Money from relatives and friends can supplement the business financing you're receiving from other sources -- or even fill a critical gap in starting up your business. Getting friends and family involved in business financing is not uncommon -- nearly one in ten Americans reports a loan outstanding to a relative or friend. This is not surprising, as both you and your family member or friend can stand to benefit from the deal.
Here's what you need to know before you launch into a sales pitch: the basics of private financing, how to present your proposal, and steps to formalize the deal. (To learn about the different options for raising money from family and friends, read Nolo's article Raising Private Money: Gifts, Loans, and Equity Investments.)
Raising money from family or friends may seem straightforward: they do something nice for you, and you owe money to somebody who is understanding. However, getting private money has even more advantages for both sides -- though certainly you should tread lightly when making your personal relationships financial.
Raising money from family and friends has a number of advantages, especially as compared to other financing alternatives.
You needn't see yourself as preying on the charitable instincts of your family and friends. They also benefit in several ways from investing in your business.
Of course, there are potential pitfalls and hassles that come with mixing money and relationships. Family members may feel that you "owe them one." Or, you may not like having some lenders or investors watching your every move, then criticizing your new car or family vacation. And, not every lender will be sympathetic as you try to explain your need to reschedule or skip a payment.
For the most part, these are issues that can and should be dealt with in advance. Make the arrangement as professional as possible. That way, your private lender or investor will treat this as business, not a personal arrangement. You can, for example, offer collateral to secure your friend or family member's loan. And, you should agree on clear and definite terms for any loan, including payment dates, interest rate, and penalties, if any. If your friends or family make equity investments, you might agree to give them a right to share the proceeds from the business's assets if it's sold.
The biggest hurdle preventing many entrepreneurs from getting private financing is simply the fear of asking. You can overcome this fear with a combination of careful preparation and choosing a time and place that makes you and your prospective lender or investor comfortable.
Before actually asking for the loan or investment, plan out how you'll approach your friend or family member.
To actually make a compelling pitch, start by getting your potential investor excited about your business idea. Then, ease into your request when it seems to arise naturally. If the conversation goes well, wrap up by explaining that you'll shortly be sending a copy of your business plan and a request letter; don't try to formalize the loan or investment right then and there. If the conversation doesn't go well, give them time to review your request and maybe your business plan, then follow up to determine what your prospect needs to get to yes.
Once someone has agreed to participate in financing your business, it's crucial to get the agreement in writing. In the case of a loan, you and your lender would draw up a promissory note detailing the amount you'll owe, your repayment schedule, and penalties if you fail to make a payment. In the case of an equity investment (which assumes that you've set up a corporation or LLC), you would negotiate a stock purchase agreement that includes your disclosures about the business and a description of the investor's ownership rights.