Friends and Family Financing: 6 Things You Must Know

Pros and Cons of Friends and Family Financing

Loans and investments from your biggest fans can be easy to get, but make sure they don’t damage your relationships.

It’s not surprising that one of the first places many immigrant entrepreneurs turn for small-business financing help is to friends and family. The folks who know you well may be willing to give you a chance even when the financial community won’t.

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Donna Marie Thompson

Accepting money from the important people in your life isn’t something to take lightly. They may be more patient with you if your business hits a roadblock than, say, a banker. But whether you take a loan from them or sell them a small stake in your business, the personal fallout can be extreme if your business fails and you lose their money. “Make sure no one puts in so much money that it will hurt them,” advises Donna Marie Thompson, a former consultant with PriceWaterhouseCoopers who now advises small businesses through her consultancy,  Expert Profit Solutions.

What is the best way to borrow from friends and family?

You might think oral agreements with those you know and love are all you need, but most small-business experts recommend putting any loan arrangement in writing and setting up a regular schedule for repayment. “Most people who deal with friends and family do not use contracts, and it ends up in universal misunderstanding,” says Thompson. Services like Virgin Money can help you handle the paperwork.

 

Make sure no one puts in so much money that it will hurt them

Your mother and best friend may not ask you for a business plan, but it’s never a bad idea to write one and provide a copy to them. It will show them that you take the business seriously and will spend the money they loan to you wisely.

What if friends and family want to become owners in my business in exchange for their cash?

It’s not uncommon for entrepreneurs to sell a percentage of the ownership in their business, to friends and family in exchange for cash to grow it. The idea is that when you eventually sell the business, their shares will be worth more than at the beginning, so they will make a profit. If you want to go this route, get advice from a lawyer in how to structure the deal properly and how much of an equity stake to provide in exchange for their money. You’ll need to put agreements in place that spell out each party’s rights and responsibilities, the same way you would with an investor you don’t know well.

What are the challenges of getting financing from friends and family?

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Marilyn Landis

Once their money is at stake, your loved ones may want a greater say in your business than you expect, so make sure you consider this possibility carefully, says Marilyn Landis, a former commercial lender who is now principal of Pittsburgh-based Basic Business Concepts, which provides financial-management services to businesses around the country. “If you borrow money from a parent, they may want to parent you in the business,” Landis says. “You may find yourself facing expectations from friends or relatives: ‘I loaned you money. Why can’t you hire my son?’” You may also discover that accepting their money brings personal dilemmas that you won’t face with, say, a bank loan. For instance, she asks, what will you do if a friend or relative has a personal or medical emergency and asks for his money back immediately—but you realize that paying it back right away will bankrupt your business?

What if friends and family can’t provide all of the financing I need? Where else can I find private investors?

Many entrepreneurs turn to angel investors—wealthy people who like to back very young companies. Like friends and family who invest, angels will expect to receive equity in your business in exchange for the cash they put up and may want a say in how you run it.

 

You’ll need to put agreements in place that spell out each party’s rights and responsibilities, the same way you would with an investor you don’t know well.

Because many are seasoned business professionals, they can offer good advice that will put you on strong footing later to go after venture capital, equity financing that comes from a firm that specializes in it. Some will even help you out by providing resources like free or low-cost office space.

Where can I find angel investors?

Often angel investors meet regularly in groups known as angel networks to review business plans and hear pitches from entrepreneurs, so attending such a meeting can be the best way to connect with them. Often, these groups have websites that outline what you need to do to present your plan to them. Typically, you will need to submit a business plan in advance.

To find angels, join local business groups such as the Chamber of Commerce and ask members if they know of any angel networks, check in with local business organizations for immigrants from your country, or search Finance.com.

Often, angels will invest in groups, coming up with an investment deal that they have tailored to your business. “It varies by industry and by angel group,” says Alan Tratner, director of Green2Gold, a national nonprofit network of low-cost work spaces, known as incubators, for environmentally-friendly businesses, and a counselor based in Santa Barbara with SCORE, a nonprofit that provides free and low-cost advice to small business owners. Get advice from a lawyer on any deal you are considering signing. “When you’re very hungry at the beginning, some people give away the whole show and regret it later,” Tratner says. “Other people are paranoid about giving any equity away and don’t get anywhere.”

Are there any special considerations for immigrants?

Getting financing from friends, family, and community members is a time-honored way for new Americans to start a business, notes Tratner. It may be the quickest and easiest source of financing you can find. Just bear in mind that if you disappoint backers you know well, your relationships with them may suffer.

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10 comments

I think selling your relatives a stake in the business makes more sense than just getting a loan, and more desireable prospect for many…

often the only place to turn for financing is family and friends, this is a fact for immigrants who dream of being entrepreneurs, but if youre creative and choose wisely, this can turn out well, good story…

dont borrow money from your family members (distant or otherwise), I learned the hard way, many banks will offer loans just keep trying

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