It’s tempting to ask friends and family to invest in your work when first starting a company. Money is tight and they want to help. However, soliciting money from loved ones can be a risky venture. To help mitigate this risk, we asked seven entrepreneurs from Young Entrepreneur Council what rules one should always have in place before raising money from family and friends. Here’s what they recommend.
1. State Gift, Loan or Equity Very Clearly
You have to be clear from the start and make sure you state your terms with ABSOLUTE understanding on both sides. Is this a gift? Great! You don’t have to pay it back. Is it a loan? Still great—make sure you write out the terms of the loan and when it’s expected to be paid back. Is it equity? Make sure you write the terms out for when you have to pay them back due to your profit or cash-out. – Tweet this!
2. Have a Contract
Give family and friends the same contract and terms you would an angel investor—there are widely-used templates available for free online. One benefit is that you get all the terms down on paper, just like in any situation. But more importantly, you’re communicating that this is a serious business relationship. Tell Uncle Jessie that he should run the agreement by his lawyer before signing. – Tweet this!
3. Don’t Do It
One of the biggest mistakes entrepreneurs make is borrowing from friends or family. The reason this is a mistake is simple—nothing ever goes according to plan. You end up with a high risk of bringing work home, fighting over it, or even worse, owing them forever (if you can’t pay it back). The rule is this: Don’t borrow from friends or family. – Tweet this!
4. Have Objective Third-party Advisors
All parties should have objective professional advisors protecting their interests. Because of the relationship, one or more parties may be inclined to give more than is appropriate, which will pressure the relationship when problems arise. By also having an arms-length negotiation, professionals can protect their client’s interests and even the relationship by acting as the bad guy when necessary. – Tweet this!
5. Communicate Risk Honestly
One of the most important things to communicate is the degree of risk. If the contacts you’re talking to haven’t invested before, it’s very important to educate them on the failure rate of early stage startups and the likelihood that they’ll see a return. Without that disclaimer, relationships could suffer if the investment doesn’t pan out the way you hope. – Tweet this!
6. Expect the Worst
Don’t do it. But if you do, be willing to lose them as friends or family. Seriously, expect the worst. Assume it won’t pan out, assume they won’t get the money back. Where would this put you with those people, and how would it effect your relationship with them? – Tweet this!
7. Only Accept Money They Can Afford to Lose
You have to be upfront and completely transparent on this point. It’s your responsibility to make sure that family members fully understand the risks before parting with their money. And if they can’t afford to lose money, do not accept their investment. – Tweet this!