The first place many entrepreneurs get money from is themselves. Founders of a startup must be personally and financially committed to the startup. Many entrepreneurs mortgage their homes, cash RRSP, and use credit cards to finance the initial operations of the startup. Access to these sources of capital may be critical to the startup, but they come at a high emotional and financial cost.
After entrepreneurs exhausted their personal financial resources, they usually turn to their friends and family for financing assistance. According to a popular quip, when the personal resources of the founders are exhausted, a startup turns to “the 3 F's”: family, friends, and fools. Most startups, however, have too few family members, friends, and fools to achieve the scale necessary to finance a startup development. Additionally, if the business fails, and the probability of that is high, the friends and family will lose their investments. Failure invariably strains relationships. The last but not the least, by adding multiple investors, the founders adds complexity, such as holding management meetings and potentially losing control of the startup business.
After initial funding by the 3 F's, the second stage of startup funding comes from venture capitalists, who are not family, friends, or fools. If the startup has something to show investors, they may be willing to invest in the startup. However, institutional investors, are hesitant to fund startups owned by a large number of individual investors or startups controlled by family members. Venture capitalist fill the gap. Venture capital is a form of private finance based on expert knowledge, not relationships. Venture capitalists are the experts at ascertaining risks in the early stages of a startup's development. Venture capitalists are also experts at organizing startups to extract full value from them. They structure their relationship with the founders of the startup so that they can seize control and reorganize the startup if it does not succeed. This is important because individuals who have the best ideas are often bad at organization and administration.