How Friends & Family Investors in Venture Capital Become Sacrificial Lambs

Ironically, two investor groups that often suffer at the hands of inexperienced or unscrupulous entrepreneurs are Friends and Family & and Angels.

These two groups typically share three common weaknesses:

  • They ignore that, as the earliest investors in a company, they bear the highest risk of failure.
  • They have limited capital resources for follow on investments and don’t know well enough to ask for pro rata rights (or budget for them if offered); and
  • They are unsophisticated with respect to understanding capitalization tables, dilution math, and market-based financing terms and conditions.

Two distinguishing features that reveal just how unsophisticated these investors really are:

  1. When they speak about price per share as opposed to pre-money value; and
  2. When they get upset about suffering dilution from new capital, revealing they have no money or intention to follow on themselves.

In my view, the most disturbing thing about the relationship between entrepreneurs and these investors is that the former take advantage of the latter—some entrepreneurs will blithely sacrifice their devoted friends and family as collateral damage along their own path to glory.

Organized angel investing organizations bring the benefits of portfolio diversification to small individual venture investors. Nonetheless, many of the syndicates within formal angel investing organizations are managed by part-time or retired businesspeople who do not derive significant income from the organization—in effect, hobbyists with credible resumes but no gas in their tank.

Consequently, some angel investor groups may not be aware of current market pricing or terms for investments, a shortcoming that leads to future challenges, especially if these individuals serve on the company’s board of directors.

While these outcomes are possible, many inexperienced angels and, in particular, F&F financings, are formalized with a poor understanding of the risks of failure and of future capital needs.

“One and done” may work for a small group of gifted investors, but it is not an easy row to hoe.

Go back