Monday, 27 may 2019 | Redacción CEU
Both in order to be launched and to survive, new projects always need funding. One of the most natural steps in the starting up of a business is the search for capital among friends, family and acquaintances. In this way, the entrepreneur's close circle becomes the first reliable source for their projects. However, this accessible and close alternative is not without significant risks. What advantages and disadvantages does the financing mechanism of "Friends, Family & Fools" offer? What could the members of the three Fs expect from this type of investments? How and when should entrepreneurs resort to them?
The first headaches that new entrepreneurs must face are related to where to find enough capital to be able to set up their projects. There are different funding sources: some of them very innovative such as crowdlending or crowdfunding, others more conventional such as bank credit. However, there is always one kind of financing which is easier to win over and persuade: the one that is known as "Friends, Family & Fools".
This alternative model of financing, which is also called 3Fs funding, refers to the individuals who are precisely characterized by being the most accessible and close people to entrepreneurs. Of course, the two first categories are easy to understand, but: What do they mean when they talk about fools?
As family and friends, fools are also inexperienced investors which, unlike them, have a distant relationship with entrepreneurs. They have heard about the idea, either because they have come across a particular entrepreneur on a one-off basis, have some kind of irrelevant relationship with them or share a contact. Therefore, these investors are not guided by emotional issues (like family and friends). They really believe in the project to the point of betting on it with their own money. This type of trust has served as a seed for the birth of new investment alternatives on the Internet.
The different types of financing are proportional to the maturation phase of projects. If they have not taken off yet, they have not started to bear their fruits or, simply, they are just an idea on a paper, entrepreneurs may find in the 3Fs a good tool. Among relatives, friends and acquaintances there might always be an investor who is willing to help take the project to the next level (the management of marketing and advertising campaigns, the taking out of insurance, tax payment, the coverage for travel expenses, the purchase of equipment, etc.). Then, the funding from "Friends, Family and Fools" becomes a powerful instrument to give the first push to a business.
This type of financing has great advantages. First, it is faster and cheaper. As a general rule, these groups do not charge interest or demand a large number of requirements. Second, no investor will trust entrepreneurs more than their immediate surroundings. Most times, the members of the 3Fs may not impose repayment terms, they could even back up the project as sunk costs. Finally, entrepreneurs are independent, so they might have greater freedom when developing their idea.
Although emotional bonds play an important role that facilitates the transfer the transfer of funds, they also sometimes serve as an obstacle. When projects do not work properly or go through a rough patch, entrepreneurs are subject to a greater pressure from their environment. This situation may even lead to a confrontation or conflict. Therefore, they are not only exposed to debts and legal problems, but also to personal consequences. On the other hand, friends, family and inexperienced investors usually do not have a high capital. In other words, their investment might not always be enough to help start a project. Also, it is likely that overconfidence will lead some of these investors to want to be part of the business, reducing thus the freedom that entrepreneurs had fought for on the other hand.
Most of these disadvantages that are found in getting financing from the close circle of relatives and friends could be avoided through a good approach. The fact that investments come from people who are close to the entrepreneurs, does not mean that they do not need to give a good presentation of the project. Entrepreneurs will be able to avoid future misunderstandings and conflicts as long as they are clear about what their project entails, what idea of the future they have and what limits they set. It is important to keep in mind that many of these investors do not have investment experience, so this is simply based on trust.
On the other hand, overconfidence may be counterproductive. When entrepreneurs show their idea to family, friends and acquaintances, they should explain what expectations in relation to their investments they may have (repayment terms, profit sharing, holding, etc.). If entrepreneurs offer a wrong idea to investors, they might be up against a difficult situation in the future. It is also possible that some of these investors want to take part in the company as partners, this decision does not have to be bad or good, although it must respond to a deep reflection. A decision of this magnitude needs to be carefully considered.
The CEU IAM Business School is aware of the fact that the financial sector offers stimulating job opportunities. Both large and small companies need managers with a solid background in finance. That is the reason why we have designed our Executive Master's Degree in Finance. It is a training program that provides a complete perspective of the financial world and that takes into account both the business dimension and that of the banking sector and the world of finance. Ask for further information!