Have you considered borrowing or obtaining money from people you know best, who are closest to you, people who believe in you, and whose most natural inclination is to want to help you be happy and successful? More than 50% of people have gone that route. This type of financing is considered as “lovemoney”.
“Lovemoney” financing, although attractive, is not without its perils. It is most important to consider all the implications for you and your family and friends before approaching them for investment monies or loans. It is a cruel fact of life that relationships are almost always damaged when money is lost. Even when the prospective investor or lender has confirmed in advance that he or she can afford to lose the money, and is willing to take the risk of doing so, when it actually happens it is quite another thing.
In a complex, frenetic and impersonal world, our family and friends are the safe refuge with whom we can seek comfort, solace and sanity. You may feel extremely confident and enthusiastic about your business potential, but go slowly and thoughtfully before bringing your family and closest friends into your business deal. How will you feel if you let them down? How will you feel if they never look at you with quite the same degree of trust and respect again? Or if permanent estrangement occurs or you cause them serious financial hardship and stress? While people can forgive, few will ever forget. Parents are generally the most forgiving of financial loss, while friends tend to be the least.
If you are still determined to access financing from family and friends, here are some recommendations to temper the outcome in a worst case scenario.
Attempt to give security for the loan and always put the terms of repayment in writing and give a promissory note. It shows good faith, responsibility and concern. Security could be in the form of collateral security on assets of your business or a collateral mortgage on your home, if you have one. By securing the loan, your family or friends would be secured creditors and would be paid off from assets before any unsecured or general creditors.
If you are asking friends or your family to invest in your business, by putting in equity capital in your enterprise and becoming shareholders then there are additional options to consider. You could structure the money received as a shareholders loan in part or in full, with flexible terms. That way the investors would be paid back their investment money tax-free from your business. Before they invest, show your investors your business plan, including risk factor and suggest they have it reviewed by their accountant, lawyer or outside consultant to receive an independent opinion. Have a shareholder’s agreement prepared. A carefully written agreement that sets out the possible upside and downside, the risks and benefits, the rights and remedies, is essential to attempting to maintain good relationships with your investors when things go bad, or at least are off target as can frequently happen. Finally, make sure you report to your investors on a candid and regular basis, to keep them fully informed. Do so at least once a month and as any problems develop. This is against the inclination of most entrepreneurs, who optimistically believe, or at least hope, that the solution to a problem is around the corner. Most investors however, can accept your failure and their financial loss if they know that you have kept them fully and honestly informed, and you have done your best to make the business work.
There are pros and cons to some of the options covered, so make sure you get good legal advice before structuring your business financing relationship.