Why Friends And Family Might Not Be Your Best Investors - Or 
The Case Against Inviting Uncle Mike To Your Cap Table

By Fernando G. Russo, MBA MSF, vice president of investment banking at Young America Capital.  Edited by Sean Santa.

So far, you’ve spent a couple thousand bucks. You built the website, got a desk at WeWork, ordered 1,000 business cards to get the volume discount, and yet struggle to explain the value behind your “cloud-based-AI-powered” spreadsheet, offered for an affordable monthly fee of $12.99.

Day 33 of your Kombucha-fueled adventure and you’re ready to go to market. You quickly discover that companies you email answer less than 3% of your messages, return 2% of your calls, and visit your site only when you pay the PR firm housed three sad glass doors away from you to write about how disruptive your technology is.

Day 71 and you are not hitting the sales targets on your insanely optimistic proformas. Bills start to pile up. Not to mention you quit your job as a finance manager at a fortune 500 company with great benefits. Now, your sleep goes away, you gain weight and in the back of your mind you start to believe this might not be such a great idea after all. This is the moment most entrepreneurs step onto the destruction path. They tell themselves, “I’m strong”, “I will take this company public”, “I can do it”. Sure, you can. It’s not you. It’s your idea: it’s your company that is a bust.

“Ok”, you tell yourself, “to keep this slow-moving train of success going forward, I’ll raise money”. You go online, download a pitch deck template and start on

your presentation. You sign up for a fundraising course on Udemy and pay your niece 20 bucks an hour to help with the PPT of this unicorn in the making.

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You randomly decide to raise $100,000. You call a fraternity brother who is a real estate lawyer, and for dinner and a couple beers, he prepares a draft of a term sheet for you. Yes, a freaking term sheet. An invitation to buy 100,000 shares of your newly formed Delaware C-Corp at a very affordable price of $1 per share.

At lunch, a mix of thanksgiving leftovers and soggy salad, you talk to a guy named Pete who proudly calls himself CEO of a biotech company in which he is the only full-time employee. Pete has been on the destruction path for 16 months now. Like you, he is not even close to the offensively optimistic projections in his investor deck. The soda flavored bath bombs he makes in his garage are not selling. He tells you the bombs are just a proof of concept and he can make money adding soda flavor to anything. Pete adds soda flavor to things and calls it biotechnology and you believe him.

Pete ends up encouraging you and you, him. Pete tells you that he likes and trusts you. As you get back to your desk, you see an email from Pete who explains the need to ask for NDAs before sharing your presentation and that he thinks that your 2.5 million pre-money valuation is low.

Your First Capital Raise

Next Monday you receive another email from Pete in which he shares a list of the most prominent VCs and angel investors in the world, including family offices in Dubai and Monaco. You recognize a good sign from the start-up Gods when, on the list, you find a family office in Monte Carlo with the same Italian last name as your neighbor Tony. You plan to ask him if there might be a connection to this wealthy family 6,000 miles away. Your walk along the destruction path intensifies.

The first 27 emails you send go unanswered. The next day you send another 20. Nothing. Then— suddenly, a reply. An email from an address with the same domain as a very successful VC firm on Sand Hill road. You are anxious and afraid to open it. One deep breath and you click. Your entire 82-day long entrepreneurial life flashes before your eyes. The white Tesla, the mansion in Crescent Park, an invitation to speak at Dreamforce, Burning Man with your new BFF Elon, all of it. Suddenly so real.

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“This message was created automatically by mail delivery software. A message that you sent could not be delivered.” You read these words in disbelief as you realize you misspelled the email address of the lifesaving VC that was going to buy all 100,000 shares.

191 emails later: nothing. Actually, a little bit more than nothing. One conference call with Pete and a potential investor in his “network”, a 76-year old retired doctor in Kenosha who thinks that social media is TV for social purposes. The call ends in a whole lot of confusion. Next, you get a reply from a paranoid crypto millionaire demanding to know who gave you her email address. No one ready to write a check. No one but you. So, you do it.

You write that check to buy shares of your company so you can run payroll for yourself and tell your terrified spouse that things are going well. The destruction path widens. To make things worse, on your way home from “work,” you start to read Tony Robbins. Even the stuff from the 90’s.

Pipe Wrench IPOs

Like always, Christmas dinner is at Uncle Mike’s 5-bedroom cottage located on a hill overlooking a lake. You love Uncle Mike and he loves you. He taught you how to drive and gave you the keys to his 1956 yellow Mustang when you were 17

and desperate to impress. For you, Uncle Mike is like a father. Much cooler than your dad, who is disappointed you didn’t go to law school.

Uncle Mike went after his dreams and he always encouraged you to do the same. Mike made his money fixing frozen pipes during winters. He started right after Vietnam with one pick-up truck and a handful of tools. Then he bought another pick-up truck and hired a guy with a drinking problem named Roy who wore overalls every day of his life. Then he bought more tools and two additional pick-up trucks, he hired four plumbers, and promoted Roy to Vice President. He made money and grew the company the old way. It took him 42 years of hard work to build the largest frozen pipe repair service in Detroit and eventually sell it for a good chunk of change. Now he’s retired and enjoying life fixing old mustangs.

After dinner, you both go sit next to the fireplace, and you tell him about this exciting new company you started. He listens and nods his head at a hypnotic pace. Eventually he mumbles “right, right, aha” and smiles. You feel good telling Uncle Mike. Like you, Uncle Mike is an entrepreneur. He gets it.

