There are many types of investors and, at the risk of oversimplifying a complex topic, let me start with two categories: smart investors and dumb investors. That latter category includes, for example, friends and family. Dumb investors are not necessarily bad investors, since they have money and often very good intentions. They tend to invest based on fairly superficial criteria, however, including first impressions, their prior relationships to the CEO and key executives, and they tend to invest funds quickly, often without performing any significant due diligence. On the positive side, these types of investors can be easier to convince to write a check and, if you have enough of them, you might be able to raise most if not all of your initial capital requirements.

 

Indeed, this is the most common way of getting started and also helps to demonstrate to follow-on investors that you have “skin in the game.” On the negative side, less sophisticated investors can make your life miserable by being overbearing and wasting much of your time with their questions and suggestions. Accepting too many small checks means that you will have that many more phone calls and e-mails to answer.

 

In a worse case, if things go bad, less sophisticated investors can be more inclined to take legal actions to recover losses and you may end up losing close relationships over business matters. A bigger concern is that investors in your next round will want to see a list of all current shareholders and may pass on your deal if they conclude that you have too many unsophisticated investors on board.