As we’ve written here, funding is critical to any startup operation, and there are several possible sources for that important infusion. Many people did into their own savings and nearly 11 percent borrow from banks, according to the Census Bureau.
By contrast, only about 2.5 percent got funding from family or friends in 2012, the bureau estimated. That’s probably because most entrepreneurs are wary about risking close relationships by involving those people in their ventures.
No, it’s not easy asking a loved one for a loan. However, the perks of borrowing from relatives might far outweigh the negatives for some people. You can negotiate the amount, the loan terms and the repayment schedule, including interest and when payments start.
Here are some tips to consider if you’re in the market for startup funds from family and friends:
Know What You Need
If you were to go into a meeting with a major investor, you would bring every scrap of material that could sway the investor in your favor. You should have this same mindset when meeting with family and friends.
Never forget: This is a business deal. Treat it accordingly. Have a sit-down meeting and pitch your plan. Explain how you will use the money, how you will pay it back and, most importantly, your backup plan if things don’t work out.
It’s also important that your friends and family understand how their investments work. Make it clear that you need an investment, not a board of directors. Be polite but firm. Sometimes people expect to have a say in how you run your business if they loan you money, but this can strain your relationship.
Let’s say you need $10,000 to start your business. Many people would try to get the amount in one chunk to keep things as simple as possible. Sometimes, though, this just isn’t an option.
Asking for smaller loans is a great alternative. It can get messy, so you must be vigilant about keeping track of every loan you receive.
Small loans also provide less pressure on investors. Loaning an entrepreneur $100 is a lot more feasible for most people than loaning $1,000, and they still get the satisfaction of helping out.
You can also give your friends and family options on how you pay them back. Payment plans can be monthly, quarterly or annual. Depending on your business, you can also offer perks like free products or services.
With any of these options, make sure both parties fully understand how the system will work. It’s sometimes helpful to get a lawyer to help you draw up a payment system. Some first-time entrepreneurs don’t realize that cash flow isn’t always immediate. You’ll need to take that into account when drafting repayment plans.
Get Everything in Writing
This is a big one. Most people like to think that friends and family will be satisfied to simply receive a pre-agreed repayment for their loan. This isn’t always the case, especially if your startup goes big.
Think about it. If someone lends you $500 and your company grows to $5 million in the first year, some people might expect a larger repayment. Is this fair to you? No. But it happens.
To avoid any problems in the future, make sure you and your investors have your agreements written down, signed and dated. If possible, have an impartial witness sign the agreements as well.
This can make a friendly loan feel stiff, but it’s designed to protect your relationships with loved ones.
Keep Investors Updated
One of the most important steps for any business owner who has borrowed money from family or friends is to update them regularly. Some repayment plans won’t go into effect until your business has made a certain amount of money, which can take years.
Updating your investors every month, either through email or a conversation, is a good way to keep everyone on the same page. It also gives your friends and family more of an emotional stake in your company, especially if they don’t own equity or hold a position in your business.