A couple of months ago, I found my jaw hitting the floor during a start-up pitch. The founder of an early-stage B2C startup revealed that he had previously raised a family and friends’ round of the princely sum of 5+ crores (~$900k). That capital was exhausted in less than 18 months; the monthly burn was over 50L per month with a double-digit staff strength. All this effort was delivered less than 25 lakhs in sales – since inception!
Runaway spending, low traction, running out of cash are situations that I regularly encounter as an early-stage investor. What worried me was the lack of oversight the family and friends had on how the founder invested their capital and their lack of experience steering the founder from avoidable expenses.
For example, precious and expensive capital found itself funneled into:
- A massive PR & Branding campaign which wasn’t delivery but continued to burn a hole every month
- Lobbying for international “paid awards” that cost a bomb but did not deliver results.
- Massive allocation on R&D, but it was a ruse. The money got spent on traveling to different countries to find manufacturers to white label their products to the company I have seen others do it at 1/10th the cost & time
I cannot hold the founding team entirely at fault here too – part of the blame should be on the investor class. They infused excess capital into the business, thereby encouraging the founder to burn the money on things that don’t matter, ultimately setting up things to fail. My presentation of these entrepreneurial misadventures is not an attempt to rub salt on the wounds of the family and friends’ investors or the founders. I want to point out something fundamental. Except for unusual situations* family and friends must limit the amount of capital they commit to an entrepreneur.
Leave the larger rounds of capital to the professionals.
Not only will it save capital for generous family and friends, but it will also save founders from committing hara-kiri with their startup ambitions. If this were a one-off situation, I would not have written about it, but I am witnessing a marked increase in the number of ventures backed by family and friends and coming to us for a seed round. We like family and friends supported investments because it shows that those closest to the founder also believe in them, but like healthy foods – too much green can be injurious to health.
Most of the time, family and friends judiciously put in a small amount of capital, just enough to get the venture started. However, there were many examples where family & friends have drowned a lean start-up culture with a deluge of capital – killing the enterprise and blowing away the capital.
So, the obvious question that arises is, how much should a family or friend commit to an entrepreneurial family member or friend? The good news is that a family or friend need not look too far.
The best accelerator programs in the world, i.e., Y-Combinator or TechStars, commit $150,000 (~₹1 crore) for a 7-10% equity stake in pre-seed ventures. Similar programs in India like 100x.vc, Indian Angel Network accelerator, or VentureNursery (in the past) invested between 25-75 lakhs for a similar equity position.
All the branded investors mentioned above have many good and bad investments; therefore, with their experience, they can guide founders on promoting the right and shunning wrong behaviors in their start-ups. So, for inexperienced family and friends’ teams, the correct amount of capital would be between 50% to 75% of what these guys invest, i.e. anything in 40-75 lakh range.
Family and friends can decide where to invest in this range based on the domicile of the venture but ensuring that the founder has 6-9 months to find a professional investor while they continue to grow their start-up. It is the founders’ responsibility to consistently update their investors whether things are going well (or not). Developing this habit is vital but critical in case things are going well, but finding a professional investor is taking time. Family and friends could opt to put in some more capital IF they are comfortable with the start-up’s progress and are objectively taking the additional risk.
However, the family & friends' capital tap must end at that.* While It is still advisable to leave the more giant cheques to a professional but in certain situations, it makes sense for a more significant allocation from family and friends. These are exceptional situations, not the norm.
- If the family and/or friends have in-depth domain knowledge and are objectively backing one of their own
- In Meditech or Healthtech like start-ups that require more massive upfront investments and the family and friends’ investors have in-depth domain knowledge
