Friends & Family are a Common Source of Business Financing

I wrote a few blog entries recently about how difficult it can be to raise startup capital, or raise money to make a business acquisition.  Although fraught with obvious drawbacks, the friends & family network (I’ll just call it the F&F) is often employed to raise money.

I’ve talked to venture capitalists that even say, “has the company done its F&F round yet”?  They want to see that an entrepreneur is willing to take money (and risk losing it) from his Dad, nephew or good friend.  In fact, I’ve done two raw startups in my life where I did indeed do an F&F round to get it started.  In one the F&F investors did very well, and in the other they lost all their money.  Sorry, Dad, about that classroom scoring device idea.

When raising F&F capital, it is extremely important to manage expectations, and to me that means telling the F&F network that there is a very good chance that you will lose all their money.  Tell them that frequently.  In fact, I refused to take money from my sister because she didn’t have much money at the time and I didn’t want to lose it.  Unfortunately, that was the venture that made lots of money.

As business broker I have to qualify buyers, and that means finding out whether they can afford the business.  It is pretty common to find that buyers plan to use F&F funds to do the business purchase, and it is important for us to actually get the F&F involved from the start, because often that source of funds isn’t as solid as the buyer thinks it is.  In other words, they often believe Dad will put up the money and will happily progress down the time-consuming process of buying a business, but in the end Dad doesn’t think it is a very good idea after all.

I’m not saying it doesn’t happen, only that Dad (or the F&F network) has to be involved in the process or I as the broker will recommend to the seller that they not invest the time in negotiating with this buyer.

I sold a business in 2006 that was actually initiated by a father for his two sons.  Dad did all the negotiating, funding and arranging of financing, and his sons now run the business.  I’ve kept track of this business and it is thriving.  The sons are doing a terrific job of growing the business, and Dad is still active in looking around to see if they might buy another company to add to that one.