Friends & Family Financing

You have a business that’s facing some short-term cash flow trouble. Or perhaps you have a startup idea, but need some capital to get the business off the ground. You can’t get approved for a bank loan and you may have trouble attracting investors. Where else can you turn? For many business owners, the answer lies in their network of family and friends.

It is very common for business owners to turn to friends and family when financing a business. Be careful, though. Money and business can sour even the best relationships. When a friend or family member helps with financing, the details of the financing should be written down and agreed to. Is it a loan, gift, or investment? How will it be repaid? Does the friend or a family member have any role in the business? These questions should be answered to protect the relationship.

Going to friends and family may be a good idea when you are extremely confident in your business’s future success. Like a bank, your friends and family will be more likely to help if they are confident that you will be successful.

Also, keep in mind the financial situations of your friends and family. It may be wiser to ask for small amounts of money from a number of people than one large amount from one relative. If the friend or family member is unwilling to help, it’s best to thank them for their time and let it go.

Advantages & disadvantages of family financing

Friends and Family Financing Pros:

• Could have favorable repayment terms – or no repayment at all!
• Helps to generate excitement and interest in your business

Friends and Family Financing Cons:

• Could ruin the relationship if the business fails
• Friend or family member may want a larger role in business than you want

Borrowing money or taking investments from family and friends may be an easy solution to your cash flow issues, but that doesn’t mean it’s always the correct decision. The old saying goes that one should “never mix business and family.” There’s a reason why that advice is so popular.

Once you take money from your family, they may feel that they’re a part of the business too. When they ask how work is going, they may not be asking simply out of loving curiosity. They may have real concerns about your business and the decisions that you’re making. You may need to be prepared to answer tough questions about work even at friendly family gatherings.

Of course, the big risk is that you may not be able to repay your family. If that happens, you may damage or even ruin the relationship. Losing a business is tough, but losing family is often a far greater price.

Before you ask your family for funding, consider the questions below.

Are your friends and family willing to invest their savings in your business?

This is the most important question to answer. If you believe the answer is no, then you probably shouldn’t move forward. You may abide by the rule, it doesn’t hurt to ask; Or you may think that the worst they can say is no. There’s validity in both of those points. However, if you truly feel that they don’t want to invest, you may do more harm than good by asking.

If they’re not willing to invest and you ask for funding anyway, you’re then putting them in a challenging situation. They have two choices, neither of which are positive. They can say yes and commit to making an investment that they really don’t want to make. Or they can say no and risk offending you or hurting your feelings.

Before you discuss funding with your family, take time to really consider whether it’s something they’re willing to do. If not, don’t go any further. You’ll only put them in a no-win situation.

Are your friends and family aware of the risks of investing in a business?

Your mother may be more than willing to loan you money. That doesn’t mean you should accept it. If your family members quickly agree to lend you money, it may be that their judgement is somewhat clouded by their affection for you. Of course they love your idea. You’re family.

When you borrow from a bank or other lender, it’s not your job to worry about the other party’s exposure to risk. When you borrow from family, though, you may have a little more responsibility to make sure they understand what they’re getting into.

Ask yourself how experienced your family members are with investing or with business ownership. Do they know that most relatively new businesses fail? Do they have realistic expectations with regard to revenues and profitability? Do they understand the challenges your business faces?

If they don’t understand these issues, ask yourself whether their willingness to invest may change after you educate them. It’s good that they believe in you, but you wouldn’t want them to feel that you mislead them if the investment goes bad. Give them all the information and then let them make an informed decision.

Will you be able to keep your relationships with friends and family healthy if your business fails?

This a major question that deserves serious consideration and honesty. What will happen if your business fails and you lose the investments of your family members? Will they resent you and hold a grudge? Or will they understand and move on?

The answer may lie in how you present the investment to your family. If you present them with all the facts, risks, and possible outcomes, then they may be more prepared for a loss. However, if you’ve promised them a positive outcome or failed to properly prepare them for risk, they could be severely disappointed.

Again, if you do decide to approach your family for funding, be sure to give them every piece of information they could possibly need. Err on the side of oversharing and don’t press them for a decision. Set their expectations at a realistic level and help them understand the possibility of loss.