There is any number of ways to fund a business. You can go after a traditional small business loan, attract an equity investor, or piece together an array of assistance, from home equity loans to your credit cards.
But one of your best resources may be closer than you think.
Funding With Friends and Family
When it comes to funding a startup, most people are not particularly aware of how financing works. Because the media tends to cover bigger stories, in which startups attract obscene amounts of seed money, inexperienced entrepreneurs might presume that venture capitalist and angel investors have money burning holes in their pockets.
Though that might be true of the big spenders, these equity investments are few and far between … especially if you’ve got a small, early-stage startup.
According to research on the topic, less than one percent of all startup funding comes from venture capital and angel investors combined. The majority of funding — 57 percent to be exact — comes from personal loans and credit.
But the second leading source of funding is friends and family. In sum, investments from friends and family of the company owner account for 38 percent of all startup funds: $60 billion annually!
Though many entrepreneurs don’t think of their friends and family right away, this alternative typically entails the least amount of legal hassles. The paperwork is usually minimal, and there isn’t any of the extensive due diligence that bank loans demand.
Depending on your personal network and the type of people you know, it could even be the most lucrative option. “With respect to funding range, in our experience, the average amount of funding that people usually get is between $5,000 and $500,000,” explains Seek Business Capital, a leader in small business startup loans.
“The funds are very flexible because you can use them for anything that you want, in contrast with SBA startup loans where you are required to only use the funds for approved expenses.”
Still, for all the advantages of investments from friends and family, you could also encounter some potential downsides. These include the potential for strained or damaged relationships … particularly if the startup fails.
If you consider friends and family as a funding option, take the necessary time to weigh all the pros and cons. You won’t necessarily see a clear-cut choice, but the proper amount of research should ultimately help you make an informed decision.
Five Tips for Borrowing From Friends and Family
You can’t expect friends and family to fork over money just because they care about you. Money is money, and they’ll probably require some persuasion. Here are five tips for how to win them over:
1. Be Selective
For starters, you need to be selective about whom you pitch. Gathering too many friends and family members together for one big presentation can make you appear desperate. It’s far better to make a short list of the most promising candidates and pitch them individually in an intimate setting.
2. Develop a Pitch
Just because you have casual relationships with your friends and family, that doesn’t mean you can be casually informal in how you pitch the idea. For best results, come up with a somewhat formal presentation, closer to the way you would try to interest a professional investor you don’t know.
3. Tell a Story
A good pitch is one that paints a picture and tells a story. Data points and concrete information are vital, but you should try to avoid getting too technical with this audience.
You need to get them excited about the potential of the business, while simultaneously depicting the venture as a solid financial investment. Don’t be afraid to alter your story based on the person you’re pitching to 98-year-old Grandma Ethel and 31-year-old Cousin Rick will have different motivating factors, experiences, and resources.
“Too many people create one pitch deck and pitch the exact same thing to every audience. Instead, do your research,” sales professional Ruthie Miller advises. “Customize your deck per audience. It’s not a huge time commitment, and the results could pay dividends.”
4. Be Realistic
Don’t go in asking for $1 million in financing if you know that your family and friends are working middle-class jobs and have moderate savings. Be realistic about what you need and what you expect them to contribute. Something is always better than nothing; you don’t want to come across as greedy or needy.
5. Set Smart Terms
It’s crucial to provide specific terms and conditions for the investments you receive from friends and family. You should be ready to address such questions as Will your backers be receiving equity? Are these strict loans? Is the debt convertible or non-convertible?
It’s a good idea to schedule the first payment six months after the business opens. This will give your investors some confidence and is more likely to keep everyone happy. The rest of the terms should also be clearly identified ahead of time.
Understand the Risks and Challenges
Friends and family can represent an excellent source of startup capital for your new business, but make sure you take all the risks and challenges into account.
“Never allow friends or family to invest their life savings or drain their retirement account, even if they are willing,” UpCounsel advises. “This kind of personal risk puts too much pressure on you to return their investment. Only accept what they can afford to lose no matter your level of confidence.”
You also have to be prepared for overly involved investors. Because friends and family have personal relationships with you prior to and beyond the investment, they may feel like they have the freedom to say and do things a traditional investor wouldn’t dream of attempting.
In order to prevent this from happening, be as formal as you can in your business interactions with your backers, and try to draw a line between your personal and financial dealings.
If you do a good job of selecting the investors and setting the terms, you may find this form of startup funding is one of the best and most versatile. Do your homework, then enjoy the ride!