Start-up finance from friends and family is a popular way to kick-start a business; favourable terms and flexible repayment schedules are often just what entrepreneurs need when trying to get off to a good start.
Pros of raising money from friends and family
Closing finance from investors is likely to take more time than with friends and family. Investors typically expect a considerable period of due diligence, and may delay negotiations (particularly if your need for finance is urgent) in order to secure a better deal. Friends and family are more likely to make a quick decision and provide you with the money in a shorter period of time.
Whilst banks may require you to secure a loan on your property, it’s unlikely friends or family will ask you to do so. This reduces your personal liability and helps ensure that, should the business fail, you retain your property. This is a particularly attractive benefit for most entrepreneurs who may have a family to take care of.
Whilst investors aim to guarantee a good term for themselves, friends and family are more likely to offer you terms that are primarily designed to help you out the most. This may mean reduced equity, no equity or the ability to reduce equity over time as the loan is repaid. This can be very useful if you wish to retain a majority stake in your company and don’t want to give away too much, something that often happens when dealing with private investors.
Repayment periods are agreed in advance when taking out a bank loan; if you can’t afford to keep up with monthly payments then your bank can repossess your assets in order to cover the deficit. Friends and family are less likely to offer such rigid repayment structures and will probably not mind if you miss a few months’ repayments due to poor liquidity.
Leverage for future investment
Businesses that contain finance from either the owner(s) or friends and family are attractive to investors as they know there’s a significant emotional investment as well as a financial one. Taking finance from friends and family in the early stages of the business lifecycle can therefore make it easier to obtain funding as the business grows, perhaps to fulfil a large order or to expand.
Cons of raising money from friends and family
Taking finance from those close to you tends to add an emotional level to the investment, rather than it being purely a professional transaction. In business, where logic and innovative thinking are often key to success, emotion can skew decision-making and encourage owners to make decisions that are perhaps not ideal for the company.
Exchanging finance from friends and family in exchange for equity can be problematic as they may use their shares to take part in company decision-making. Even if you maintain a majority share the politics of decision-making may turn your relationship sour, particularly if you fail to consider their viewpoints.
If money is given to you on the basis of a loan, and your business fails, your relationship with the investor may go downhill if you’re unable to repay the loan amount. They may become resentful that the money has been ‘squandered,’ even if you tried your hardest to make the business a success.
Private investors are often experience business professionals that can pass on extensive knowledge, helping to guide your company in the right direction. This help can be invaluable, particularly if an investor decides to work with you directly. Unless your friends or family have a background in business, it’s unlikely you’ll receive any additional support other than the money itself.
Tips to keep things amicable
Apply these tips when raising finance from friends and family to help keep the process professional:
- Debt v equity – once loans are repaid then the professional relationship ceases, which can be beneficial when it comes to close investors. With equity, unless the stake is sold or exchanged, your investor may have voting rights and a say in the business for good
- Deal with strangers – whether the equity is from a friend, family member or a private investor, treat all transactions the same. Ensure legal paperwork is drawn up to keep the deal strictly professional. Verbal agreements are a big no-no as they can lead to arguments and resentments down the line.
- Non-voting stock – instead of offering voting shares in exchange for finance, consider offering non-voting stock. Your investor gets a good deal and a share of the profits but can’t interfere in the decision-making progress which helps to keep emotion out of the transaction