Friends and Family Funding and Why I'm Dreading Thanksgiving
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When I was starting a small theater company in NYC with some friends we raised money for our first off-off-broadway ("broadway", "off" & "off-off" are a definition of seating capacity, btw, not geography) show, we turned to friends and family for our funding. This was very much the norm when you were just starting out. Usually these were small amounts, aiming to raise maybe 5-7 thousand dollars total, often even less, all depending on location & run of the show.
Anyway, we raised a few thousand, put on a great show of original one acts from writers and directors in our own company and it was shockingly well received. In the end, we actually managed to turn a few thousand dollars profit, which was less typical. In the meetings we had afterward with what to do with the money, everyone but myself and one other partner were blatantly treating it like a lottery win. A completely unencumbered windfall with which we could just buy beer for a year if we wanted. It was infuriating.
For me, and the other partner (who both left the company due to these and related issues soon after) we felt that while we may not owe that money back to the family that supported us, we at least owed it to them to keep it rolling. Instead, we rented out office space on 42nd street for ~6 months and never did anything more than use it as a storage unit. Most expensive storage unit you could find in the city.
Finally, the time had come to put up our next show, a full-length new work by one of our best writers, and with absolutely 0 compunction 7 of the partners enthusiastically recommended we return to the friends and family well. There was nothing left of our profit and no one cared. After the first show we had enough to mount the second, had we just set it aside for that purpose.
That was my first real experience in small business and unfortunately I was too young and angry to properly learn those lessons at the time. Took me another 8 years to really comprehend what we had done.
Edit: Faulty memory, updated for accuracy.
I do not know the specifics of the 2nd round of begging, but I do know the show they launched had a shorter run in the same theatre, so the amount raised must have been significantly less. They folded entirely very soon after that production closed.
In addition to asking for money from family, I also filed grant applications, and both were treated similarly. None of the people giving had any expectation of a return, but I think they similarly had no expectation that they would ever be asked again, or that we would squander profits as we did.
It doesn't really favor the notion that the startup world is an egalitarian meritocracy.
My wife's family, on the other hand, is solidly upper middle class all around. Her grandfather worked from a Kansas dust bowl Depression childhood to a Harvard MBA and probably several million in net worth. Several of them are "qualified investors" in the legal sense and could angel-fund a startup.
But I won't ask them for a cent, not even take it if it was offered. Why? Because they're family, and not blood family at that. If I took investment money from them and it failed, I would be paying for it in non-financial ways for the rest of my life, and my wife would be paying even worse. Even asking would be a tremendous misstep of the delicate dance of family.
So yeah, even if Grammaw and Uncle Barry have twenty grand to invest doesn't mean there's anything "casual" about it.
It used to be that going to Harvard was largely a measure of whether you had enough money to go to Harvard. In 1950, the acceptance rate at Harvard from elite preparatory schools was almost 90%.
Today, it's an "egalitarian meritocracy." The acceptance rate is around 5-6%. A quarter of students come from families that make below $80k, and 60% of students receive some financial aid. In other words, a household income of $80k, which is top 30% nationwide, puts you at the bottom 25% mark at Harvard. Further, 40% of students apparently come from households making over $180k (the point at which aid phases out), which puts them in the top 5% or so of households nationwide. The statistics at Princeton, Stanford, etc, aren't any different.
People in the start-up world talk about "egalitarian meritocracy" in the same breath as they say they give explicit preference to kids coming out of Stanford, a place where the median person is from the upper middle class. It's true in a purely relative sense. It's very meritocratic compared to how things were historically, and how things still are in many parts of the world.
That is not to say that these institutions could be appreciably more meritocratic by their own efforts. Rather, when talking about whether a field is "meritocratic" you can't ignore the fact that class and income-based sorting takes place at a much earlier stage in the pipeline.
In the UK this was called being of 'good breeding'. It's no more true now than it was back then. Bear in mind that money is also heritable.
Is my logic incorrect? Does merit not correlate with the ability to make money? Is merit not heritable? None of those questions have been answered, but we did get to see some good ad hominem reasoning.
These are interesting academic questions, but I wonder if you'd agree with this - having access to 5MM in no questions asked family funding is more useful than 50 extra IQ points, because you can always hire clever people.
You're using the word "merit" in an impossibly vague and poorly-defined way. You might as well say that having a sweet tattoo is a merit when picking up dudes/ladies, and merit is heritable, therefore sweet tattoos are heritable.
And, again, you're the one making extraordinary claims, so you're the one who needs to provide extraordinary evidence. I would genuinely love to see it.
It's especially true right now, as depression era children have all retired after a lifetime of deeply-ingrained frugal living.
For someone in their 40s, having 20 grand available for such an investment isn't always the result of good fortune. It's a low enough sum that can be attributed merely to frugal living and smart financial decisions. It's easily the difference between packing a lunch instead of eating out every day throughout a career. It's the long term difference between driving used Hondas instead of new Hondas.
