There are many different ways you can finance your new business: a bank loan, venture capital funding, or even crowdfunding. But if you've tapped out the traditional methods, including your savings, retirement accounts, and the equity in your home, obtaining money from family and friends is a great way to get or keep a business going.
It is common for small business owners to start up a business by using funds from family and friends. Borrowing money from family and friends or giving them an equity interest in the business is much easier than obtaining funding from a bank.
Benefits of Borrowing Money from Family and Friends
Unlike a bank loan, acquiring private money does not require filling out paperwork or waiting for the loan to go through. Obtaining financing from friends and family offers several advantages.
Asking for Money
Asking friends and family for money for a business endeavor can be uncomfortable. Money is a touchy subject, but if you believe strongly in the business and the possibility of its success, it will be a lot easier to sell friends and family on the idea.
Depending on how well you know the potential private lender will determine the appropriate environment for making your sales pitch. In the living room or at the kitchen table in a home, in a coffee shop, or at a restaurant are all appropriate places. Take these steps when planning to obtain financing:
Put the Terms of the Loan in Writing
The terms of the lending arrangement should be in writing. An arrangement should include the terms regarding the interest rate, late fees, repayment terms, and the length of the loan. A written agreement establishes the legal obligations of each party and defines the important terms of the arrangement.
Offer an Equity Interest
Some friends and family might prefer an equity interest in the business. An equity investment will give the investor a share of the business. This means that the investor will share the profits and losses as a co-owner of the business. Unlike a loan, if the business fails there is no obligation to pay the investor back. The investor, therefore, bears all risk, unless there is a guarantee on the investment.
Most investors are unprepared to risk more than they have invested. A business that operates as a sole proprietorship becomes a general partnership when an equity investor becomes a part of the business as a co-owner. General partners are subject to personal liability for the debts of the business. To shield an equity investor from bearing more loss than the initial investment, consider converting the business to any of the following business structures if you offer an equity interest:
Get Legal Help When You Need It Most
If you're considering seeking financing from a friend or family member, you'll want a business law attorney on your side. A qualified attorney can help you negotiate important terms and ensure the agreement is in writing.