An LLC that needs money to get started or expand has several options for funding. Asking friends and family for money is an obvious choice, but it does have pitfalls. Cash-strapped entrepreneurs may also want to consider other sources of financing, including bank loans, outside investors and crowdfunding.
LLC Investment from Friends and Family
Friends and family are appealing sources of LLC financing because they can provide quick cash without having to review forms, profit projections and business plans.
But friends and family financing presents some unique problems. Your friends and family may not have experience in business or investing and may not understand that they are taking a financial risk. They may expect big returns and if you can’t deliver, your relationship may be forever damaged.
Minimizing Risks with Friends and Family
If you plan to seek funding from people you know:
- Make sure you advise them of the risk.
- Only take money from people who can afford to lose it.
- Have a detailed written contract to minimize misunderstandings, and specify whether the money is a gift or a loan and how any loan will be repaid.
- Urge your friends and family to seek outside advice before deciding to invest in your company.
When an Investor Gets a Share of the Business
Sometimes, a friend or family member will invest in an LLC in exchange for a percentage ownership of the business. This does not mean that they must become a full business partner. Although most small LLCs are managed by all of their members, LLCs can also be managed by a group of members who act as managers. In a manager-managed LLC, there may be members who invest money and share in the profits but who are not actively involved in the business.
If you have outside investors, you may also need to comply with federal and state securities law. What is securities law? It’s a group of laws that govern stocks and other investments in companies where the person owning the investment does not participate in management. Most small LLCs with outside investors can obtain a securities law exemption. You can speak with an attorney to learn more about security laws.
Other Sources of LLC Funding
Outside LLC Investors
Your LLC may be able to attract investment from wealthy individuals, investment groups, or in rare cases, venture capitalists. These savvy investors will expect you to have a solid business plan and project an image as someone who can successfully run the business and provide them with a return on their investment. Your community’s Small Business Development Center may have resources to help you explore this type of funding.
Loans and Grants
The U.S. Small Business Administration makes loans to small businesses through local banks. To qualify for a general small business loan, you must be able to demonstrate that you need the loan for a sound business purpose. You must have some money invested in the business and you must have used other sources of funding, such as business and personal money, before seeking a loan.
SBA and other bank loans have helped many small businesses get started or expand. However, if your LLC does not have a track record of profits, assets and credit, you will probably have to personally guarantee the loan and/or put up your house as collateral. That means that you risk your home and your personal bank accounts if your business is not able to repay the loan.
An alternative is to borrow money personally and use it for your LLC. This might include a home equity loan or credit cards. But beware: a home equity loan places your house at risk if your business fails, and credit cards can carry high interest rates that make them a poor choice for long-term borrowing.
Finally, LLC grants may be available through state or local governments or nonprofit agencies. Often these grants are targeted to a specific industry.
Crowdfunding sites such as Kickstarter and Indiegogo allow entrepreneurs to solicit small donations online to reach a funding goal. In exchange for their contributions, investors receive a premium such as a product or service.
Crowdfunding is an all-or-nothing proposition: if you don’t reach your funding goal, you don’t receive anything. To be successful, you must be willing to work hard to market your campaign on the Internet and to everyone you know.