There may come a time in a founder’s journey when he or she must admit the financial resources have been tapped out. Of course, there is no shame in this as many startups would not be able to get very far without the help of outside investors. After weighing the risks involved, that founder may decide securing funding from an outside source is, indeed, the best recourse. While this is a potentially risky move for an entrepreneur, investors also face the risk of uncertainty when it comes to investing in a startup. Investors can come in the form of friends and family, angel investors, or venture capitalists. Each of these types of investors stands to lose money if they do not chose wisely. One wrong investment could prove to be catastrophic.
A lot of entrepreneurs turn to their friends an family as a means to raise money for their venture. On the surface, this seems to be the less risky option. These investors are more accessible, because founders “have frequent contact, long-term trusting relationships, and an emotional connection” with them (Wasserman, 2012.) There is much less pressure involved and a lot less leg-work to get funded in this manner. However, this type of arrangement can have a bleak outcome. Alicia Syrett, Founder and CEO of Pantegrion Capital, cautions against this practice citing “ they may be unsophisticated investors,” meaning “they may not know how to negotiate fair,” “the lines between your work and family relationships may become blurred,” and “you may not want the stress of letting your loved ones down” (Syrett, 2017.)
The next option for an investment is an angel investor. While angel investors are tougher to sell than friends a family, getting funding from an angel investor is easier than getting it from a venture capitalist. However, according to author, Murray Newlands of startupgrind.com, using an angel investor can have a few cons. For instance, angel investors usually have “higher expectations,” “you hand equity over in your business as a portion of the deal,” and they rarely take a “hands off approach” when making an investment (“Pros and Cons of Using an Angel Investor to Fund a Startup.”) While this may sound risky for the founder, these things are good for the angel investor, although those benefits do not come without risks. “Early stage investing is inherently risky;” furthermore, “high-level risks,” such as “financing risk, technical risk, and market risk” are prominent and should be in the forethoughts of every angel investor (“Key Risks of Angel Investing.”)
When all else fails, a founder may be able to secure an investment from a venture capitalist. Venture capitalists “focus on investing in high-potential startups” (Wasserman, 2012. ) There are not as many risks for venture capitalists as compared to other investor; still, there are potential risks. Some venture capitalist firms are funded by outside resources. When one of these firms make a failed investment into a startup, it causes a ripple effect to those who invested at the time. So, while the risks are not as great, there are still some hazards involved in this type of investing.
When a startup is successful, all parties involved reap the benefits. When it fails, the loss can be felt by founder and investors alike. Not only should entrepreneurs choose wisely when it comes to investors, those investors should also weigh their options as well.
“Key Risks of Angel Investing.” Angel Investing Returns – A Guide to Exits for Angel Investors | Seraf-Investor.com, seraf-investor.com/compass/article/key-risks-angel-investing.
“Pros and Cons of Using an Angel Investor to Fund a Startup.” Startup Grind, http://www.startupgrind.com/blog/pros-and-cons-of-using-an-angel-investor-to-fund-a-startup/.
Syrett, Alicia. “What You Need to Know Before Letting Friends and Family Invest in Your Company.” Inc.com, Inc., 8 June 2017, www.inc.com/alicia-syrett/what-you-need-to-know-before-letting-friends-and-family-invest-in-your-company.html.
Wasserman, Noam. The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup. Princeton, N.J: Princeton University Press, 2012. Print
3 replies on “Taking Risks: The Investor’s Side”
Good read! You did such a great job defining the types of investors so that your audience would be better able to understand your discussion. I also like how you brought in several outside resources on Angel Investing and Friends/Family which gave your audience a lot of background information. If I had to choose, I would prefer a venture capitalist over friends and family. Each type of investor group poses benefits and risks, however, the VCs seem to provide more value to the startup in the long run.
Wish you the best with everything!
Tanaya D. Jackson
While I do agree that using family and friends as investors seems like an option without risk, it does have the potential to become detrimental to your relationships. In my opinion, the angel investor would probably be the least risky. The investor may want to have a hands on approach, but they may also offer insight that could improve the business.
I agree 100%!