Woo! You’ve decided to start a business. Whether it is a startup or small business you are going to need some start up capital. Even if you are just opening a lemonade stand on the side of the road, you will still need money to get the business off of the ground. You will need cash to pay any employees, make or buy inventory, rent office space, market your ideas etc…. The old adage is true, you have to spend money to make money.
There are a variety of sources for where that money can come from. A while back we may have initially thought of banks as our primary source of borrowed income, but thanks to the popularity of the show “Shark Tank,” many of us may immediately jump to a scenario similar to that when thinking of raising funds for a startup.
The reality is that the most common source of funding for startups is family and friends. It makes sense. They love you and probably believe in your idea without you needing to go on a reality show. Plus, for you, it may seem like they will be more lenient and generous with interest rates and terms for repayment. Definitely seems like a winning situation, right?
In fact, having commitment from family and friends can help with gaining other investors down the road. In an article for Forbes, Martin Zwillig writes, “The reality is that investors…look for evidence that people who know you well are willing to bet on you, even before your idea has a chance to show traction.” So, it’s not a bad idea to start with friends and family.
However, borrowing money from family and friends can be a tricky business—especially since you aren’t just asking your roommate to spot you a 20. You are most likely asking for quite a bit of money.
While in my 20s I loaned money to a friend for personal reasons, and I never got it back. I would watch her do things such as go out to eat or get a pedicure and wonder how she could do that if she couldn’t afford to pay me back. This, unfortunately, ate away at our friendship. When deciding to whether or not to ask your friends and family for money, you want to keep in mind how it could affect your relationship if things don’t go as planned.
Here are some tips for making this as smooth as possible:
HOW to ask for money
Asking for money can always be kind of uncomfortable, unless you’re Veruca Salt. But, following this advice will make it a little bit easier.
As we talked about earlier, things can get tricky when you mix money with family or friends. It will help make things less awkward at your niece’s birthday party or Thanksgiving if you choose to work with someone who you are comfortable communicating with. This may not be your best friend or your parent, and that’s okay.
Even if they are your parents or have been your friends since elementary school, they will still be investors investing their own savings. Though you may have had no qualms about asking for money from them when you were 12, you’re an adult now and it should be approached with more sobriety. Make sure you have a proposed business plan ready to go. Show that you know your stuff. Know your target market, competition, future milestones etc…, and have prototypes available.
Don’t assume you know others’ financial situations
When approaching friends and family about borrowing money from them be aware that you never really know other people’s financial situations. Just because they seem like they have cash to spare, doesn’t mean that they necessarily do.
They Said, YES…Now What?
Don’t shy away from the nitty gritty detals
Startup advisor Martin Zwillig writes, “Non-specific and open-ended agreements are the quickest way to break up family and friend relationships when things get tough, and they will.”
From the beginning decide if the funding is coming in as a loan or as an equity investment, which will determine how to proceed. If the funding will come as a loan, you will want to have a promissory note with clear interest rates and terms of repayment signed. Don’t be afraid—you won’t regret having this all worked out from the get go.
Be upfront with your lender or investor from the beginning. Discuss your vision and hopes, but also be clear about possible risks. It is also helpful to explain to your lenders exactly how you will be using their funds and where exactly the money is going. If things start to head a little south, be upfront about that too. Remember how we said being able to easily communicate is important? Not only do you want to remain on good terms with someone who is invested in your company, but you also want to maintain a positive relationship with a loved one.
They Did NOT Say Yes….Now What?
Don’t be offended
People have all sorts of reasons for not lending money. It doesn’t necessarily mean that your idea is a bad idea. It could be that the person does not feel comfortable with mixing money and friendship or kinship. Don’t pressure someone into giving you money, and don’t let his or her refusal get in the way of your bond.
Want more financial advice for your small business or start up? Contact Lucid Advisory and Finance!