What is FFF-money and Do You Need Them?
For almost 40% of startups, the key source of seed money is FFF money, money received from friends, family and private investors with no experience in venture business. Non-professional investors are attracted by the potential high return on early investment.
That being said, the easiest way to lose all your money without venture experience is to invest in startups early on.
What should you do if you want to invest but don’t like the idea of taking high risks? Konstantin Sinyushin, co-founder of The Untitled Ventures is here to help.
What is FFF-money and why is it needed?
It’s no secret that the key source of start-up investments is the so-called FFF-money. This is money received by founders from friends, family and conventional “fools” (friends, family & fools). Usually, the last F is what startups are ashamed of, although it only means money from private investors with no experience in venture business. While their investments are sometimes quite successful, they are rarely strategic or coherent.
Every year, about 35–40% of startups receive funding from this source. Even Google in 1997 also started with a $ 1 million investment from the FFF.
Why does a startup need FFF-money? First, they are faster and easier to obtain than from business angels or institutional investors. Second, FFF investors rarely demand a stake in a company or participate in decision-making.
Finally, and most importantly, FFF-money is a vital fuel that is burned before entering the venture pipeline. It is this conveyor belt that should drive the startup through rounds of funds, each of which predicts future growth based on past achievements.
It is more and more difficult to get on the conveyor every year. To begin with, the average seed round volume has nearly doubled in four years, from $ 2 million in 2015 to $ 3.9 million in 2019. Obviously, with an increase in the amount, the requirements of investors also grow: if in 2010 only every tenth startup that received seed investment earned money, then in 2019, among the recipients of seed rounds, 67% of projects already generated revenue.
Thus, only projects with real numbers can now count on sowing from professional investors. And FFF-money is attracted not on achievements, but on emotions. Friends and family show support, and lay investors look at it like Russian roulette or lottery — lucky / unlucky. And startups are increasingly turning to this source: the average size of pre-seed rounds has grown from $ 100,000 in 2010 to $ 1.2 million in 2019.
Since the number of friends and family is always limited, an early-stage start-up should rely on non-professional investors for explosive growth. At least until he managed to accumulate enough results to be interested in early-stage funds investing smart money based on reason and metrics.
Why does “fools” money exist in the market at all? It would seem that looking at more mature and understandable startups in the face of uncertainty is a more obvious strategy, especially for non-experienced investors. However, this segment is dominated by late-stage funds, and it is not easy for private investors to participate.
The market also needs “fools” money. They allow you to significantly increase the number of startups at the top of the venture funnel and contribute to the development of the market as a whole. But, on the other hand, changing economic conditions dictate new rules of the game, where “smart” money has a better chance of success.
In addition, the potential high return on early investment attracts private investors. The universal principle, when reliability for investments conflicts with potential profitability, also works in venture business. At the same time, the risks of such investments often negate the final result.
That is why the easiest way to lose all the money without venture experience is to invest in startups at the FFF stage. But if friends and family are less motivated by material returns, then it is the “fools” money of private investors, which they expect to return, that are at maximum risk. What to do if you want to invest but not take risks?
How to make “smart” money out of “fools” money?
Firstly, for novice investors there is always an option to work with more conservative instruments — bonds and stocks with a low degree of risk. However, against the high liquidity of such investments, investments in early stage startups have the main argument — the potential return can be much higher. However, it will take time, patience and a certain tolerance to risk to wait for those high growth rates.
Another option is to diversify your portfolio and invest in early stage startups with either surplus or profits from more conservative instruments. With such funds and interest in the venture capital economy, you can increase the likelihood of return on investment by using an early stage fund.
The risks of investing through such funds for novice investors are lower than with direct investments. In fact, an investor with no venture experience gains access to the expertise and analytics of the fund, while investing at a stage when the profitability is still potentially high.
Of course, for a startup, the first round from a VC is not a guarantee of success. However, the survival rate of startups that were able to get money from a professional venture fund (and not just FFF money) increases with each round.
