If your small business needs funding, there are multiple options. Many people think first of loans or lines of credit from traditional lenders, such as banks and credit unions. But don’t overlook asking friends and family! Roughly 10 percent of small business financing takes place this way, according to a recent survey of small business trends we undertook.
Asking family and friends to invest in your business has multiple advantages. They are likely to be more flexible in the terms, such as the repayment schedule and interest rates. Obtaining funding is likely to be less expensive, without application fees to a lender. The requirements of a traditional lender like a bank may be stringent in ways many small business owners find challenging, such as three years’ worth of business history and a three-year forecast to boot, or a stellar credit rating. Family and friends are likely to be more flexible in the history and forecast area, and they’re unlikely to want a credit score!
At the same time, though, asking family and friends for small business funding can come with challenges. As a business owner, you will need to prepare business documents that in some respects are similar to the ones a lender would use to assess a loan. You will need to make a pitch, just as you would with investors or lenders you don’t know.
Some of the challenges are unique to friends and family. You don’t want to damage the emotional bonds and relationship. You will need to choose wisely which friends and family might be good sources of financing and interested in backing you. You will need to make sure that both they and you feel fairly treated. You will need to communicate clearly, both when asking and during the funding period.
Here’s a best-practice guide to how to approach getting money from friends and relatives for your business.
Prepare a Business Plan
You will need to give friends and family a business plan, just as you would other investors and lenders. At a minimum, the business plan should include a mission statement, a description of your business and products, an overview of why you think the business will be successful (your unique selling proposition and any market and competitor analyses), and financial statements.
Your financial statements should include any existing balance sheets, income statements, and cash flow statements for the past three years. It also needs to include forecasts for at least three years. Your friends and family need to see how much your products cost, what your revenue projects are, and more.
The business plans should be professionally prepared. You can do them yourself, of course, but “professional” in this context means they need to be typed, formatted appropriately and clear — not only verbal, and not scribbled on a napkin! Your family and friends need to think carefully about your business and the effects of your request on their life. To do that, they need a copy of the business plan for your pitch session and to refer to afterward, as they make their decision.
How Do You Pitch?
What’s the best way to pitch? First, have your business plan prepared and reviewed.
Second, spend some time thinking about your ask — the part of the pitch when you ask for the funding and give your reasons. Here are some steps toward the ask.
1. Determine how much funding you need
It’s all too common for small businesses to ask for too little at first. Think carefully about what you need, price it well, and consider any ramifications. If you need office equipment, for example, does that mean you’ll eventually need more space, and thus have to pay more rent or buy a space?
Your pitch will need to include how much you need from potential investors, and for what purpose. It is working capital, operating cash, or money for expansion? The more clear and definite the purpose, the more likely it is to be persuasive.
2. Decide what form you want the funding to take
There are three forms money from family and friends can take: 1) a loan, 2) an investment, in which they own equity in the business, and 3) a gift. There are big differences between the three.
With a business loan, you will need to pay the money back. You will need to pay the money back at mutually acceptable terms (interest rate, length of loan, when and how much you will pay). To make the loan official, you will need to create and sign a promissory note (you should hire a lawyer to help you with this part). The advantage of a loan is freedom; you have complete control over your business.
With equity investments, the funding you receive translates into some ownership in your business (in other words, in exchange for equity) for the friend or family member. They may want some control in running the business or a say in the business decisions in exchange for the equity stake.
A gift is money free and clear, with no obligation to pay it back. Gifts do need to be documented for tax purposes, though, for both the giver and receiver.
3. Choose a time and place for the pitch
Don’t spring a request for funding on friends and family suddenly! Set up a mutually good time and place. It could be after a family get-together, after a dinner out, or in your conference room, depending on what’s comfortable for all parties. Make sure they know you will pitch them on a funding idea, and make sure they know roughly how much time will be required to hear the pitch and ask questions.
4. Answer all questions
You’re asking family and friends to put up some money and devote some time to backing you. It’s only natural for them to have questions about the business and your plans. Answer all questions completely and thoroughly. If you don’t know the answer to some, be candid. Tell them you need to gather more information on the topic yourself. Then, find the answer and get back to them.
5. Think about contingency plans
It’s very common for family investors to ask about contingencies just as professional investors might. What happens if you don’t meet your sales forecasts, for instance? What happens if raw material prices skyrocket? It’s understandable that they have these concerns because it’s possible you won’t be able to make loan payments or keep your business afloat in the way you’d planned.
So have some contingency planning in place. If you have to skip a loan payment, for example, how will you make up for it? How does it affect the repayment terms? Will you pay more over the life of the loan? You need to reassure them that they will not lose any money or equity they contribute.
Which People Should You Approach?
You need to prudently choose family members and friends to approach. You also need to know which ones not to approach.
First, the folks you approach should be in a position to help you financially. While you might not always know the details of their financial circumstances, choose people you appear reasonably well-off and established. Your great-aunt on a fixed income or your younger sister who just had twins and bought her first house last year may not be candidates for family loans, as they may have little left over once they take care of their own financial needs. But your college roommate who’s now a hedge fund manager, or a great-uncle who just sold his own business? They may be excellent candidates.
Second, they should also be interested in helping you. They may be close to you emotionally or long-standing people in your life who cheer you on and want to see you do well. If you have challenging relationships with a family member, they are likely not the best candidates, even if they are able financially. It’s said that choosing professional investors is like getting married — the relationship is that long-standing and serious. The same is true when getting loans from friends or asking family for money: you don’t want to risk straining the relationship.
Third, look for people who might be interested in the business itself. For either friends or family members, it might be an opportunity to see how a business operates, how products are made, and so on. They don’t have to work with you, but it can help if they find the process intriguing. It’s an additional something for them, in addition to loan payments or equity.
Getting It On Paper and Making It Official
While you may have personal relationships with these people, obtaining funding from them needs to be placed on a business footing. Doing so protects the personal relationship from things that can go wrong, like guilt or feelings of being unfairly treated!
To that end, you need to get details on any funding you get on paper and make it official in the form of a promissory note. If you obtain a loan, you need a contract specifying the amount, the payback schedule, and the interest rate, if any. If they will have equity, you need a contract specifying how much they own and what their rights and responsibilities are, if any.
If the funding is a gift, that has tax implications for both you and the giver. The Internal Revenue Service will require documentation that it’s a gift and not a loan.
It’s prudent to consult with lawyers and accountants throughout this entire process.
How Guidant Financial Can Help Small Business Owners Get Funding
At Guidant Financial, we know how important funding is for small businesses. We offer a multitude of funding solutions and advice, geared to your needs and business sector. Contact us today to get started.
