For many businesses and startups, the earliest efforts and operations are financed via pre-seed capital.
Which is to say, the fruits of a friends & family round.
There are pros and cons to going this route. On one hand, winning the support and trust of those closest to you and bringing them in on the ground floor of a hopefully profitable new business can be gratifying on many levels. On the other, skipping a friends & family round can immediately put your venture in front of expert, accredited investors—an experience which can often prove invaluable as you strive to accurately gauge your true viability and potential.
Is an F&F round of funding the right choice for your enterprise?
The following concise-yet-comprehensive guide can help you answer that foundational question.
What Pre-Seed Can Mean
Whereas a company’s seed funding is meant to nurture its early stages of business growth, the financing that comes before it—pre-seed—generally covers startup costs.
And although some founders view raising a friends & family round as a rite of passage for covering startup costs—especially for their earliest business ventures—the truth is it’s not necessary in many scenarios.
After all, plenty of entrepreneurs self-fund their companies, take out commercial business loans, or bootstrap their startup phase on other income. Doing so provides founders runway to build up the kind of traction, revenue, or performance data they may require to either satisfy the expectations of return-seeking seed investors or scale organically as revenue grows.
Yes, relying only on personal capital allows founders to retain full ownership and control. It also places them at high risk of debt or bankruptcy if the business fails. Of course, getting friends and family involved simply passes some of that financial risk on to a founder's personal connections—creating additional considerations for entrepreneurs.
Funding for Understanding
When founders bootstrap or otherwise cover startup costs without friends & family financing, they can move to formal seed round with a clear, defined understanding of the role seed capital will play in the company’s future.
As we’ll discuss below, that can often be a smart way to go: When no expert investors are financially staked into the business’ success, there’s often a lack of third-party feedback to lessen the failure risks for entrepreneurs.
In other instances, an F&F round can provide the gap funding necessary to get the business off the ground—provided the founders have kin that welcome both the investment opportunity and the risks involved.
Making Business of Relationships
F&F funding can either take the form of equity—in which you give up a small percentage of your company’s future success—or low- to no-interest debt. In either case, no matter how much your F&F investors believe in you, the key danger is clear: Should your venture fail, you risk losing the trust of your closest connections.
Further, once you’ve convinced your closest connections to believe in you, they may expect to contribute to the business strategy and decision-making. If they lack technical or specialized knowledge, you may not welcome that input or find it useful.
That last issue—i.e., the knowledge gap of one’s earliest investors—can be damaging, especially to a niche-market company.
“Raising cash by leaning on people’s love and respect for you personally rather than belief in your business can skip important checks on your business model and how it scales, your traction to date, maybe even your ability as an entrepreneur,” writes Stasher Co-Founder Anthony Collias. “This can have catastrophic outcomes when these checks should have surfaced serious issues.”
Raising to Win
Fundraising is ultimately one of many tools in a founder’s arsenal for driving business success. As Collias points out, it’s a strategy that should elucidate both the strengths and weaknesses you can hone in on and the areas in which you can positively evolve and improve your business.
Starting that process pre-seed can have advantages. Even if a founder fails to secure financing from institutional investors—and must pursue F&F for more runway—seeking out institutional funding can provide common-sense checks as to whether the venture is even interesting to investors.
Ultimately, who’s involved in your startup or business matters. Securing institutional funding at any stage can help you gain introductions to clients or experts, building up your credentials in the eyes of industry peers.
That said, plenty of entrepreneurs have clients, experts, and peers in their friends & family network that can help solidify the business as well.
So should you go the F&F funding route? It ultimately depends on your unique business concerns, the character and temperament of your loved ones, and how your pre-seed startup capital will help you build the foundation for growth. Remember, you have options—and it’s important to recognize that and explore each path at your disposal fully before charging forward to make your dreams and reality and success.