Family- and Friend-Funded Startups: Best or Worst Idea Ever?

May 14, 2016

6:06 pm

Funding your startup via family and friends is becoming an increasingly popular option. Startup funding is the first big hurdle you have to overcome. But there are many who believe that family and friends funding is the worst idea in the world for any new business. We’ll go into the pros and cons of funding your startup through family and friends.

Why Would You Fund in This Manner?

The main reason why so many companies are now funding their ventures through family and friends is because it’s the only option open to them. They have no chance of acquiring trust with the banks because they have either a poor or no credit record. Banks are more conservative after the financial crash of 2008, so getting funding is hard.

Even heartlands like Silicon Valley are spending less, with spending numbers down by 20 percent at the start of 2016.

Another reason why businesses are choosing to use family and friends is because they can get the money faster. There’s nothing worse than having to put your business ideas on hold for six months due to waiting to find out whether the bank will fund your business.

Readily available funding from a close family member or friend allows you to get started with building your business reputation right now.

Understanding the Risks

You already know that the majority of startups are destined to fail. Unfortunately, this is a fact that many of your close relatives may not understand. Your startup has a high chance of failure. It’s something you have to make clear to your family members and friends. They need to grasp the fact that you may not survive the first year.

This is why a lot of entrepreneurs are hesitant to involve friends and family. They don’t want the pressure of potentially costing them their savings.

The Terms of the Loan

Just because you are lending money from someone you know doesn’t mean that you should treat it as anything but a conventional loan. There can be just as many disputes between people who know each other as between an independent lender and a small business.

Write down the terms of the loan. You don’t need to draw up a contract with a solicitor. Any written document signed by all parties would be perfectly valid in a courtroom situation.

You should clearly state how much money you have borrowed, the interest rate, and when you will be expected to repay the amount in full. This will prevent any disputes later because you can simply refer to the contract.

Will You Give Your Company Away?

Startups that are funded by family and friends can get complicated. Sometimes you may have to give away some company equity or provide a place on the board for the person giving you the loan. But you won’t make friends at the office if that person happens to enjoy meddling in business matters they are wholly unqualified for.

You should only work with the person giving you the loan if they actually have something to offer the company, other than their money. There’s nothing worse than a family conflict interfering with your core business operations. Running a startup is stressful enough without any extra problems.

In most cases, entrepreneurs prefer to take the money as a conventional loan without giving up any control of their company. It’s the most hassle-free method of funding via family and friends.

What Other Options Do You Have?

Like many entrepreneurs before you, it may be the case that you decide the added stress of allowing someone to interfere with your business isn’t worth the money. You still have other options available to you, including:

And you shouldn’t automatically discount the idea of traditional loans. It may take a while to actually receive a decision on your loan application, but they do come with no strings attached. You simply have to make the repayments on time and the lender won’t interfere with your business, nor do they gain any stake in your business.

Not for Everyone

Funding via family and friends can work from time to time. If you have the right support network around you, it can be a great idea. It’s a decision you have to make on a case-by-case basis.

Will you look to family and friends in order to fund your business today?

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AJ Agrawal is an entrepreneur, speaker, and writer. He is the CEO and Co-Founder at Alumnify Inc.

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