Business loans from relatives and friends can also be extremely problematic. "The borrower and the people loaning the money, they need to be clear that this is basically a lark," says Stephanie Brun de Pontet, an associate of the Family Business Consulting Group, a consultancy based in Marietta, Georgia, that works exclusively with family-owned businesses. "It would be stressful on a relationship if you borrow money and a few years later they need it back."
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Pitching Your Business to Friends and Family: Decide on the Stakes
Loans and investments involve different risks. Brun de Pontet says the nature of the funding needs to be clearly stated. A loan, no matter how informal, should be written out contractually and include a time horizon. "For it to pass muster from a tax standpoint, it needs to be charged an interest rate that is reasonable or it's possible that the IRS would interpret that as a gift," she says.
Investments can create a different kind of challenge. Dashew gives the example of a father who invests with a son's business. "While it might not be explicit, the father is thinking, 'I have years of experience in the business world. I will be able to give my son advice and keep him from making mistakes,'" she says.
Brun de Pontet suggests outlining exactly how much voice the investor will get. "As a minority owner, what right do you have to communicate your expectations to the people with an ownership stake?" she says. "You don't want family members to be cranky with each other: 'I loaned you this money but you never listen to the suggestions I make about this!'"
Success can change the dynamics of the original agreement. Take an investment value that continues to remain at five percent, Brun de Pontet says. "All of a sudden $10,000 is worth $2 million. They have a two million investment in your business."
In a worst-case scenario, Kruzel says, the friend or relative who provided funding dies unexpectedly. The transaction becomes part of the estate and can be transferred to a spouse or children, essentially going to a third party.
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Pitching Your Business to Friends and Family: Formalize the Deal
Planning for every eventuality should be decided at the start and agreed on in writing. Serious money might be exchanged over a handshake, but Kruzel tells entrepreneurs that they're selling unregistered securities. After all, any returns aren't made through the investor's work. Returns are based on others' efforts.
"That's a pretty big one," Kruzel says. "Sometimes I have that discussion with people and that's the only time they're in my office."
Once everyone is on the same page, it's time to bring lawyers back to the table, along with an accountant. Dashew suggests that the documentation make all conditions explicit. Whether the lawyer's fee is $5,000 or $10,000, the security is worth it, she says.
Friends can be just as tricky to deal with as relatives. "It's your friendship and you do want to tread lightly, both in terms of how much risk is that person capable of exposing themselves to financially, and balancing the expectations," Brun de Pontet says. For example, a friend who invests might feel entitled to a job.
Close relationships can easily tear apart when money is at issue. Kruzel points to Facebook as an example of what can happen when friends start a venture that becomes wildly successful without articulating rights and ownership. "It starts in a dorm room. Maybe one person thought about it and the other person ran and did it," he says.
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Pitching Your Business to Friends and Family: Keep Communication Lines Open
Even with a formalized agreement, clear expectations, and a promising business plan, a startup can still fail.
"In the quiet of the night you have to confront your deepest fears," Rivers says. "If things go to hell in a handbasket, what am I going to do to make things whole should things go bad?"
When the business struggles, entrepreneurs might be reluctant to give friends and family bad news. "What's more helpful is to be honest and open and be able to say, 'We're struggling and here's what we're doing to deal with it,'" Dashew says. She invested part of her retirement in a high-tech company that her nephew is also investing in. When the company began to falter, she received more frequent e-mails describing what they were doing to stay on track, which she found reassuring.
Dashew grew up with a serial entrepreneur in the family. Her father started a new business at age 90. She remembers a time when she didn't own a jacket and another when her father was listed as one of the richest men in America. "I think entrepreneurs by definition are overly optimistic," she says. "They're less cautious or they wouldn't do it."
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