You may find it easy to raise money from family members because, well, they love you.
Someone who loves you and believes in you may not ask the same hard questions that a professional lender or investor will. They’re more likely to give you the money you need with very few strings attached – if any.
Failing to do their due diligence presents risks to both giver and receiver. Explore these issues before you accept business funds from any relative or friend.
Debt or equity
A relative who ‘gives’ money to you for your business may be unclear regarding the classification of the funds – and the kind of deal their money buys them. Decide how you will document any funds received before you accept them.
Debt financing is a loan, usually involving interest (although some family lenders may not want to levy interest). Define the:
- Repayment terms.
- Repayment method.
- Interest, if applicable.
Be careful about setting it up as a secured loan, which could attach your personal assets.
Are they lending to you personally, or to the business? It’s an important stipulation because money received by you personally (to inject into the business) impacts your estate, while money received professionally will affect your business. Make sure you’re clear.
Equity involves share ownership in your business. Shareholder status opens up a number of issues and potential complications.
For example, will your family investor receive common (voting) shares? Or, will you issue preferred shares that will return a dividend? What happens when your family member sells or transfers those shares?
When someone buys stock in your business they become a business partner. For this reason, you may prefer to qualify the funds received as a debt your business can repay. Consult your team of advisors.
Define the expectations of your lenders
It’s unlikely that your mother will ask to see your business plan before she writes you a cheque. That can be a mistake, because your plan – and the ensuing conversation surrounding your plan – will help to define investor or lender expectations. So you should show it to her anyway, and make sure she understands it.
The more casual nature of family financing can create two very different sets of expectations. For example, your dad may not be experienced in business matters and might simply assume that you’ll pay him back when you can – which means he’s expecting a cheque the next time your business secures a sale.
You, on the other hand, may define ‘pay back when you can’ to comprise smaller, monthly loan repayments to begin when your business achieves positive cash flow.
Ensure clear communications
Clear communications between both parties should help to openly define:
- Expectations pertaining to repayment.
- Any involvement or implied rights in your business operations.
Protect your relationship
I remember an entrepreneur who accepted business funds from her father. She wisely inserted this condition in the loan papers: “Dad can’t ask about the business or his money during family occasions.”
Knowing her father well, she wanted to set boundaries around the business transaction to protect the more important personal relationship.
Look beyond the individual
Right now you’re accepting funds from Aunt Rose. She’s a reasonable and kind person, who believes in you and your business vision.
What if Aunt Rose suddenly dies? Now, you’re dealing with a completely different lender – her estate. This may involve:
- Her not-so-friendly heirs who are anxious to collect on that debt.
Money transcends relationships. Think through such scenarios and their impact on you and your benefactor.
Draw up papers
They say good paper makes for good friends.
While you might trust your life to Cousin Jim, Aunt Susan or Nana Smith, in a business context you must treat them as strangers and insist on drawing up a professional agreement to document and define your financial transaction.
Money can change everything, so it’s imperative that all parties can refer to a well-constructed agreement that’s signed before any funds are transferred. A legal agreement protects your family too, because they’ll know their rights in case something happens to you or your business.
Hire a lawyer
Hire a qualified lawyer to work with you to develop an agreement – and insist your family members review the document with their own independent counsel.