Jon: God. Take it away. Peter. Peter. Peter.
Peter: All right. Thanks for joining us for another episode of the Venture Capital podcast today. We are going to talk about this business proposition, right?
Jon: Not a business proposition about investing in your friends business.
Jon: Have you ever done a full disclaimer? This is not legal advice. This is not financial advice. This is only for investment advice. Investment advice, An investment or financial only for the purposes of entertainment. Basically, in the last week are Reddit, the Entrepreneur Forum. A comment popped up and I thought it might be just kind of like an interesting topic because it's a long that it's technically venture capital to invest in and it's specifically investing in a friend's business.
Jon: Maybe I'll read the first part of the comment or you went to the deep dive. That's why I didn't see the other part. This is my friend has asked me to invest in her business. She has a lot of experience in this sphere and is offering me 50% of the profits that the business makes and to invest 100% of the cost upfront.
Jon: Is that a good idea? So you can go deeper.
Peter: Now we can just keep it at this level.
Jon: Yeah, I just want to keep it this level. Yeah, I didn't need to go deeper, but we've got the link so you can see it below. Yeah, but what are your thoughts, Peter? Like when I saw this, I kind of cringed.
Peter: Why did you cringe?
Jon: So I think the challenge is there are certain market terms that I think whether you're big or small, are kind of best practices. I mean, you don't do it. It'll bite you later. So, for example, about ten years ago, a company that sold modest clothing came and they wanted to get investment. And the investors found out that there was this silent partner who no longer contributed, who did not have a vesting schedule, who had 30 or 40% of the business.
Jon: And the investors claimed that that was a deal breaker for them. They wanted to invest, and I think they were very, very serious. But they didn't want to work because I think not only was going to be an actual cash investment, but they were going to spend a lot of time mentoring the founder. Yeah, because they were going to go into big box stores and they did not want to have almost half of everything.
Jon: They do go to this inactive individual and this person. I think it literally killed the deal. And they know and because the person is like, why are you pushing out of the business? I'm getting screwed. Yeah. And it literally blocked the deal for their friend. So the challenge is like when I see things like this, you know, they're great, but if you get any form of success, it turns into a burden and it creates, I think, negative feeling that it's like, how do you get out of it?
Peter: Yeah, I don't know.
Jon: But then again, you can say a win. The win is a win.
Peter: But I would push back on that because I think there must there must have been a little bit more going on. And I say that because.
Jon: There's always more always two sides.
Peter: Like investors do this all the time, right? Like the seed investor owns, you know, 30% of the business or whatever. And like does the series, they get all grumpy and upset because the seed, you know, invested at a riskier stage and owns a big chunk of the company? Not really. Right. So, I don't know. The problem is when that person is, like, really hamstringing the business.
Peter: Right. And makes it difficult for them to hire more people and so on and so forth, like the things that I see that, like, really kill deals. I mean, maybe it's the fact that they own like 40% of the business that could maybe be part of it, right?
Jon: It was either 40% or it might have been 50%.
Peter: Yeah. See, those those numbers actually do get challenging because there's just not enough equity left to keep the person that's running it day to day incentivized them.
Jon: Which is, I think, a huge problem. Yeah, because I think it let they literally just shut the business down.
Peter: Yeah. Well, in that case then the person was kind of stupid to not, you know, be willing to negotiate or find a reasonable outcome because they ended up owning, you know, 50% a zero. Right.
Jon: But I think a lot of people, they don't have the foresight. Yeah. And then they get into these shootouts and the shootouts happen and it's like.
Peter: A chicken and end up, you know, both dead. Yeah. Yeah. And I it's an interesting point. I think in this example for Reddit. So I guess there's a couple of ways to read it. One is to say, like, they end up owning 50%. The other is to say that they were getting 50% of the profits. So those are two very, very different things, right?
Peter: Like, I could have a 50% profit interest, but either way, I looked at this and I would like immediately was like, there's no way this is a venture deal. Right.
Jon: And it may never be a venture deal.
Peter: Right. But if it's like a pure lifestyle business, like, okay, that can make sense. If I ever the investor, I'd be, like, asking questions around, well, how are profits calculated? Right? Like, what kind of rights do I have? What kind of protections do I have? Right? Like all these things, if I'm going to be running up a bunch of capital, like, you know, how do I know that this person's not just going to plow a ton of expenses into the business and, you know, they're going to pay themselves like a, you know, fat salary and then there's nothing left in profits, right?
Peter: I think that's tricky if they don't actually end up owning equity. And it's just like a profit interest, right? Like, then they can't control things, right? They could end up selling the business and you would get nothing for it. Right. Like, there are a bunch of issues there. I think if I were to do a deal like that, I might do it.
Peter: Maybe more RBF based rights or revenue based financing or it's like, okay, I want I want a cut of royalty is right.
Jon: RPF became popular and Utah and like ten years ago for like a year or two, and then it just disappeared.
