The Pros and Cons of Friends and Family Investors

Posted on August 18, 2010

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Despite economic stimulus plans and Small Business Association incentives, many entrepreneurs are still having trouble finding start-up funds. As the Wall Street Journal recently pointed out, this means that aspiring business owners turn “to a capital source often better suited to slow-growing times: friends and family.”

Bad economy or not, friends and family are usually the first fundraising target of entrepreneurs. According to the Journal, “If Mom, Dad and the neighbors are a more popular option, it’s not because they’re a soft touch; it’s because they’re less likely to demand terms that constrain the way the business develops.”

While investments groups and angel investors often expect high returns on their capital infusions or large stakes in the company, friends and family tend to be less demanding – and less formal about their investment arrangements.

However, unless you’re willing to endure uncomfortable family gatherings and dinner table conversation for the next decade or so, depending on the success or failure of your business, lax investment arrangements are not necessarily a pro to friends and family fundraising.

Regardless of the source of your capital, the Journal insists that “it’s crucial to formalize financial arrangements.” Business plans, contingencies, return on investment, etc. should all be discussed – and put in writing – whether you’re talking to the bank or your parents.Some start-ups only accept money from friends and family “who [can] afford to lose it,” lest you “invite some serious dysfunction into your life.”

Also, unless you plan on only discussing your business with friends and family for the foreseeable future, Andy Dunn of Bonobos.com suggests formalizing more than just the financial terms of your investments. “Set appropriate conversational boundaries,” he told the Journal.

The bottom line is that Grandma might believe in you more than anyone, and has a stash under the mattress to prove it, but that doesn’t mean she won’t have a lot questions whether your venture takes off or hits the skids.

Mike Goodrich
Goodrich Law Firm, LLC

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