I understand there are plenty of people who don't have such choices, but I guarantee there are plenty of individuals here on HN that could squirrel away 20k a year if they really tried. Saving 20k over the next decade is well within the reach of most individuals.
FWIW, 20k is still a big number to me, but not that big and I'm a 20 something that quit my job a few years ago to start my own business. I didn't ask any family or friends for money, instead I saved for 2 years to give myself a > 12 month emergency fund / runway[1]. I can't imagine how people would ask for a loan/gift from family rather than simply live frugally for a year or two.
[1] - my wife and i paid off ~30k in student loans, and saved a ~30k emergency fund in about 22 months making ~80k combined a year. We lived frugally so that I could quit my job and start my own business.
Oh, God, this bullshit again.
When you've got two adults with no kids making 80K a year, "living frugally" and saving money is as easy as falling off a log. Now try doing that on 28K as a single parent, just for example. When you haven't eaten out in a year, clip coupons every day, get all your clothes from Goodwill, and are still only breaking even if everything goes right and the car doesn't break down and no one gets sick, "simply spend less than you make" is about as realistic as "simply grow wings and fly."
And don't try to tell me that that's a tiny minority of the population. In modern America, it's really not.
Let's do some math. Saving 32k a year on 80 grand is not in fact as easy as falling off a log.
80k - (taxes + tithe) = 52k. we saved 32k per year, so that is 2 people living on 20k. Don't tell me it can't be done, I did it.
For single parents making 28k 20 grand is always going to be a lot of money. That's why I said most, not all. As it happens, single parents with 28k in income is not the median, not even close. There are a lot of people making a lot more than that. I was clearly not referring to the people living at the poverty line. FWIW, ~25% of America makes less than 30k[1]. The other 75% is who my comment was directed to. But hey, it's easier to be snarky than to let facts get in the way.
[1] http://en.wikipedia.org/wiki/Household_income_in_the_United_...
People in my extended family go out of their way to help family members when they are down; for instance covering a few college loan payments or providing a bed to sleep on for a few weeks, but going to them for a business loan? That is not done, even with comparably small amounts of money. I kind of always assumed that was the common attitude, but I guess not.
Although it is a weird dichotomy if you think about it. People let parents pay for their college to the tune of $100k+ and don't feel any obligation to justify or defend the investment.
Financing someone's business is much more of a mercenary decision; "do you run your own business" isn't really a social class marker in the way "did you go to college" is. It's strictly for the money (or for some, a kind of consumption in the form of a "hobby business" that doesn't actually make money).
The logic of Romney's positin on borrowing is that it is <market efficient>. That is to say, the parent has more information on the borrower than a bank, and therefore is in a better position to measure risk and avoid the typical market failures that correlate with the type of non-stochastic uncertainty that cling to first-time founders with no track record[2]. Your parents have much lower information gathering costs and monitoring costs than a bank, in other words. Also, since the return on the investment can be higher than what that money would otherwise get in a normal debt investment, the idea would be a win/win also in theory for the parents. This is, even with a true debt structure (ie, repayment with interest) which is again different from the way many parents 'pay' for college.
[1] Gifts over 10k are taxable.
[2] This is not technology risk, which is a different ball of wax. This is the risk that would keep a bank lending you money for a low-tech business, like a lemonade stand.
I can't fund any ordinary circumstance under which a gift would be taxable to the recipient.
http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Empl...
The annual exclusion is $14k per donor per recipient. So a married couple can give at least $84k per year to their three kids (total). But in practice, that's not the relevant limit. Amounts over $14k per donor per recipient per year count against the lifetime exemption, and are only taxed once that exemption is exceeded. Currently, that exemption is over $5 million.
Its true that tuition paid directly to schools is not taxable, independent of any annual or lifetime exemptions, but the high lifetime exemption virtually assures that nobody who isn't extremely rich will ever hit the gift tax even with direct cash gifts.
and once you pass $5M, it is simple enough to set up a trust or corporation to give the child control of the funds.
http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Empl...
It turns out there is also, this:
Beginning January 1, 2011, estates of decedents survived by a spouse may elect to pass any of the decedent’s unused exemption to the surviving spouse
Why would you believe that parents who would selflessly spend $100k+ on college without expecting any personal monetary ROI wouldn't offer money on the same terms for their kid to start a business?
In either case you're buying experiences and trying to create opportunities for your kid. Even from a purely educational perspective, launching a business can be far more educational than lots of college programs.
Haven't delivered an exit after two years?!? What's wrong with you?!?
Sarcasm aside, while taking money from friends and family may not always be desirable for a variety of good reasons, the problems that arise from it are usually the result of unrealistic expectations.
