What is FFF and how to invest in early-stage startups?

For a whopping 40% of all startups, the main source of early-stage investment is the so-called FFF money. FFF here stands “friends, family & fools”, where the “fools” are individual investors with close to zero experience in venture funding. Non-professional investors are attracted by the high return potential of early-stage investments, often not realizing that this is one of the easiest ways to lose their money.

So, what should you do if you want to invest but don’t want to take any risks? Here are some options.

What is FFF-money and why it’s needed?

It’s not a secret that a major source of early-stage investment is the so-called FFF-money. As we mentioned earlier, FFF here stands “friends, family & fools”, where the “fools” are individual investors with close to zero experience in venture funding.

Although these investments are sometimes absolutely successful, they are rarely strategic or sustainable. Every year, some 35-40% of startups get funding from these sources. By the way, even Google started out way back in 1997 with $1 million worth FFF-money.

So, why do startups need FFF-money? First of all, FFF-money is easier and more straightforward to get a hold of compared to business angels or institutional investors. Secondly, FFF investors rarely seek a stake in the business or any decision-making roles. Last but not least, FFF-money is the coveted ticket to get you rolling on the venture train. Once onboard, this train will take you through funding rounds spurring future growth based on past performance.

Climbing on the venture train, however, is getting harder and harder. Let’s start by saying that in four years, the average amount of seed funding almost doubled (from $2 million in 2015 to $3.9 million in 2019). Obviously, as the money gets bigger, so do investor demands: while in 2010 one in ten startups that got seed investments made some money, in 2019, 67% of all seed-round beneficiaries generated profits.

Thus, currently only projects with some real figures behind them can actually count on some seed funding from professional investors. On the other hand, FFF-money does not come based on achievements or growth potential – it comes based on emotions. Friends and families are supportive, while for non-professionals investing in a startup is like a Russian roulette or the lottery – sometimes you win, sometimes you lose. Therefore, a growing number of startups are choosing to go down this path: the average amount of pre-seed rounds grew from $100,000 to $1.2 million in 2019.

Since the number of friends and relatives is always limited, early-stage startups traditionally rely mainly on non-professional investors. At least until they are able to generate sufficient results to catch the eye of early-stage VCs, willing to invest their “smart” money based on common sense and metrics.

Why does FFF-money exist in the market in the first place? Even for non-professional investors, and particularly for them, it makes sense to bet on more mature startups, especially faced with the uncertain times we are living in. However, these startups are the territory of later-stage VCs and they are often difficult to access for individual investors.

Besides, individual investors are attracted by the high return potential of pre-seed investments. The universal principle that RoI and risk grow in proportion, is also valid here.

Therefore, the easiest way to lose all your money without any venture experience is to invest them in an FFF-stage startup. But while friends and relatives are less motivated by the material gain they would potentially make, the “fools'” money of individual investors, who are counting on getting them back and making some on top, are at extremely high risk. So, what do you do if you feel like betting some but don’t like the risk involved?

How to make “fools'” money “smart”?

First of all, newbie investors always have the option to use some more conservative tools – bonds and shares, which are low-risk instruments. In this case, however, you will have to put up with much lower return rates.

Another option is to diversify your portfolio and put aside some cash (that you are ready to lose) for early-stage startup investment. If you have some money and a sweet tooth for the venture business, you can also use the services of an early-stage VC fund. This is associated with a lower risk compared to direct investments. In reality, inexperienced investors in a VC gain access to the fund’s expertise and analytics and can make an investment at a stage when RoI can still be very high.

Of course, the first funding round of a startup is not a recipe for success. But its chances for survival increases with each stage of funding from professional VCs.

Of course, “fools'” money is also necessary for the market – it helps increase the number of startups and develop the market in general. On the other hand, however, the market is evolving and the rules of the games are changing. Like it or not, in our world today, “smart” money has much higher chances of success.