FRIENDS AND FAMILY INVESTMENT

Where Do You Go?

Small-business expert and former Inc writer Tom Ehrenfeld discusses the various financing options entrepreneurs have in this excerpt from his book, The Startup Garden.
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Introduction
Simple Loans
Friends and Family
Outside Investors and Banks
Government Programs

Roughly speaking, investments break down into two forms: debt and equity. You take on debt when you borrow money from a lender, and pay interest on that investment. You are compelled to repay the money with interest over time. Or, you can take on an equity investment -- in which you sell a portion of the company to an investor in return for cash or something else of value.

Each source carries advantages and disadvantages. Consider them well before making choices, for finance decisions are hard to undo. It's not enough to find lenders and investors; you have to pick the right ones. Try to find investors who bring more than cash to the table. Look for supporters who can help you with financial advice, technical assistance, or who can connect you with key customers. Seek patient capital from a sage who can listen to your problems over breakfast and set you straight by the time you reach the office.

And: make sure that you find investors whose interests align with yours. Naturally anyone who lends you money is banking on the success of the company, but be sure that you have clear mutual goals and what (and when) that that definition entails. If you are going to friends or family, for example, make sure that they are not investing money that must be repaid in a few months. And be clear with others what your long-term goals are. You don't want to surprise investors if you eschew rapid growth, or make other decisions that are consistent with your vision, yet don't reconcile with theirs.

"Capital raising should be an extending circle," says Scott Shaw, founder of the Austin Grill, a successful Tex-Mex restaurant in Washington, DC. He explains that you start small with an immediate group of investors who can help you directly. Then you gradually build on that platform, seeking larger amounts from people you come to meet and with whom you will probably have a more formal relationship. Shaw also counsels that you "listen to the capital markets." They may be trying to tell you something about your venture. If you're having trouble raising money, there may be a very good reason why. If you are going out to seek capital -- and the associated advice -- from people who may have more experience, it's a good idea to listen to them! They may know something you don't.

Simple Loans

So, what are your capital choices? Let's start with simple loans. Your first source of capital will probably be a loan from yourself. Most businesses are founded with cash from the founder's pocketbook. Sure, there are simple advantages here: pure control and ownership. You own the whole company, control the show, and stand to reap the gains should your venture become valuable. Great.

But there's a huge potential downside here as well. Even the best-researched and well-run startups involve risk. And you are putting your assets on the line. It's great to read about risk-takers who take out second mortgages on their homes and borrow from their retirement funds to launch businesses that turn them into millionaires. There are far fewer stories in the news about the many people who take great risks -- and fail. And unfortunately, these stories are very real and very common. So while I believe you need to trust yourself, and take the leap, be sure to consider (and reconsider!) the risk of your venture carefully when investing your own money.

There are wild stories of individuals who turn to credit cards for their startup capital. Sure, in our credit-easy economy, credit cards represent an easy form of quick cash, one that many starting entrepreneurs exploit -- especially when they come with low rates. Yet the eventual high rates and lack of any other support rate them low on the list of sources.

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Last updated: Apr 24, 2002




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