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Why VCs rarely back “family” founders

August 30, 2011, 5:51 PM UTC

By Jonathan Tower, contributor

I recently met with a promising start-up led by a husband-and-wife founding team. This was not a standard investor pitch meeting. I had known the husband for several years and agreed to meet informally to be brought up to speed on the company’s progress.

Admittedly, it is not often that I meet with a founding team that is connected via bonds any deeper than college, a previous work experience or a long-standing friendship. Start-ups founded by married couples or other familial bonds amount to a tiny fraction of the companies that successfully raise venture funding each year. On the one hand, might appear odd given how many “mom and pop” businesses factor into America’s current economy and economic history. The dearth of family-founded venture-backed start-ups, therefore, is intriguing.

To be sure, there have been family-founded start-ups that have raised venture money and gone on to be quite successful. WebMethods is one such company. However, the bias in traditional venture circles against investing in such startups is long-standing and rooted in some uncomfortable realities.

1. Idiosyncratic risks in a husband-wife or family-dominated team. It’s axiomatic that investing in young, unproven companies involves a great deal of risk. To be successful, a venture investor must adroitly balance that risk. That involves making choices and tradeoffs over which risks are tolerable and acceptable as part of the venture process, and which risks are not. What differentiates family-run startups to a venture investor is that they introduce risks that are unique by their very nature. Hence, these risks are idiosyncratic and not in evidence at start-ups backed by the more common assemblage of former colleagues, college roommates, and friends.

One such risk is that of divorce in a husband-wife team or a severe disruption in a familial relationship. Both can cripple management effectiveness. Any venture investor who has been involved in the removal of a founding member from a portfolio company can attest to how complicated and disruptive that process can be. Add to that the aspect that the co-founder being removed could be bound by marriage to another co-founder–with the common circumstance that one co-founder is engineering the removal of the other–and one can quickly see what a morass this situation can become. Sons firing fathers or brothers firing brothers play out no less dramatically and painfully for the companies and the investors involved. The emotional fallout in such disruptions can all but disable a company.

2. Recruiting difficulties. For any emerging growth company to scale effectively, it must attract a world-class team. However, top management talent interested in advancement will typically avoid a family-dominated startup where decisions on hiring, promotions or compensation could be colored by family relations or other marginalia. Accurate or not, the perception will persist that a talented manager will be unable to ever take the top leadership post at a company where the competition for that post is likely a family member. Additionally, few people who ever sat through a tense Thanksgiving dinner of their own relish the idea of ever getting in the middle of a familial or matrimonial spat, much less on a daily basis.

3. Lack of defined roles. Finally, there is the touchier discussion about the importance of clearly defined roles in both the business context and in the familial/marital one. Couples and family members that go into business together too often learn that this is a decision that can damage their underlying romantic or familial bonds in ways they never imagined. The bluntness and constructive criticisms that must occur in order for there to be efficient business communications can often fray emotional connections and strain relationships, sometimes permanently. Roles get convoluted. Spouses and siblings lose their identities in service to the needs of the business and find they have trouble talking about anything outside of work but work itself.

As any management textbook will attest, the effective management of teams requires clear leadership, objectivity in decision-making, some reasonable approximation of “professional boundaries” and a clear demarcation of roles and responsibilities. The blurring of lines that comes from founders and/or managers having one role at the office with their “colleagues” and another role at home too often flies in the face of that reality for venture investors to ever become sufficiently comfortable in order to proceed with an investment.

Jonathan Tower (@jonathan_tower) is a Managing Director at Citron Capital, a global private equity and venture capital firm, where he focuses primarily on Consumer Internet, Software, Digital Media, and Web Services investments. He blogs at Adventure Capitalist.