Getting funding from your friends and family can sound like a good idea – in theory. It’s not unpopular, as there’s even a term for it, called the “friends and family funding round.” Your friends and family are often your first supporters, and they believe in your business from the start. So, why wouldn’t they make good investors?
In a 1998 episode of the sitcom, Fraiser, Dr. Frasier Crane lends his producer and best friend, Roz, $1,500 to help her with being a new and single mother. When he finds out she did several questionably luxurious things directly afterward (going to the spa, buying new shoes, etc.), he questions her motives and becomes suspicious of her spending. After all, she was just complaining about how she was strapped for cash. He then snoops around her business and creates a rift in their friendship.
It turns out Roz had a good excuse for her spending (the spa day was a present from her mother, the shoes she had a store credit for), but this example illustrates the problems that can present themselves if you borrow money from someone you know and love. When done improperly, It can cause stress and suspicion, not to mention rifts in relationships.
They say your family has to love you, but they don’t necessarily have to express it in the form of monetary value. It’s always a sticky situation to accept money from friends and relatives. But still, getting funding from your friends and family can be tempting when you need starting capital, and you’re not likely to get it from a bank or formal lender yet. If you plan on getting early funding from those close to you, here are some things to keep in mind.
Formality is Key
When you’re borrowing funding from friends and family, it’s a good idea to remain formal about it. Even though your daily interactions may be casual, don’t fall into that same routine with business interactions. No matter how close you are – whether it be your now-rich college roommate who owns a successful tech business, or your father giving you some of his retirement savings – it’s better to keep it strictly business.
If you choose to take a loan, treat it like you would any other loan and make formal payments. Even if they insist that you don’t need to pay it back immediately, it’s always smart to structure their loan as you would a loan from a bank. Figure out payments and pay them back on a time schedule. That way, it’ll let them know you’re not taking their money for granted.
It is recommended to come up with some sort of written agreement. You can create it yourself, or you could use a lawyer. There are multiple websites that can help you out with this, such as DocuSign. This is advised just so you have a record and track of what’s been said and agreed to, and proof just in case the deal is disputed.
Equity via Friends and Family Funding
Instead of a loan, you could treat friends and family funding as you would that from a venture capitalist or an investor. By giving them equity in your company, you’re making sure they get paid back later on, but not by way of a loan. They’ll get a percentage of ownership in your business, and eventually, if you become profitable or are acquired by another business, they receive a profit.
This is more formal than borrowing money from them, and it’s advised you involve a lawyer to draft a convertible note. This will likely mean that, in the future, these people will be shareholders in your company, but the rate will most likely be determined later on in a Series A funding round or seed round.
At the beginning of starting a business, it’s nearly impossible to determine what the value will be. Since you’re not usually making revenue yet, predicting the future is hard. That’s why you need money from relatives in the first place. Don’t try to over-sell your business, because that’s setting you up for disappointment with your friends and family. It’s alright to be optimistic, but not misleading.
It’s your responsibility, as a new business, to detail the losses that could be involved when it comes to investing or loaning money. Don’t try to lure people in with the promise that they’ll make a ton of money off of your business. Don’t try to sound revolutionary. You don’t want to burn bridges by not being fully transparent with those who believe in your company. It will always come back on you for accepting the money. You don’t want to end up on Judge Judy.
Please, Do Your Research
Don’t just take money from anyone. Try people with a professional and business background. Also, on your side, make sure you research all the things you need to know when starting a business. Have a plan. If you don’t invest time and effort into starting your business, why would you expect anyone else to invest their money in it?
If you’re not really feeling the friends and family route, or don’t want to risk tensions within personal relationships, there are other options for business funding. If you’re looking for a more traditional way to fund your business that doesn’t require this process, you might want to look into traditional loans or lines of credit. The SBA even has a microloan program for brand-new businesses.
If you’re curious about other funding options, FaaSfunds is here to help you out. We offer a loan and credit marketplace to find the best option for your business, and a specialist to answer any and all of your questions.