Here you confront the misconception fueled by obscene success stories in the start-up world. Uncle Mike never thought about “investors.” He was terrified of asking for a loan. He grew his business with hard work and time. He made a little profit here and there and put it back into the business. He wasn’t desperate. Uncle Mike didn’t dream of an IPO. He did what he knew to be right: he worked. Nothing disruptive about proper pipe wrench handling.

Taking Off

After New Year’s, you sit at your shared desk alone. Half the people you met in the last couple of weeks are not there anymore. The hipster girl tells you that those people “upgraded” to a bigger office in another location. You tell yourself

one day you’ll upgrade too, along with your team of 20 employees all wearing matching hoodies.

You have started to jog along the destruction path and don’t know what is even possible anymore. You keep going forward because that is what Tony Robbins says and you know that you can do it. This— and your 8 clients who agreed to try your technology for free. “8 people subscribing to use my Ai-powered-cloud- based spreadsheet”. “Wow”, you tell yourself. “I think this is happening.”

What’s really taking off are your bills. You blew 1/4 of your IRA and are about to sign a fourth check to buy more shares to run payroll for yourself and the part- time developer you met at a free wine tasting.

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There is also office rent, health insurance, AWS, the PR firm, the coffee mugs, the hoodies, and a decent amount of meals & entertainment expenses mostly in the form of lunch with Pete and investors in his network. Nothing makes sense anymore. You know that your business is a waste of time and money. You know that this was a mistake and that you should’ve stopped a month ago. You consider closing shop and going back to your old job.

While you frantically browse LinkedIn to figure out what happened to your old boss, you come across a Gary Vee video and after 92 seconds of perfectly edited inspiration, you find yourself in tears, and, with more determination than ever, you pick up the phone and call Uncle Mike.

Paving the Destruction Path with Other People’s Money

After 10 minutes on the phone, Uncle Mike says, “Sure Kid, send me the papers and I’ll wire the money tomorrow.” Your first investor. 50k. Uncle Mike’s investment adviser tells him not to do it. His lawyer tells him the subscription agreement looks like it has been written by a mortgage underwriter. Uncle Mike’s

lifetime of business acumen tell him he’ll never get his money back. But he loves you.

Herein lies the most fatal mistake about friends & family rounds. Friends and family do not invest in your company, they invest in you. The term “investing” is far from reasonable here. The money is not for the company, nor the idea, nor the disruptive technology. The money, for them, feels like a loan to you.

You spend some of the money on another 3 months of PR with the giggly Juul obsessed kids down the hall. They happily take your Venmo payment and show you some impressive sales projections for an Instagram campaign. Another Gary-Vee video on LinkedIn and you are more determined than ever. You even hire a full-time developer and call him your CTO. He is good with the website and adds an automatic date function to your disruptive spreadsheet. A completely worthless function which takes him 3 days to code.

You take the remaining money and sign up for an investor conference in Miami which promises to put you in front of prominent Ultra High Net Worth individuals for an affordable $4,000. Add air tickets, hotel, and dinners with Pete who decided to join after you offered to share your room. Pete is broke and filed for bankruptcy 8 days ago. You don’t know that and thank him for bringing a bag of Cherry Coke flavored bath bombs to enjoy after a long day of meeting rich investors who will, without a doubt, give you money.

You up your seed round from 100k to 500k. Your last round was practically oversubscribed if you count Uncle Mike buying most of the shares. The rest snapped up by your cousin Bill, you, your neighbor Tony, and $2,000 from one of your golf buddies. By the way, according to the SEC – Rule 501 of regulation D, the only accredited investor in this whole madness is Uncle Mike. Add a brick on your path marked securities fraud lawsuit in this dark comedy.

You tell yourself that your cap table is impressive. You update your pitch deck and one-pager with manuka honey to reflect your user count increased 75% in the last month. You do not disclose that you went from 8 to 14 free subscribers. You neglect to mention you have never made a single cent in revenue by reminding yourself the word “revenue” is banned by Zuck at Facebook meetings. “User count is what matters, and I am growing like crazy” you tell yourself before a one-on-one with a tanned used-car salesman from Tampa looking to invest in a software company. The meeting goes really well, you end up talking about mustangs. You tell him he will “click” with the other investors in your company. At lunch with Pete you tell him about the $7,500 soft commitment. Your afternoon one-on-one meeting is with a 23-year-old associate from a real VC firm in Mamaroneck, NY.

That meeting doesn’t go well. The finance savvy kid laughs when you ask him to sign an NDA on the spot to take a look at your confidential cap table and your extended 32-page long investor deck full of orange bar charts and fake testimonials that Pete is so good at writing. Even though he refuses to sign the NDA, you walk him through the presentation.

“What are you doing in revenue?” he asks. “And, how much have you raised so far?” You purposely neglect the revenue part of the question and say, “$102,000 from a previous oversubscribed round.” He blinks once and sighs. Then he asks, “Who participated in the round?” You have a flashback to the day when you were about to close shop and with a heavy tone say, “Mostly friends and family.”

The kid taps you on the shoulder, stands up and vanishes into the crowd. Suddenly you think about Uncle Mike, and the now real possibility of telling him that you lost his 50K sends cold drops of sweat down the back of your neck. The path becomes a spiral.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

Lead image by Ilona Szentivanyi. Copyright: Benzinga.

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