Right about now, startup founders are probably starting to sweat. The funding faucet had been running full blast for years, but recent shakiness on Wall Street has recently put a whole lot of deals on pause. For early-stage startups on the brink of big funding rounds, the wait can be agonizing, if not altogether fatal.
I know. I’ve been there. We weathered the tech bust of 2000 just as my company was getting off the ground. With traditional funding out of reach, we had to fall back on one of the oldest, and arguably most misunderstood, funding options out there: raising money from family and friends.
It was the best decision we could have made. Of course, this route isn’t for everyone. If you need a huge influx of capital up front, for instance, or if your business idea is especially high risk, then personal relations might not be the best source of funding. But it was instrumental for us as we grew BuildDirect from a local startup into a global company with hundreds of employees. These are a few lessons we learned along the way.
My funding saga starts back in 1999. Amazon was changing the way people shopped, and we wondered if the same online approach would work for home improvement supplies: easy ordering, huge inventory, on-time delivery. The more we explored the idea, the more promising it seemed. We began to approach a few family and friends for startup funds–mostly they were our closest available option.
It turns out that nearly 40% of startups are initially funded this way, though you rarely hear about it in the news. That’s probably because it’s a lot sexier to announce a large investment by a hotshot VC than it is to admit that your parents are backing your startup. According to some recent estimates, checks from friends and family average out at around $23,000 apiece, but that funding adds up to some $60 billion a year all told, more than the total funding from VCs and angel investors combined.
Most of our early investors contributed small amounts—as little as $10,000. But we asked everyone we knew, and it added up. We were able to pool nearly $500,000, which I thought was an incredible amount of money at the time. Of course, all that money came with obligations and lots of soul-searching.
While your intentions may be good as gold, your startup still constitutes a risky investment. For us, it was critical to be transparent about the odds of failure, especially since loved ones had a tendency to look at our efforts through rose-colored glasses. In the end, anywhere from 75–90% of startups end up going belly up, and we were sure to make that possibility crystal clear.
But the truth is, I believed so strongly in my business idea that I couldn’t imagine failing. In fact, I actually felt guilty not inviting my loved ones to join me in what I was convinced would be a huge success. Looking back, I’d say this is a pretty good criteria to use when asking the people you know to fork over their hard-earned savings. Of course, most entrepreneurs are optimists–comes with the territory–but if you feel there’s a fair chance you’ll squander that cash, think twice before asking for it.
As the business started to get off the ground, it slowly (and terrifyingly) dawned on me how much work lay in front of us. Getting something as simple as flooring from the factory into a customer’s hands involved endless middlemen. We needed to engineer a new solution, and it wasn’t going to be cheap.
So we started knocking on doors, again. Colleagues, friends, even employees chipped in with more funds to quite literally keep the lights on. My wife, in a gesture of solidarity I’ll never forget, let me sell our own home to keep the business afloat. These are the raw moments of entrepreneurship nobody warns you about. It was nerve-racking, but I was also supremely motivated–far more so than I would have been had a VC just dropped off a big check and promised to give us a call next quarter.
Disappointing my own family and friends simply wasn’t an option. During the hard times that followed–housing busts, investors getting cold feet and, of course, the Great Recession–the thought of protecting their investments kept me going. Without a doubt, raising money from friends and family made me a better entrepreneur: more resilient, more calculating, more driven.
As the years went by, money from those close to us continued to be our sole source of funding. This was truly a bottom-up effort; in the end, we collected from more than 300 friends, family, and associates.
And our platform was finally booming. We suddenly had more business than we could handle and began to approach big investors, who seemed all too eager to take us to the next level. There was just one problem.
These new investors insisted they be paid out first, and on more preferential terms, not the hundreds of people who’d believed in us from the beginning. This “last money in, first money out” concept is, of course, fairly standard in the venture capital world. But to me it felt like a betrayal of all the backers who had supported us for so much longer. Business priorities dictated one course of action; personal loyalties another.
In the end, we passed on their offer, and on many that followed. Eventually the business had enough momentum that we found an investor who came in on our terms. Interestingly, it was precisely because we had been so loyal to our original backers that this particular firm was convinced we were for real.
When money from friends and family enters the picture, business isn’t just business any longer: It’s personal. That’s something that anyone soliciting funds this way has to come to terms with from the very start. To some, this is a liability. But I’d argue it can also represent a huge advantage. The bottom line is important. Profit is, too. But money from loved ones, used right, can be a chance to build a business that means something more.
Jeff Booth is cofounder and CEO of BuildDirect. Follow him on Twitter @JeffBooth.