Most companies never achieve an "exit", the average time to a liquidity event for companies that do is well more than a couple of years and most liquidity events don't produce Hamptons money for everyone involved.
If you have raised capital from friends and family and are sweating bullets after two years because you haven't made yourself and your investors wealthy, the expectations you set for yourself and your investors were way, way off.
;)
[] In a case like this, buying out the founder's mother is less of a red-flag than buying out the Angel investor.
Most of my investors were well meaning. And, their expectations were often set by what they read in the media. I had one investor dream that he was a millionaire, and was initially very upset when we sold for a lower valuation than his investment valuation, and did not understand why he was not receiving all of the purchase funds rather than an amount based on his ownership share. There was a generally poor understanding of investment and this was hard to explain to a friend. Angels, supposedly, know that they will probably lose their entire investment, while F&F almost never think that, nor can they afford to.
Of course there are pros and cons of each type of investor.
The thing that would have me hold off from taking investment from friends & family would be that they often cannot to bring anything other than money to the table. If you read about Ron Conway, for example, you'll see he brings money and his whole being (connections, advocacy, etc.) when he invests. This is a big deal. F&F investors intend to do this, but they are as different in this way from "real" investors as growth hackers are from government workers. They don't know how to build businesses, and don't have much other than more opinions, generally.
And, if you have a family member that does not fit this bill, then by all means, take them as an investor.
FWIW I've been bootstrapping my startup for the past year and we're finally making a profit.
That's easily a year's runway for yourself, or half a year with a cofounder.
Proof: Nearly every large (and many/most small!) business in the world started with a loan or investment.
Seven: this rule is so underrated Keep your family and business completely seperated Money and blood don't mix like two dicks and no bitch Find yourself in serious shit
I'm constantly bugged by the level of privilege amongst the startup crowd. Not even just being able to borrow from family, but being able to rely on them, or friends as something to fallback on when it all goes wrong.
There are a lot who seem to be seeking investment and I really don't get it. If your idea needs money then go make money... or don't be so selfish and take the risk and illuminate someone who does have the money. (hint, how dare you ever complain about patents when this is your attitude)
For me not having money rules things out. Borrowing that money to take a risk /is stupid/ it just is - even if it pays off - success is nothing to do with intelligence, sensibility or even doing anything right necessarily. I simply never enter into such an arrangement, nor does the thought realistically warrant consideration - I might lose my home and the few meagre possessions I have - along with an enjoyable lifestyle - if I screw up.
Having done both, I find there's a level of engineering growth that you miss out of by doing freelance work. Most freelance work won't involve supporting millions of requests a day. There's value in that exposure.
If it is just enough to cover your operating expenses plus a small surplus, it will be very easy to fall into the trap of doing consulting and then creating the product "on the side".
>I’m confident I will (deliver an exit) - I bust my ass every day - but I haven’t yet.
That confident are we?
... but maybe you should consider scaling your expectations.
When I started my small business, even with customers in the queue, I didn't have the heart to ask him or anyone else in my family for funding.
I remember hearing stories about 'Patels' who came to the USA. The small but robust tribes of Indian(not Native American) families in each community would then each fork over $1000 to the new family for the purpose of starting a business(hotel or convenient store). One of the older families would then coordinate payments and ensure the new family made payments back to the loaners. It was a zero interest loan.
I'd rather eat macaroni and eat canned food for a month than consider asking mom and dad for money.
All that's required is that your family know you're in the throes of starting a company and suddenly you'll get lots of questions some perhaps hard to answer.
And then there are hard questions: Am I going to get my money back?
Don't raise a bunch of money from a crazy person with unrealistic expectations. Don't fund a business you don't understand. Don't invest money you can't afford to lose. Don't do business with people whose character you can't count on in good times and bad.
Now, obviously you need to not let your emotions blind your judgement so you can actually follow these rules, but that's always true, whether or not its family. And there's a very good reason to consider family deals: you have deep insight into the psyches of the people involved. (Or if you don't, you're probably not cut out for this kind of investing in the first place.)
I have a lot of friends and family I would never do business with, because they don't fit the criteria. But I also have people I would fund in a heartbeat, and I've done it happily.
If you're the investor, it comes down to accurately judging yourself. Can you really put relationships ahead of money?
If you're the startup, you need to judge the investor by that standard. Are they truly mature enough (and wealthy enough) to honestly not give a fuck about that money if they never see it again?
Best decision I ever made.
-adam (6 startups, 3 IPOs, #7 on the way, bbfdirect.com, ask me about killer snacks for your office)
I have no idea what business he's in, after reading the article.
Busting your ass isn't going to make a bad idea any better. I took a look at your lobster schtick and think you need to go back to the drawing board.
Startups come and startups go, but family you will always have (unless you blow all their money in a failed startup)
This is a very bad idea.