Peter: Yeah. Yeah. Although it's been totally, like, institutionalized. There are a lot of very good funds that do RPF.
Jon: I also think it makes a lot of sense for most angels.
Peter: I actually disagree. I don't think it makes a lot of sense for angels. Well, this is why I think it makes a lot of sense for life style businesses backed by angels.
Jon: Okay. Like, I think fair. I mean, I mean, I think the big concern is if you're in a market where you have to grow at all cost, taking anything out of the business that doesn't have to be is a risk is hurtful. Yeah, it hurts. It's you know, it's you know, to get to Mars requires so much rocket fuel.
Peter: Yeah, but if it's a lifestyle business, you don't need that rocket fuel, Right? Like, you can make a ton of sense.
Jon: Yeah. My point is that most it's.
Peter: Effectively a loan.
Jon: Yeah. My point is that most angels have a hard time. Will never get money back out of deals.
Peter: Yeah, but think about how much risk you're taking. You. You know, you're.
Peter: I was talking to an angel investor about this once, and he was like, yeah, Like, we got this other guy that, like, did this RPF. And. And I'm like, This is the best deal ever. Like, this guy is getting paid a pittance on his, like, money. He's taking the exact same risk we are, which is like high degree of likelihood this company fails.
Peter: The only difference is he's going to get like, 5% of his money back. Right. If it fails, and we'll get zero. But even then, like, we probably, you know, we might get even more. You might even get that 5% back because, you know, we sit on the preferred stack. So. Yeah, I don't know. Feels like a lot of risk for and potentially not a huge outcome on the back end if you're really swinging for the fences.
Peter: Drives their risk up.
Jon: For entertainment purposes. Would you invest in a friend's business?
Jon: Okay. What. What would be the advice for entertainment purposes would you be giving to others if they wanted to invest in friends businesses?
Peter: Write a check and don't expect anything back. Go away when they lose it. Yeah, like I'll.
Jon: Make sure there's an actual contract.
Peter: Well, yes. Make sure you're actually buying an asset.
Peter: Right. Do your diligence. but, yeah, look, I mean, I think, you know, I've. I've. I've invested personally in a few friends businesses, and, you know, I never invest enough that will fundamentally change my life if I lost it. Right. It's kind of like, well, that sucks.
Jon: Have you been paid off of any of those yet?
Peter: No, I Yeah, I've been.
Peter: They're all early so they got, you know, but they're all doing well. They're also growing and performing. So I've invested my time and been rewarded and paid off for that.
Jon: So invest your time in a lot of places.
Peter: This is true pride to me. I don't.
Peter: I. I just love it so much.
Jon: All right. What other advice you have for investing in your friend's business? I mean, my number one is don't invest more than you're willing to lose and you should never assume you'll never get it back. So usually, like, if I do do a deal. Yeah, it's more ultimately, hey, I won't help this person out. I don't really care what the terms are.
Jon: Hey, here's a way to kind of.
Peter: Yeah, but the other side of it is like the investments I've made. I've also made in companies that I'm excited about. Right.
Jon: Like you're also writing much bigger checks than me.
Peter: Yeah, maybe. Maybe not. But either way, like, I kind of look at it as, yeah, maybe I'm helping him out. But like, I also am a believer here. Right? Because I've had other friends that are like, Hey, I'm raising money and I'm like, Yeah, well, good luck. Okay, Just because you're my friend doesn't mean I'm going to write a check through.
Jon: I think you've got to get close knit group, close a close knit group of friends.
Peter: This is different, but I don't know. I still have to have conviction around the deal. Otherwise, I don't know, like giving people money, in my opinion, doesn't always solve problems. You got to solve your problems first and then raise money.
Peter: More money. More problems.
Jon: All right, well, sounds good.
Peter: Well, what do you think?
Jon: What do I think? I would generally avoid it. I think it creates too many issues. And it's hard. It's hard to give money and not have expectations in return. So even if you think you're in a good spot, at some point, you're probably going to be in a crunch.
Peter: And you're like, Hey, I really need that that money I gave you.
Jon: And then when they're not willing to return it, that's going to create negative animosity. So the cost, I think, ultimately is higher. It's almost better to give to two friends or family as a gift. Yeah. Not that you should be given as as that.
Peter: But I think I don't know. Maybe. Maybe the difference for me, though, is because this is what I do for a living. I have a like a very different.
Peter: Approach and perspective on that money. Like, I don't view it as a loan. Like, I'm never once I write that check. I'm I know I'm never going to go back to them and ask for it back.
Jon: But I think that would make you unique.
Peter: Yeah, I know. That's kind of what I'm saying. I'm like, I kind of have a unique perspective on it because it's what I do.
Jon: My my advice is, if you give some money, there's a chance that you will never see that person again.
Peter: That something will go and never see that person.
