Part 2 of the two-part series considers the potential drawbacks of raising startup funding from friends and family. Part 1 detailed the benefits. Most of the drawbacks relate to interpersonal issues that can occur. It is important to take the business relationship seriously. Be transparent about the risks, lay out the business plan for the money they provide, and get everything in writing. If you can invest your own personal finances first, friends and family will be more willing to match your contribution.
It takes a special pair of people to not let money get in the way of their relationship, and there is no exception when it comes to borrowing for business. There is always a risk of losing longtime friends or straining family relationships if your startup fails (which 90% of tech startups do) and you are unable to pay back the money loaned to you. Each party should go into the deal professionally and be aware of the potential risks involved with the investment. Make sure the investor is financially secure and understands that they potentially may not see the money again.
Benefits Beyond Funding
Friends and family usually bring nothing more to the table as an investor besides the initial capital.
Investors can give you business advice whereas family and friends may not be able to. Investors can give guidance along with money since they have experience working with startups.
Lack of Clarity, Meddling, Whose In Charge?
Often friends and family do not realize how risky startups can be. They want to support you, but sometimes do so because they expect to make a lot of money from your business. It is important to extremely formal and ask your business attorney to draw up documents on what your friends and family should expect to get out of this investment, as well as all the loan details.
Friends and family frequently have an extremely limited ability to evaluate the potential of your business, though they tend to give advice because of their monetary stake in the company.
With these types of loans it is possible that the friend or family member may feel that they have a right to make business decisions and put their two cents in. If it becomes an issue, you have to remind them that the loan did not buy them a stake in the company and that you will be in charge of the daily business operations
No Credit Reporting
If you get a loan from a family member or friend, it is not reported to the credit bureau. Even if you paid your loan back as agreed upon, your credit score will remain the same, making it just as difficult to get a loan from the bank.
Want To Learn More?
Download our free Raising Capital From Friends, Family & Founders eBook.
This book overviews best practices for raising money from the first people you go to — your family, friends & founders. Dealing with money in personal relationships can get a bit tricky. This guide will cover fundamental concepts, legal issues and material you’ll need. It will help prepare you for the difficult conversations and in some cases enable you to avoid them altogether.