.Families and friends are an important source of capital for many small and home-based entrepreneurs. In some cases, they are your only source especially if you have poor credit and cannot borrow from banks or even the Small Business Administration. However, they are also the riskiest as personal relationships are put on the line.
The article “Raising Start-Up Capital: How to Borrow from Family and Friends” suggests some steps to prevent unwanted problems when borrowing from families and friends:
- Choose the right person for whom to ask for money.
- Understand that this is high risk capital and consider how the worst case scenario – e.g. you can’t repay the money back – will affect the relationship
- Ask for money only when you are prepared and ready, when you have done your research and have presented in clear terms the opportunities and risks involved in investing in your business
- Discuss how their investment will be structured – even before you receive the money. Make it clear if this money is considered a debt, or an equity stake in the business.
- Put everything in writing. Even if these are your family and friends, keep the agreement clear and professional, for both your protection.
Speaking of being professional, Inc Magazine offers three suggestions on how to keep the borrowing from family and friends as professional as possible:
- Give investors letter acknowledging their investments
- Pay out attractive interest, giving due consideration to the cost of borrowing money from other sources as well as incremental borrowing cost
- Includes a clause that allow investors to get their money back at any time
