Historically speaking, borrowing money from family and friends to start a business has been viewed with a somewhat cynical eye. So much so, in fact, that tradition has bequeathed us an alliterative phrase about it to help jog our memories as to its downside whenever the subject comes up.
“Friends, family, and fools” is the phrase of which I speak. It implies that only a parent blinded by love or a naif blinded by inexperience would do something so risky as to finance the dream of an untested entrepreneur.
Small business financing has undergone a revolution over the past few decades. Finding it is now easier and more convenient than ever before. But even the most adventurous lender is going to want to see some positive track record before doling out a mountain of cash to a brand-new business owner.
In some cases, in other words, the generosity of friends, family, and fools is all that a young, ambitious, capital-starved entrepreneur can hope for. I can say this from both good and bad experiences.
How to Raise Money You Don’t Have to Pay Back
What borrowing from the “three Fs” usually looks like
Let’s start with the bad. The first time I reached out to a family member about financing one of my ideas, I made a fool of him in the process. I was a kid, it’s true, but in retrospect my scheme was ridiculous to the point of cliche – why had anyone fallen for it?
I myself had fallen hard for a multi-level marketing (MLM) scheme that, for a one-time payment of $2000, would doubtlessly make me a millionaire. I went to my dad for the money, which he promptly supplied.
I just as promptly lost it, but he kept his faith in me, which underscores both the strength and the weakness of financial transactions between young business owners and their family members. In the end, the whole thing is motivated by love. My dad, from one angle, was blinded by his love for me to the point that he lost $2000 he could hardly afford; from another angle, he made an investment thanks to that love that in the future would pay off big time for both of us.
Speaking of which, let’s get to the good. Years after the debacle described above, I founded an honest-to-goodness business repairing commercial signs. I enjoyed some success right out of the gate, but my total dearth of credit history ensured that formal lenders wouldn’t give me the time of day.
Once again, I approached my old man. I asked him for a substantially higher sum than $2000 with which to buy an expensive piece of equipment to take my business to the next level. Once again, he came to the rescue. My business exploded soon after, and I’m pretty sure that life hasn’t been quite the same for either of us ever since.
In a nutshell, borrowing from friends and family is terribly risky because there is a lot more on the line than mere money. Their love opens their eyes to your potential, but it also blinds them to your weaknesses and exaggerates your strengths. To be fair to them and yourself, never consider entering into such an agreement without taking the following steps:
1. Be completely honest about the risks involved
When I went to my dad about the MLM, I never even bothered bringing up the fact that I might not be able to repay him. I was so sure I’d succeed that it seemed like a waste of words.
Being honest about the potential of losing someone’s hard-earned money is never a waste of words. No relationship is so strong that miscommunicating about finances can’t damage it.
I’m extremely fortunate in that my dad forgave me so instantly for losing his dough, but nothing like that is written in stone and happy outcomes often depend on factors that change from moment to moment and relationship to relationship.
If I’d been straightforward from the get-go about the riskiness of the MLM, on the other hand, I’d have taken a major step toward guaranteeing a happy outcome regardless of what happened.
We earn a commission if you make a purchase, at no additional cost to you.
2. Put everything in writing
I would have strengthened that step immeasurably if I’d written it down with my dad beforehand. Memory, after all, is a fickle thing – when was the last time you and even your best friend remembered a complicated event precisely the same way?
No matter how honest you are beforehand about the risks involved, chances are good if you end up losing someone’s money, the main thing they’ll remember is that you seemed awfully enthusiastic about your prospects when you asked for it.
Writing a simple contract will help keep you both honest under those circumstances. It’s a lot harder to blame someone for a choice you made when there’s clear evidence that no one twisted your arm.
What is Seed Money and How Can Entrepreneurs Get It?
3. Be prompt (and open) about repaying the loan
When you borrow money from family and friends, make sure to set up a repayment plan and then never, ever place them in the awkward position of having to approach you about it. Be as proactive about making it right as if your very life depended on it.
On the few occasions I’ve lent to family and friends, I’ve been very honest up front that I expect this courtesy to be shown to me. Regarding one friend in particular–a small business owner whom I helped bail out of financial trouble–I was blunt in the extreme.
“Don’t make me chase you down about repaying this,” I essentially said – and I said it because it was essential to maintaining the relationship. He understood that I wasn’t saying I’d break his arm in case of a late payment – I was simply saying, “Be honest with me. Stay ahead of it. Communicate if you’re feeling overwhelmed.”
Image by rawpixel.com on Freepik
