Why the “Friends and Family” Round Needs to Change

I am a true believer in the American Dream — the idea that anyone, regardless of race, social class or birthplace can find success in this great country.

I believe because I’ve witnessed my family’s journey. My dad immigrated to the U.S. from India 50 years ago. He had no job and only $5 in his pocket. The only thing he knew for certain was that a friend was picking him up at the airport.

The day after he arrived, he started knocking on factory doors to see if someone would hire him. Eventually, he found someone willing to take a chance on him. And he threw himself into the job, climbing from entry level to plant manager and then jumping to sales and marketing. 

When he had saved up enough money, he arranged for my mom to join him in the U.S. Her plane took off from India just as Pakistani jets began invading the country. It was one of the last flights out of India before the war began.

Nothing came easy. But through hard work, resilience and determination, my parents realized the American Dream. They became American citizens. They moved into the middle class. They sent their kids to college. And they took care of their family in India.

In theory, the startup ecosystem is supposed to work the same way. Anyone can come up with a great idea, work like crazy to make that idea a reality, build a successful company and reap the rewards. Hard work, creativity and ingenuity get rewarded. 

But in reality, most startups never get off the ground because founders don’t have enough money to launch their companies. 

According to the venture capital (VC) world — which finances much of the startup ecosystem — founders are supposed to launch their companies by asking friends and family for money. In theory, founders should raise anywhere from $50,000 to $150,000 through personal connections. The thinking behind this is if you can’t get your friends and family to believe in your startup, you’ll never get investors or customers to believe in it. In fact, there are many VC firms that won’t invest in startups that haven’t done a friends and family round.

Requiring startups to have a friends and family round creates serious problems. The median income in the U.S. is $68,703, according to the U.S. Census Bureau. And according to one poll, 56% of Americans are living paycheck to paycheck. It’s not realistic to expect most Americans to have a network of people with $150,000 in spare capital.

Just imagine how devastating it is for the average American (let’s call him Gus) to find out he has no shot at pursuing the American Dream.

Gus makes about $69,000 a year. He lives paycheck to paycheck. And he has an amazing idea for a company — but he needs to raise $100,000 to launch his startup.

Gus researches how to raise money to launch a startup. Then he borrows $25,000 through a combination of credit cards and loans to get started and build a minimum viable product. And he reaches out to VCs to see if anyone will back him.

The VCs carefully read through his proposal and pitch deck.

“We love this idea!” they say. “It has the power to disrupt a massive market. You’d be the first mover in this market. Your technology is clearly 10 times better than anything else out there. There’s no way any competitors could catch up to you if you did this. This is obviously the next big thing. We just have one question for you.”

Gus can’t believe his luck. He thinks he’s about to get the money he needs to launch the startup.

“Why haven’t you raised $100,000 from friends and family?” the VCs ask. “We can’t invest in you until you have a friends and family round.”

Gus is devastated. He comes from a poor town in Ohio. Most of his friends can barely afford childcare. They’re still paying off student loans. And his parents don’t even have enough money for retirement.

Gus knows that with a little help, his startup can succeed. He’s tough. He’s determined. He’s smart. He’s been a high achiever his entire life. And his product seems destined to succeed. But VCs won’t back him. Because his family and friends aren’t wealthy.

If you think this sounds un-American, you’re right.  

The wealthiest Americans don’t have a monopoly on the best ideas. But they do have access to capital. The friends and family requirement locks most Americans out of the startup ecosystem. And as a result, the startup universe isn’t a meritocracy. It isn’t the best ideas that rise to the top — it’s the best ideas that happen to have easier access to money that rise to the top.

That’s why Early Investing supports changing the name of the “friends and family round” to the “launch round.” 

This isn’t our idea. And it isn’t going to change attitudes or behavior right away (though it helps that people within the VC community are pushing for this change). 

But words do matter. As people get used to the idea of founders needing launch money — instead of founders begging friends and family for cash — VC behavior will change. Founders will be encouraged to seek out capital from a growing network of groups that fund startup launches. And after they get capital, they’ll likely move on to equity crowdfunding, where investors embrace good ideas and investment opportunities instead of worrying about where the launch money came from. (The VCs will catch on eventually.)

And investors will start embracing good ideas and investment opportunities instead of worrying about where the launch money came from.

Founders will be judged on the merits of their ideas and execution — not on how wealthy their friends are.

And anyone will have the chance to create the next Google, Amazon or Apple.

This change won’t happen overnight. But that’s okay. We’re willing to wait. The American Dream is worth it.