Asking for business capital from people you know is very different from putting in a loan application at the bank. The good news is that you already have a personal relationship, so chances are they won’t run a credit check or ask you to put up your home as collateral, and may even give you a good deal with a low interest rate. The bad news is that the whole process – from asking to repaying – can be emotionally charged and an administrative hassle.
Here are the Top 10 Tips on how to navigate these potentially rough waters to access the capital you need:
- Look for entrepreneurs. Seek an older, wealthy individual who has been or still is an entrepreneur. Studies show that these folks are most likely to make informal loans and investments in the businesses of people they know.
- Pay close attention to the personal relationship. Don’t ask for money from people who can’t afford to lose it — such as those on a limited, fixed income — especially if you know they’ll have a hard time saying no to you. Also, be sure you’ll both feel OK about it when you owe this person money. Trust your gut and don’t take money from someone who will be a thorn in your side.
- Be prepared. Have a business plan ready. Grandma Rose deserves a good description of how you plan to use the money, as well as when and how you will repay her. Decide in advance of the request how much you need, what interest rate you’ll pay, and what kind of repayment plan and security you can offer.
- Use email to introduce your business idea. Email is a great way to cast a wide net, gently and informally. Describe your concept and invite anyone interested to contact you for your business plan. Follow up with those folks, discuss your need for capital, and ask if they have any suggestions on how to raise it.
- Ask for advice. If it’s too hard or awkward to ask for money directly, ask for advice. Explain what you’re trying to do, describe what you need and ask for suggestions on how to accomplish your goals. You’ll be surprised at how many of these conversations actually end with an offer of financial support.
- Suggest a range, instead of a fixed amount. When you finally start talking about money, let your supporter decide the amount by providing the range needed. If you don’t feel comfortable using a range, suggest up to three options.
- Offer a competitive return. Offer an interest rate that is better than what the person could earn in a similar-term financial investment. For example, if the return on a 5-yr CD is 4.5%, offer 7% to really grab their attention. Chances are, you would have to pay 8 or 9% to borrow from a financial institution, or more on your credit card, so it’s still a good deal for you.
- Make the request informal. If you make the request in person, be yourself, describe your business and your passion for it, describe your fundraising effort and gauge their interest. Indicate why you thought of them in particular. But don’t confuse informal with unprepared. Show the person that you’re prepared with a business plan, and have ready the financing options you hope they’ll consider.
- Make the agreement formal. The secret to successful private lending is to treat the agreement you reach the way you would if it were with a stranger. If it’s a gift, you only need a letter from the giver. If it’s a loan, you need a promissory note signed by the borrower and a plan for repayment. If it’s an equity investment, you need a stock purchase agreement. When you formalize the agreement, both parties feel more confident because expectations are clear and both parties’ interests protected.
- Offer to have the loan managed by a professional. Companies like CircleLending can formalize and manage your private loan, all the way down to sending you an email to remind you that monthly electronic funds transfer from your bank account to your lender’s is about to occur. Having a third party creates a neutral buffer to handle the business of the loan, allowing you to keep it arm’s length from the personal relationship.