Funding your startup with family and friends
For many entrepreneurs when starting out, the option of raising money from family and friends can seem like the most straightforward. With no banks or institutions to persuade, the flexibility to dictate your own terms and the belief of people who know you, it can look like an easy option. However, failure to communicate and insensitivity can result in falling-outs, bad feeling, and in the worst-case scenario lawsuits and loss of money, whether that’s for you or your loved ones.
Why borrow from family and friends?
- Others might not be willing to take a punt on your fledging business or idea – but friends and family, who know you well and are probably familiar with your passions and your strengths might be.
- If your business hits some rocky times, they are likely to be more forgiving and patient. Where the bank might repossess your house if you miss a payment, your friends and family might be willing to renegotiate terms or give you a repayment holiday.
- Demonstrating that you have an engaged network that believes in you can be a really positive feature for investors, when the time comes to raise more capital.
How can it go wrong?
- You have to step very carefully to avoid ruining friendships and family relationships – for example, will your friends feel they’ve been ripped off if your business fails, or will aunt Mabel be annoyed if you go on holiday to Barbados when you’ve only paid half her loan back?
- Worse than ruining relationships, if a well-meaning friend or family member has lent you more than they can afford and your business runs into difficulties, you can also hurt them financially.
- If you take everything at face value without properly thinking about terms and how their involvement can impact upon your business, you can end up with lawsuits as well as disgruntled family members.
Prashant Lagisetti is the founder of Localoids, an international community with the aim of bringing together like-minded people, creating international friendships, and bringing together skills, knowledge and languages. He borrowed money from his family in order to help start his business. James Royall is the founder of Propeller Bikes, selling electric bikes that are a cleaner and cheaper alternative to mopeds. He borrowed £6,500 from a friend to help start up.
Avoid recrimination over the turkey this Christmas time with these tips.
Decide if it’s the right time
Whether you’ve been offered money by a friend or relative or have decided it’s the best option for you, think carefully about whether it’s the right time to be taking on this kind of investment. What will the money specifically do for your business, and how quickly from taking the money do you estimate you’ll be able to pay it back?
“I made my decision based on how much I needed to get to the next level,” says Prashant. “I didn’t have a big product, so I decided to borrow from my parents to take me to a full product, which would put me in a way better position for raising equity later on.”
How do the funders perceive the funding?
It’s vital to be ensure that you’re 110% certain about how the funder sees the money. Is it a gift? A loan? Are they expecting to be investors with shares and influence in the company, with a say in how things are run? Or will it literally just be the money and hands-off from that point? Do they have a certain timescale within which they want the money back, and will they be accruing interest on the loan? These are all things you need to consider.
“It was pretty informal for me,” says Prashant. “The views that my father and me have on it are slightly different – he sees it as more of a gift, when I see it as more of a loan. From my perspective I’m expecting to make money, and so it’s obvious to me that I’ll be paying it back!
“They don’t have a hand in the running of the business at all, as it was done mainly to help me out and not as a potentially risky investment,” continues Prashant. “My parents don’t have tech experience, and are confident in my ability to handle it. If you get to a point where you’re providing shares in return for money invested in the business it can get a lot more complicated and difficult, as you have to think about shareholder agreements and the rest of it. Keeping it as a loan to be paid back makes it much more straightforward.”
“The friend who funded me doesn’t join me in the running of the business – I just keep them up to date with developments,” says James.
Whatever their involvement in the company, keeping friends and family who’ve funded you up to date with how the business is going is a crucial part of honest communication. Nobody likes to feel out of the loop – and it can also help warn them if things aren’t going so well.
Think about repayment terms and contracts
Why it might seem overkill to draw up contracts and terms, it can be really important down the line if things go wrong for your business. Having things in writing helps clarify any points, ensures everyone’s on the same page, and means you have a leg to stand on if things escalate to the point where lawyers get involved.
“The money I borrowed was informal – essentially a soft loan that I would repay when I was able,” says James. “But it’s still important to talk things through very thoroughly so there’s no room for assumptions about what the other party understood. Then write down a simple agreement outlining terms, even if they are very straightforward. It avoids trouble from memory fogging a couple of years down the line.”
Consider the impacts outside of the business
“Everyone’s heard the ‘don’t go into business with a friend’ maxim - I was concerned that if things went wrong it might sour the friendship in some way,” says James.
“I had to consider honestly whether I was really confident that I would be successful, or whether I was throwing money away,” says Prashant. “I also had to consider how much my dad could afford to lend me, and I didn’t want to ask any more of him. He told me that he doesn’t necessarily expect to see it back, but I’m determined to repay it.”
As mentioned before, one of the biggest dangers of borrowing from family and friends is the potential for falling out, or borrowing too much. Ensure both parties are really honest about what they expect when it comes to repayment, and that if money is lost the person doing the funding can take the hit.
- Write everything down – it’s not nice to think about your business failing or about falling out with the people you love, but having contracts and agreements in writing makes sure that everyone is on the same page and can avoid problems down the line.
- Talk, talk, and talk again. Communication is the key to making such a sensitive funding decision work.
- Go into it with open eyes. If a family member is offering you lots of money because they believe in you, it can be tempting to take it – but ensure that they can afford to take the hit if all goes wrong, rather than hoping for the best.