Financing Your Business with Your Family and Friends

By Karlene Sinclair-Robinson

Using your family or friends to finance your business might seem as though it is a non-issue. If your business is in need of a cash infusion and your family or friends can be that conduit, why not go for it? Well, this depends on whether or not you have fully assessed the ramifications of such a transaction.

I was instructing a class of startup business owners not so long ago and this topic became a lively discussion. In the middle of the discussion, it was noted that one of the students was in the middle of this type of financing solution. The student willingly shared some major issues that they had not anticipated when the transaction first occurred but now must figure out how to deal with it.

Here are a few areas that should be addressed prior to borrowing from family and friends:

1.    Legal Advice – Getting legal counsel prior to having these individuals invest their hard earned money in your business is very important. This will help you alleviate major pitfalls that you would not necessarily know about without the help of a qualified attorney.

2.    Put It In Writing! – It is extremely important that when you obtain financing from these sources that it is carefully documented. This documentation or agreement should include parties involved, terms such as length of the loan period, interest rate and ownership rights (if any), any applicable options as agreed to, signatures and date of said transaction.  It is also important to have a third party or a notary signature.

It is important that these investor sources are aware of your business position and plans to repay them. They want to know how soon they can be repaid, and why not?

3.    Unknown Factors – When you engage in this type of a monetary transaction, many things can change. It could be the health of the family member taking a turn for the worse or the friend whose spouse just lost their job and will need their funds back much sooner than anticipated. This can create rifts amongst family members or derail a friendship. You have to work on contingency plans in the event there is such an emergency.

4.    Entity Status – Here is something that some “sole proprietors” tend to overlook. When you borrow from individuals as a sole proprietor and without the protection of written documentation, this can create some major issues.  One such issue could be the spouse of the sick individual who invested in your business could now try to stake a claim in your business. Creating an entity prior to them investing in your business will help you by limiting your “risk exposure”. It does not stop there as section 2 pointed out: PUT IT IN WRITING.

It is easier to prevent some things from happening, mind you though, not everything. With that said, the above four items are solutions to help you figure your way out to additional cash infusion. It is important that all parties are on the same page.