In answering the problem of how to fund your business venture, the classic startup funding option if you haven’t the means available is to seek the three Fs: Friends, Family, and Fools. Too often family arrangements are done unprofessionally and that can destroy both a family and a business. In truth, entrepreneurs ought to be highly cautious when employing this method. Taking money from friends and family is accessible but risky. Once an entrepreneur enters in to business with FFFs, the relationship changes. FFFs are typically less professional than any of the alternatives making them easier to convince. However entrepreneurs have very strong opinions about taking their money. Some recognize that a business has to start somewhere. Others suggest that taking FFF money is playing with fire. Other see it as a sign of confidence sort of like Hernando Cortez dismantling his ships when arriving in the New World. This strategy of funding is easier but risky.
Advantages of FFF Cash
- Credit history less of a problem
- Lower interest
- No collateral
Flexibility is the number one benefit. Family is often more understanding and trusting during unusual situations. This flexibility can also be the source of taking advantage of friends and family. Flexibility or leniency is the can result in family members never getting their money back and ripping off members.
Advice from Entrepreneurs
Kevin O’Leary details in his book how he called his mother asking to borrow money and she gave him the money that saved the company. O’Leary advocates giving rather than lending because lending only leads to trouble. His belief ties to the whole philosophy of not lending what you can’t afford to lose.
Ed McLaughlin, founder of USI and author of The Purpose is Profit has a different opinion on whether to seek funds from those closest to you.
I thought over my funding options for USI and made a list of my closest friends and family, I finally realized that I could not put at risk the hard-earned savings of those closest to me. After looking into bank and SBA loans, I came to the conclusion that bootstrapping was the best option for me. I am not alone. Fully 90% of U.S. startups are bootstrapped. And while the media plays up the idea of angel and venture investors backing startups, in actuality, they fund only 1 – 2% of the companies that pitch to them.
Nevertheless, if you cannot bootstrap, seeking startup funding from your friends and family remains one of the most viable options available to entrepreneurs. If you do decide to raise startup funding from your friends and family, be careful to set up the deal the right way and to hire a lawyer to draw up a document that clearly lays out the terms of the financing. You want to give your business a solid liftoff while preserving the relationships of those people you hold most dear.
The best way to reduce the risk of this less professional fundraising is to be professional. Clearly establish whether any money received is a gift, debt, or investment. Set up terms, and make sure that they line up with your wealth or control motivations. In minimizing risk for taking money from family, the steps necessary have this funding method overlapped with debt financing, equity financing, and even crowdsourcing. The benefit of this solution is the ease, however every family is different. In this funding method, lawyers are worth their money. Protect yourself and your family. This route likely won’t increase the value of the business. And there is also a possibility this won’t be enough. However, family is the most likely, in many cases, to say yes, not because they believe in the idea but because they believe in you.