them, as the proceeds from a sale of the business will be preferential to the professional investors. It is important to realize that professional investors are just that, they are professional investors who are in business to make money. They don’t care about your family’s money and these relationships nearly as much as you do. I have seen this scenario play out all too often, resulting in agonizing conversations between an entrepreneur and their friends and family.
If you think your business will require multiple rounds of funding, you may want to consider including a person or firm in your initial round of funding that is a professional investor and has the resources to lead or participate in follow-on rounds. Not only will this investor provide valuable expertise, but they will also help you watch out for the interests of the initial investors since they will also be part of that group.
Mitch Free is an entrepreneur, investor and board member with global experience in technology, manufacturing and aviation.