Getting financing for a small business isn't as easy as you might think. Banks have tightened their lending requirements since the 2008 financial crisis, and only a tiny fraction of small businesses are funded by venture capital and angel investors.
This can leave you navigating the murky waters of asking your family for money. In a perfect world, family members will relish your success or understand if things don't work out. But few families are perfect. If your business succeeds, your relatives may be annoyed if they're not sharing in the profits. (Think how you'd feel if you'd given Steve Jobs a thousand dollars so he could start his computer business.) Or, if your business fails, your closest relatives may resent you for “squandering their money."
A careful and methodical approach can help you avoid these pitfalls. Here are five tips:
1. Start With a Business Plan
In your business plan, you'll refine your business idea, strategize how you'll deal with the competition, and develop a marketing plan. You'll also calculate how much money you believe you will need, what your cash flow will look like, and how long it will take to become profitable. If your business plan is more than about 10 pages long, you can prepare a summary that highlights the major points in an easier-to-read format.
2. Decide How to Structure Your Family Funding
Depending on your family and the amount of money you need, you may be looking for a relatively large contribution from one or two people, or you may decide to ask everyone in the family for a small amount. You also have several choices for how you set up the deal. Some of the most common include:
- A loan. A loan must be repaid, and you need to consider the term of the loan, the interest rate, and how you will realistically pay it back if the business fails.
- An investment in exchange for a perk or discount. Crowdfunding campaigns often work this way. Depending on how much you invest, you will receive a gift, product, or some other perk. This can be a good way to thank family members who give you a small amount of money.
- An investment in exchange for a stake in the company. Family members who contribute a larger amount may want an ownership interest in the company. This can raise all sorts of issues, including the possibility that you will lose control of the business or have to buy out your relative in the future. And a relative who does not have business experience may not understand the risks involved.
It's a good idea to talk these possibilities over with a lawyer, so you understand the legal and tax consequences before you approach your family.
3. Write a Pitch
To persuade your family to fund your venture, prepare a sales pitch where you talk about your new business, explain why it's a great idea, and tell them what you need from them. Practice it until you can talk comfortably about your plans.
4. Meet With Your Family Members
Find time for an informal, one-on-one chat, where you can pitch your idea and answer any questions. If relatives seem receptive, offer them a copy of your business plan or summary.
5. Put Everything in Writing, so there Are No Misunderstandings
A bank would never give you money without signed documents specifying the loan amount, repayment terms, and interest rate. You shouldn't approach family money any differently. If you think legal documents seem too formal, remember that misunderstandings about money can divide families in ways that take years to heal. A lawyer can prepare the right kind of documentation—whether you're receiving a loan, granting a stake in the company, or sending a small token in exchange for an investment.
Once you've received funding from your family, it's important to manage your relatives' expectations. Send out regular email updates to let them know how your startup is coming along. Tell them about your challenges, as well as your successes. Your family members are far more likely to be patient and understanding if they know what's going on and can see that you are thinking of them.