Though banks and other traditional lenders are unlikely to lend to startups, there are many potential sources of funding for a business in its startup or infancy period. Perhaps the most frequent is borrowing from friends and family. It’s a delicate subject. Here, we offer some accumulated wisdom from professionals in the fundraising industry about how to go about it.
Personal Loans or Equity Investment from Friends and Family
Many businesses are started with loans from friends or family. Others are started by selling part of the equity of the business to a family member or friend who hopes that at some point, you’ll be very successful, and their stake of your business will be worth quite a bit. Some people wish they could quit their day jobs and start a business, but they may not be adventurous enough, have enough time, or realistically be able to give up their career. Every family seems to have one: the fun uncle who never married or had kids, is always traveling, has a bunch of hobbies, and is always picking up the tab for drinks or food at family reunions. For these folks, the next best thing may be to help their friend, cousin, sister, niece or nephew start a business, using their money.
Family and friends are likely to be more forgiving than banks, venture capitalists, and foundations. They typically will loan to you more on your personality, drive, and whether they like your idea, as opposed to wanting to see market research, sales projections, a formal business plan, or your credit history.
While this may seem like a great idea (what could be more fun than a family business, right?), this is tricky business, fraught with patches of thin ice lurking everywhere. There are numerous horror stories about intrafamily loans gone bad, friendships destroyed, houses divided … there is a saying, something akin to
That said, however, this is still a very common option many entrepreneurs use for funding a business. Here are a few considerations that might help things go as smoothly as possible.
* Consideration 1 – Do not approach the person and ask for money. It is a better strategy to openly discuss your desire to start a business, and if the person starts asking more questions, it may mean they’re thinking about funding you. Answer their questions. If your idea inspires them (if you’re starting a green business, and your family and friend network is full of greenies, this becomes an exciting possibility), they will continue to want to learn more, and meanwhile start mentally doing some calculations on how much you’d need and whether or not they have it.
* Consideration 2 – Be incredibly open and honest about the risks and uncertainties involved. Your friend may lose much of his or her life savings, so take it very seriously. It is best to underpromise and overdeliver, as opposed to the opposite.
* Consideration 3 – Do not accept money if the person can’t afford to lose it. If your lender is someone with a well-paying, stable job and a secure salary, and has $50,000 in a savings account, it is very different than if the person has a big mortgage with a adjustable rate mortgage, an unstable job, an unstable relationship, etc.
* Consideration 4 – Draw up a contract. You both may be ‘handshake’ type of people, but in this case, put your expectations and your lender’s expectations in writing and both of you sign it. Spell out your assumptions of when the money is going to start to be paid back, at what rate (if applicable), and over how much time the loan will be paid back. If there’s more than $10,000 involved, use a lawyer to review the contract. You’ll both be much happier down the line if you have that document to refer to. One terrific option is to use Virgin Money’s program for managing the loan. According to their website, “Virgin Money manages business loans between relatives and friends. Using us means that the business of your loan – legal documents, transfer of payments, year-end reporting – will be taken care of. (Which we think will come in handy, because, really, you’ve got enough on your plate.)” See Virgin Money’s Business Loans site for more information. Note-this site is not available for U.S. citizens. In the U.S., you might try searching for a Promissory Note instead.
* Consideration 5 – Once you have the loan, be wide open and 100% transparent. Keep no secrets. If you get a loan from your cousin, take the assumption that your cousin is now entitled to know just about anything they want to about how his or her money is being used.
* Consideration 6 – Stick to your business plan unless it makes a very strong business case to change something. A lot of opportunities will come up for you to play with, and chasing them may be a waste of money and time, and distract from your business mission. These are things that will bother your lender and make the relationship strained. If the business case is really strong for a change, talk to the lender first before you proceed.
* Consideration 7 – If things start to go poorly in some aspects, your lender is the first person to know it. Engage them. They may have some useful suggestions for you, and at the very least, you’re showing them you respect their opinion and are doing your best to fix the problem.
* Consideration 8 – No matter how good your contract, unexpected things will come up. Keep the lines of communication wide open with your lender and talk to them as these things happen.
* Consideration 9 – Pay them back as soon as you can afford to. If they see you continually reinvesting your proceeds into your business, they’ll start to wonder when they’ll be your priority. Make them your priority. Remember, without them, you wouldn’t be where you are.
Hopefully, your business will succeed wildly, and your lender will be very happy with you as they spend countless hours rolling around in their newfound pile of money. As long as everything goes according to plan, and you’ve underpromised and overdelivered, everything will be hunky-dory. It’s when things don’t go well that you’re going to need your best people skills to keep things in your personal life smooth. If you follow the above recommendations, you’ll have a much easier time of doing exactly that.
Scott Cooney (twitter: scottcooney) is an adjunct professor Sustainability in the MBA program at the University of Hawai'i, green business startup coach, author of Build a Green Small Business: Profitable Ways to Become an Ecopreneur (McGraw-Hill), and developer of the sustainability board game GBO Hawai'i. As a serial eco-entrepreneur who has started, grown and sold multiple green businesses, Scott believes that capitalism, true capitalism, can be a powerful force for change, but that our current version of capitalism is severely hampered by perverse subsidies and negative externalities that make unsustainable products less expensive than healthier alternatives. Scott is a vegetarian, an avid cyclist, and an organic gardener. Find Scott on Google Plus