As a budding entrepreneur, it took a lot of work and diligence, but you finally have your business idea figured out and things start to make sense. While visions of success are running through your mind, there is likely a haunting fear left: How the hell are you going to get enough money to fund all of this? This is generally not an easy question to answer, but it is still critical that we find an answer if we ever want to turn aspirations into achievements.
One of the first places entrepreneurs look for financing is through family and friends. Sometimes an entrepreneur may be lucky enough to be approached by family and friends before they apply for funding themselves. But while the sentiment is to be appreciated, a smart entrepreneur will consider raising funds from these two groups of people with great caution. And while many people draw a strict line about fundraising from family and friends, it isn’t always necessary. Yes, these types of business transactions can have horrible consequences if they go bad, but if done wisely and with enough analysis, great things can happen. And while the range of things to consider when signing such an agreement is wide and almost endless, I have summarized the subject into three important considerations to consider when thinking about starting a business with the help of family or friends. To emphasize, these are not the only considerations to be made, nor can they be the most important of any consideration; my goal is simply to provide some pieces of thought.
1. Will the investment dramatically damage or unbalance your friend’s or family member’s lifestyle if the deal goes wrong?
Consider how financially stable the prospective investor is currently. For example, if your friend lives with unpaid student loans or other debt, she may not be the best candidate for a round of financing. Even if she is enthusiastic and willing to contribute cash, the risk that this transaction will result if her business fails is simply too high. However, this is not to say that it cannot yet provide other types of capital. Even if financial investments are out of place, personal working capital or social capital from contacts may still be desirable.
2. What level of control, if any, does your family member or friend want?
Some people will contribute money to your cause simply because they want to help you achieve your dreams, and without a second thought about having a role in the business in addition to financial backing. On the other hand, other people will expect some role or control in the company. The level of control could range from having free products and services for life or a paid position at higher levels of management. As you probe your desires, be sure to recognize that giving the individual some level of control is not always a bad thing. If you are qualified and bring talent or experience to the position, it is worth considering.
3. What is the payment for your family member or friend? Will it be financial gain or just good will?
Aside from control in business, a second great motivator for investors is the outcome or “exit strategy,” and family and friends are no exception. Ask the interested investor what their expectations are for the future. Would you like to see your investment double? Or would you just like to get your money back after a certain number of years? Either way, planning for the future by assessing the expectations created today can be critical to reducing tensions in the future.