Before borrowing money from a friend, it’s best to decide which you need most.
With bank loans tough to get and credit-card debt unattractive, this American proverb can ring true with many entrepreneurs in need of startup financing.
But asking friends and family for a loan or investment can actually be a great way to go, says Jennifer Martin, principal of Zest Business Consulting, a San Francisco-based small-business consultancy.
“Investments from people you know often make you more accountable and force you to follow through — it lights a fire under your backside,” Martin says. “That’s because the potential loss is greater than if you’re unable to repay a loan from an anonymous source.”
Plenty of entrepreneurs know this to be true. In its survey of 363 CEOs and founders of technology startups, global business law firm Dorsey & Whitney learned that nearly a third counted friends and family as sources of funding. Friends-and-family financing is attractive to both parties because the money is quickly accessible, investors really want to participate, and they understand the company’s financials.
To obtain funding from friends and family, first decide if you can deal with the consequences of a worst-case-scenario. “Ask yourself, ‘What is my comfort level in the event I cannot pay back that loan?’” Martin advises.
Then, get your business plan together. Document the marketplace, any competitors, your product’s market advantage, pricing strategy and profit time line. Identify people in your support system — mentors, advisers and colleagues you will turn to for expert advice throughout the process — and how you will be accountable to them. Put in writing what benchmarks you will reach, by when, and what the consequences will be if you don’t meet them. Then detail how much money you need now and how those funds will be allocated.
“The time that you put into the preplanning stage can dramatically affect your likelihood of success and your ability to repay debt,” Martin says. “Remember, this might be your business, but your friends and family are now, in essence, your bank.”
Hire a lawyer to create a custom contract to be signed by you and the family member. Consider including ways the lender can help your business — by word of mouth or social media promotion or by offering expertise.
Try to keep a church-and-state mentality when communicating with these loved ones about business matters. “The most important part is to keep your business hats on when you are communicating about the venture,” Martin says. “It’s easy when stress levels spike to revert to old dynamics of father and daughter, or an older sister and a younger sister. The better you can be at knowing when you are relating as business partners and when you are family and friends, the better.”
Don’t ask anyone to do something you wouldn’t do yourself. “Don’t ask for money if you wouldn’t also be willing to put your own money on the line,” Martin says. “Show the person what’s on the line for you if your idea doesn’t work out.”
Martin offers these talking points to any entrepreneur approaching loved ones for a business loan or investment:
1. Tell them how much you love them and that you’ve always appreciated their support.
2. If it’s difficult for you to ask for money, tell them so.
Try: “It’s hard for me to ask you this because your [support, love, friendship, etc.] is so important to me.”
3. Explain specifically what you need and the impact it will have on your business.
Now speak to them as professional partners. For example: “I’m looking for a loan or investment of $30,000 in my new business. Is this something you might consider?”
4. Show them your homework.
Tell them the story of your product and business. Make them excited about it. This is the sales pitch, just as you might sell a customer. Say, “Let me tell you what I have learned while doing my research about this business” and then share the high points of your business plan research, highlighting the model for success. Don’t forget to tell them how much of your own money and time you’ve already invested.
5. Specify the proposed funding terms and mention that you have contacted a lawyer to draft a formal contract if you should move forward.
6. Ask what they need to fully consider your request.
7. Ask them when you can follow up with them (then actually follow up on that date).
8. Thank them for considering your proposal, and welcome their feedback.
9. Tell them you will not be upset if they don’t offer funds — and then follow through on that promise.
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