The best advice startups will never follow

Let me tell you a few short hair–raising stories of entrepreneurs who have raised money and regretted it later. Here are some rules that entrepreneurs almost always ignore to their future peril.

Don’t take money from relatives who can’t afford to walk away without remorse.

Do take money from experienced family members only after you ask them if they are sure

three or more separate times. By the third time you can be sure that they aren’t being overly emotional or feel they can’t say no. Also, if things go south, they are more likely to remember that you weren’t pushy and that you gave them three or more separate opportunities to say no.

There’s a common expectation among entrepreneurs that seed money from family is great — letting close relatives in at the ground floor. The problem, of course, comes if the business fails. Some relatives believe that a family bond is an insurance policy, and that all investments or notes will always be repaid, no matter what the circumstance. Consider whether the family member being asked to invest has the capacity to walk away “happily” from a lost cause.

Don’t take money, especially start–up loans, from unsophisticated investors.

I was a co–lender and assumed the chairmanship of a young startup where the entrepreneur’s cousin also loaned money under the same terms. When the business failed, the cousin sued his own relative, me, my wife (who didn’t even know the names of the players), and even my family trust (an estate planning vehicle with no separate assets.) It took several times the value of the cousin’s loan in legal fees and settlement just to extradite my interests from a suit that had no merit — but would have cost hundreds of thousands more just to get to trial.

Do take loans from sophisticated investors only after you have tried everything to get them to purchase equity…

…and always with clear wording on automatic loan extension if you are making progress but need additional time to meet the full set of goals.

Don’t talk yourself into a high valuation for the first round of financing for any reason…

…even if your hair is on fire and the idea is worth billions. This lesson is one that is not only hard to teach, but ignored by entrepreneurs on a regular basis. Early investors who don’t have the experience to compare value or ask tough questions accept the word of their entrepreneur as to valuation. Later investors will enter that picture only after insuring that valuation is reasonable and comparable to other opportunities for their money, but often will walk from a deal if the valuation for earlier investments was so high as to cause pain for that cohort. It’s just not worth the effort to argue with early investors when there are so many other deals calling for the sophisticated investor’s money.