Borrowing startup money from friends and family needs to be done professionally to avoid damaged relationships.
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Whether it's right at the beginning or as the business begins to grow, most startups require outside financial resources to fund their operations. Entrepreneurs whose companies are too small for venture capital and too new for a commercial-business loan often think of turning to family members and friends for monetary support. But asking for money from loved ones can sometimes put both parties in an awkward position.
"Some individuals receive help from parents or grandparents in the form of a gift, and no repayment is expected," said Debra Doran, managing partner of the Seattle branch of financial consulting firm CTC Consulting | Harris myCFO. "If you think that someone has made a gift, and that individual thinks he or she made a loan, you have already built into the process a misunderstanding at best, and a potential lawsuit and damaged relationships at worst."
To make your funding requests to family and friends go as smoothly as possible, Doran advised taking the following five steps: [4 Ways to Win Startup Investors]
Know how much you need, and from whom. Determine the amount you wish to raise and how many people you will need to approach in order to meet your funding goal. Are there family members or friends who have had success at starting and building businesses? Could they be good mentors in addition to investors? Decide which individuals you will ask for funding and the amount you'll request from them. Be clear about what you are seeking, and know the ramifications of what kind of funding you will receive.
Prepare a business plan and other relevant data. Approach the request for funding as though you were preparing to ask a financial institution for a loan. Have you prepared a business plan? Do you have data on the marketability of your idea? Are your business projections and cash-flow needs realistic? Family members and friends will be more willing to give you funding if you approach them professionally and are prepared to succinctly answer questions about your business.
Practice your pitch. Preparation goes further than the business plan, marketability study and financial projections. Practice your pitch with other friends whom you will not solicit funding, and get feedback as to how it comes across. Don't let familiarity dampen your professional approach, either: This should not be a casual request just because you are pitching to an audience who knows you well. Treat each family member or friend as if he or she were a venture capitalist or the head of a lending institution.
Determine and document the type of loan from each investor. Are you asking for a no-strings-attached gift, a loan or an equity investment? With a loan, you will need to repay with interest, whereas with equity investments, the investor will share the success or loss in the venture. Make sure you document the terms between the parties. Any startup business involves risk, and that needs to be communicated clearly. Potential problems can be avoided if expectations are clearly set at the beginning of the process.
- Keep investors in the loop. Onceyou receive funding from your family and friends, continue to communicate with them about your business. Talk about the good and bad, because learning from mistakes is part of the process. If you eventually need additional investments, keeping your investors updated should help with the process of asking for more money. Frequent and candid communication about the progress of the venture will enhance the family communication and potentially prevent feelings of hurt or anger.
"Finding ways to fund a new venture is never easy, but having a well-thought-out game plan will increase the odds of family members and friends agreeing to be your financial partners," Doran told Business News Daily. "Business success is not assured, but by professionally approaching your family and friends to support your efforts and communicating frequently on the progress of the business, the chances of maintaining good relationships are significantly higher."
Originally published on Business News Daily.