Small Business

The Pros and Cons of Family-Funding a Business

When it comes to starting a new business, capital from friends and family can be a tempting source of initial funding. Like any source of capital, getting funding or taking on investments from those close to you has upsides and downsides.

Potential Advantages of Financing a Business Through Friends and Family

Assuming that your relationships are strong, and that those you’re seeking to borrow from have the cash to spare, acquiring private funding from people in your inner circle can be a fairly simple process.

Unlike traditional lenders, those close to you are less likely to judge your funding request based on your personal credit rating or business credit score. Instead, they’ll likely base their lending or investment decisions on more personal criteria.

There’s no lengthy application process when borrowing from friends and family. If they trust your business acumen, believe your business idea is sound, and have faith that you’ll make every effort to pay them back, then chances are good that they’ll contribute whatever they can to help.

Loans taken from friends and family often can have more favorable terms than those offered by financial institutions. These lenders are more likely to be flexible with their interest rates, or not charge any interest at all. Likewise, they’re less likely to require collateral. Additionally, their repayment options will possibly be more flexible than the schedules set by banks or credit unions, and they’ll probably be more willing to adjust those terms, should the need arise.

If you choose to bring family members on as investors, they may be willing to accept more modest returns than those sought by more traditional investors. To them, seeing a loved one succeed in business and in life may count as compensation in and of itself. And unless your private investors have experience in the field you’re venturing into or a high level of business savvy, they may be more interested in being a silent backer than in taking an active management role, leaving you to run the business according to your personal vision.

Potential Drawbacks of Family Funding

Any startup business, no matter how viable or well-intentioned, carries a certain degree of risk. Friends and family tend to be very trusting when it comes to lending and investing in the business ventures of the people they care about. However, it’s important that they be made aware of the risks inherent in any new venture before putting their hard-earned cash on the line.

While family members may be less likely to require formal agreements, it’s still a good idea to put the terms of any transaction in writing, and to review and sign with all parties involved. Make sure to consult with a qualified lawyer for legal advice before you move forward with any efforts. Unless everything is clearly spelled out from the get-go, conflict may arise if one party believes the other is not holding up their end of the bargain. The last thing anyone wants is to end up embroiled in a heated lawsuit with a family member, but such unfortunate situations are certainly not unheard of when mixing business with family. Make sure you take all the proper steps to avoid any conflict.

Spelling out expectations can also help reduce the potential for confusion regarding repayment or compensation. If the business fails, there may be disputes about whether or not the investors should be repaid. Conversely, if it’s wildly successful, there may be misgivings about what the return on investment should be and how it should be distributed.

Another reason to formalize any lending agreement with a friend or family member is to ensure that roles are clearly defined. Your backers may assume that investing or lending money in your business entitles them to a certain amount of influence over the manner in which the business’ affairs are conducted. If that’s not what you have in mind, it’s best to make that clear (in writing) from the outset.

The final consideration to take before involving your friends or family in your business endeavor should be to make sure the decision is going to be wise for the overall health of your relationship with each other. Even successful ventures can stress relationships and lead to disagreements and conflicts. This is something you should seriously consider before you put your relationships on the line for your business dreams.

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