Friends, family are key sources for startup capital

Using cash from friends and family to start businesses is a quite common practice. It is estimated that roughly half of startup entrepreneurs get financial support from friends and family members in starting their companies.

According to the Global Entrepreneurship Monitor (Babson & London School of Business), $50 billion to $75 billion is invested annually by friends and family in United States startup entrepreneurs. This is two to three times the amount of money invested annually by either angel investors or venture capitalists — each of which invests approximately $20 billion per year in new businesses. 

Just who are these “friends and family” investors? Entrepreneurs commonly pursue investment from anyone they know personally who can afford to make the investment, such as parents and grandparents, aunts and uncles, neighbors, even their minister or high-school principal. These friends and family members will invest in your business because they believe in YOU, that is, the entrepreneur’s demonstrated work ethic, integrity, curiosity and passion to succeed.

These friends and family investors usually don’t have adequate business savvy to evaluate the investment opportunity presented or the ability to advise entrepreneurs on growing their business. In fact, they are not investing in your company — they are investing in YOU. Sit down with friends and family investors, explain your business plan to them and ask for the money. You will be surprised with your success.

BUT…don’t just accept their checks with a grateful thank-you. Discuss the nature of their investment…and then document each investment in writing. Is this cash a gift? Is this a loan? If a loan, what are the terms and conditions of the debt? Is this an equity investment, for which the investor expects shares in the company? If equity, for what number of shares in the company?

While these questions seem trivial at the outset, they may become critical in the future. If you and your friends and family investors do not decide in advance, you may be allowing this investor to decide later. If she then decides the investment was debt and the company fails, then your dear old Aunt Emma may still want her money back from you personally. On the other hand, if she later decides the investment was equity and the company is successful, then just how much of the company does Aunt Emma own of your new company?

I’m not advocating a position (gift versus debt versus equity); instead I am urging entrepreneurs who accept friends and family investment to clarify the expectations of the investor.

One of the biggest mistakes entrepreneurs can make is neglecting to clarify the relationship with friends and family investors. Whether this business succeeds or fails, relationships with friends and family are important to maintain. Entrepreneurs routinely successfully pursue funding from friends and family. Friendly advice: Clarify the nature of the investment at the outset!

Columnist Bill Payne is an entrepreneur and angel investor. He may be reached by e-mail at  bill@billpayne.com or go to his Web site at  www.billpayne.com