Asking your family for money to start a company is one of the most common methods for funding a business. This practice is actually formalized in Korea where they use a “gye,” which is a private fund that family members contribute to over the years. Members then take turns getting lump sums of money distributed by this fund.
Things are much more loosely organized, informal and potentially more dangerous in the U.S.
Any small-business owner looking to family funding should consider three facts:
Fact 1: Seeking capital from a family member is relatively easy to get if they have the financial resources.
Fact 2: If your company is successful, that family member will congratulate themselves for the genius they saw in you.
Fact 3: Alternately, if your company goes out of business and you lose their money, it will damage your relationship with them. They will blame you.
In order to get funding successfully from your family and keep your relationships intact, ask and answer these seven questions, honestly, before taking a dime.
1. Can they afford to lose the money? If you are borrowing $25,000, is that a lot of money to them? Is it a significant part of their assets? If it is, do not take the money. Always warn them that there is a likelihood they could lose their money. It is important to say these exact words.
2. How will it affect your relationship with them? Borrowing money changes people. Will you be able to honestly share with them how the business is performing even when it's going poorly? Will you still be able to socialize with them under these conditions? How will this affect family gatherings? Will they be tracking how you spend your money outside of the business? Will that strain your relationship?
3. Do you have a formal agreement? Should it be a loan or investment? What will the interest rate be? What is the expectation on when it will be paid back? Remember that a written agreement manages expectations on both sides. This is even more important when you are doing business with family where arrangements tend to be more casual.
4. How will you value their investment? For an equity investment, what share of the business will you give up? Value the business too high, and future investors will be turned off. Value it too low, and the family investor may have too much shareholder control when you are successful.
5. Will their money mean they have a say in the running of the business? Set this expectation up front. Any advice should always have a formal setting and not be done ad hoc at social events.
6. Can you pay back the loan early? Will they be satisfied with their return if this is done early or will they feel somehow cheated? Ask this specifically and provide for early repayment for any document that is signed.
7. Are there strings attached? Remember that getting money from family always comes with strings attached. What are those strings in your specific situation?
Have you borrowed money from family? How did it go? What did you learn? Let us know in the comments below.