Friends & Family Financing
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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 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 widespread 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 financing details 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 highly confident in your business’s future success. Like a bank, your friends and family will be more likely to help if they are confident you will succeed.
Also, keep in mind your friends and family’s financial situation. It may be wiser to ask for small amounts of money from several people than one large amount from one relative. If a 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:
- It could ruin the relationship if the business fails
- A friend or family member may want a larger role in the business than you want
Borrowing money or investing 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 like they’re also a part of the business. When they ask how work is going, they may not be asking simply out of loving curiosity. They may have real concerns about your company 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 significant risk is that you may be unable to repay your family. If that happens, you may damage or even ruin the relationship. Losing a business is tough, but losing a family is often worse.
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 critical question to answer. You probably shouldn’t move forward if you believe the answer is no. 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 genuinely feel that they don’t want to invest, you may do more harm than good by asking.
If they’re unwilling to invest and you ask for funding, you put them in a challenging situation. They have two choices, neither of which are positive. They can say yes and commit to an investment they 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, 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 affection for you somewhat clouds their judgment. 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, you may have a little more responsibility to ensure they understand what they’re getting into.
Ask yourself how experienced your family members are with investing or business ownership. Do they know that most relatively new businesses fail? Do they have realistic expectations about 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 you misled them if the investment went 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 significant 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. Giving them all the facts, risks, and possible outcomes may make them more prepared for a loss. However, if you’ve promised them a positive result or failed to adequately prepare them for risk, they could be severely disappointed.
Again, if you decide to approach your family for funding, give them the information they 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.