Start Your Business
Do's and don'ts when friends and family fund your startup
Consider timing, choose lenders carefully, and discuss all details up front
When you start a business, it can be difficult, without a track record or collateral, to find venture capitalists or angel investors to underwrite the first stages. Entrepreneurs report not only digging into their own savings, but seeking loans from their personal network—pitching their parents, cousins or college roommates.
If you're asking friends and family to contribute financially to your business, consider the following tips from Martin Zwilling, founder and chief executive officer of advisory company Startup Professionals.
Do: File your business paperwork before asking for funding
Officially establishing your business signals to your funders that you're serious about the endeavor—that it isn't just a hobby, Zwilling says. A legal structure also provides a framework for responses in the event of financial losses. The best business structure for your company will be informed by the type of business you are starting, along with many other factors, so work with your attorney or tax adviser to make this important decision.
Don't: Take money from anybody willing to give it
Consider the background and financial position of people before asking them for funding. Zwilling points out that people with business experience are often the best source of capital, since they are more likely to understand the inherent risk in any business investment.
Another key characteristic of a good friend or family investor is someone who can afford to part with the funds in the event of failure. Keep in mind that more than money, your relationship is at stake.
Regardless of who you approach for funding, clearly explain the realistic payback scenarios in order to manage expectations.
Do: Get it all in writing
"It's a recipe for disaster," when entrepreneurs don't spell out all the details of funding transactions on paper, says Zwilling. Key elements to specify include the amount of funding, along with how, and when, you'll pay it back. Will you do re-pay funds all at once or in several payments? Agree on the amount of interest or other return that they'll receive. Consulting with your attorney or tax adviser about how companies typically structure these arrangements may be helpful.
Don't: Get your funds in the form of a short-term loan
You don't want to have to repay borrowed money before your new business has funds to spare. "Revenue always takes longer than you think," says Zwilling, noting that new startups may not have positive cash flow for years.
Extend the repayment schedule out as far out as possible. Or better yet, tie loan repayments to the revenue you will eventually generate. That way, you're not committed to making payments before you have the cash. Work with your accountant to build realistic cash flow projections, and then make a repayment plan based on that.
Do: Communicate frequently
Your funders may be people you've known all your life, but give them the same kind of attention as you would a professional investor. Promise regular updates on your progress—for example, one detailed email each month—and deliver on schedule.
Communication should be one-on-one whenever possible, tailored to the expertise level of the recipient. A cousin with an MBA will appreciate detailed reports, while a family friend with no business experience may just want the headlines.
Share milestones such as signing a lease for a location, hiring staff or gaining a new distributor. Keeping your investors informed will help those relationships stay strong through the inevitable ups and downs of a new venture.
Laura Schreier is a Chase News contributor. She has contributed to CNBC.com, Banker & Tradesman, the Hartford Business Journal, among other media outlets.