Jon: It is the risk worth it? Because it's I think it's hard to give someone substantial cash, whatever that is, to whether it's 2000 and or whether it's 20,000.
Peter: And then what happens if they blow it and then they feel embarrassed and never want to come back.
Jon: Or like you see them go skiing? Yeah, like that's part of it. They could be. That's actually a really interesting point. A buddy that goes was talking about that.
Jon: Where the entrepreneur just disappeared. It's so much guilt. Every now, every now and then you see this. We're like, this entrepreneur will literally just disappear. Move ten states away. And it's just like I've always assumed it's just immense guilt that they're dealing with.
Peter: Yeah, well, I mean, it kind of makes sense, right? Like, if I. If I. If I invested money into a company and it failed, and I didn't have this professional, like, outlook on it, I would be kind of pissed if I saw I'm, like, out skiing and living the good life, and I'm like, What the heck, man? Like, I'd rather money I gave you.
Peter: And you've, like, lost it all. And now, like, things are on the rise for you, but like.
Jon: You're skiing and vail.
Peter: You know, you're skiing in Vail and here I am, like.
Jon: And I gave you two grand. Yeah, ten.
Peter: Grand, maybe ten grand. And you lost it.
Jon: That trip was ten grand.
Peter: Yeah. Yeah. Now, I don't know. People get super emotional about money stuff.
Peter: And. Yeah, I can. I don't know. For me, I guess. I guess at the end of the day, you got to just know yourself, right? Like, if you can honestly, like, write that check and be like, it's gone.
Jon: But I think that's right.
Peter: Then go for it. But if you're not and you're going to be emotionally tied to it, then probably not.
Jon: I mean, I think here's the flip side. Let's say you're receiving money from friends now. Like that will change your life. You need to recognize that if you go skiing to Vail, you know they are going to judge you. You will be judged. And is it is that worth it? Yeah. If you buy the Mercedes. Yeah. And you haven't paid them back, you will be judged.
Peter: Yeah. Like now 100%. Like, you know, I have family members where one family member lent the other family member some money, and then they sent that family member back a Christmas gift and accidentally left the receipt for a large purchase that they had made or box. And the family member was pissed because they were like, What? You haven't paid me back yet.
Peter: You went and bought this, like, really expensive thing. Right. And yeah, it definitely, like, strained the relationship. Whereas, like, if they had not known, they wouldn't have cared. Right. Because, like, they're still making the payments on time and blah, blah, blah.
Jon: But I think that was one of the lessons that Jon Richards taught me, is that. So again, he was talking about the relationship between employees and the founder when the employees are taking below market rates. Yeah. If the founder then goes and buys a flashy car, how all the employees will feel. And I think family members will feel the exact same way.
Jon: Yeah, friends will feel the same way.
Peter: Yeah, that's true. If you're sacrificing, everybody should be kind of sacrificing.
Jon: All right. Well, I think this.
Peter: Or at least emotionally, they feel like that's. That should be the case. Right.
Jon: And does it matter how much you're sacrificing? It's their perception, not what reality is.
Peter: Right. Right. Could be like you got those tickets to Val for free, right? From. You know something?
Jon: It's tricky. So my advice. Don't do it.
Peter: Don't do it. Don't take money. If they're the only ones that'll give it to you. Don't take it.
Jon: It's kind of what Greg Warnock from Mercato would say. He says that if you're trying, it's your family members. He would say, raise all of your money from institutions. Nothing personal. But then, if it's He's an institution he wants to see, you've taken money from friends and family and that there's, like, immense skin in the game.
Peter: Yeah. Cause, you know, you don't you want you want those Christmas dinners, Thanksgiving dinners to be good. Not a bunch of grumpy, you know, friends and family. Where's my money? That's fair. I mean, that does beg the question, right? Like, does taking money from family, like, really crank up the motivation for you to, like, go out and crush it?
Peter: And maybe some people need that? I don't know.
Jon: Maybe. One last point. When I was doing Tiny Torch and I was like, super broke and trying to make things work, I had a friend, so he offered to it. He says, I won't invest, but I'll help you cover your living expenses if you agree to pay me back.
Jon: And I think he helped for like three or four months. I paid him back plus interest. Plus, like, a big thank you. Yeah. And, like, to me, I was just super, super grateful. It's like going to the super dark moment. Your life. You're like, How do I get through here? And he's like, I believe in you. Yeah. I'm not going to take a huge risk, but I'm going to make sure that you're fed.
Jon: Yeah. And I'll always remember that.
Peter: Yeah. And he was probably like. Like if he doesn't pay me back, that's okay. Right. And kept Jon from dying. That was worth it. Love it. All right, on that. That note, we should end.
Jon: All right. Thanks, guys, for watching. Go to WW w dot venture capital firm again. Let us know your questions in the comments. We've got some good ones.
Peter: What do you think? Would you invest in your friends or family's business?
Peter: Catch you on the next one.
