The most expensive start-up funds don't come from a bank, an angel, or a venture capitalist. If you really want to pay dearly, borrow from the people who raised you

The decision was so obvious, so natural, so simple. You never gave it a second thought. And now -- as you survey the wreckage of your family, your business, or both -- you wonder how you could have committed such a colossal mistake.

Back then, though, it hadn't looked like a mistake at all. Impatient to get your company going and fed up with bankers demanding double collateral, you found it hard to resist the prospect of tapping Mom and Dad for funds. Unlike the pros, they were easy marks. Due diligence? They watched you grow up. Research? They trust you implicitly. Besides, giving the kids money is an American tradition. The envelope at Christmas, the car at graduation. It's a way of showing love.

Not that they exactly beamed when you finally got the nerve to ask. Their foreheads wrinkled with concern: Why quit your secure, well-paying job? What would you do if your idea didn't pan out?

But it will, you insisted, it will. To be honest, all their hesitation made you a little edgy. "What's the matter?" you finally blurted out. "Don't you love me?"

There, all discussion ceased. "How much do you need?" your father replied. You aimed a little low; you could always return for more. And you did. ("It's just a cash-flow crunch," you would say. And your parents would nod as if they understood.)

As time passed, though, they couldn't help noticing the one-way nature of the transaction. They dropped advice here and there -- "Maybe you ought to go slower," Mom would suggest -- but never came right out and demanded anything. Deep down, you worried that maybe they still thought of you as the irresponsible college kid, perpetually broke and needing to be rescued.

Sooner or later maybe there was an explosion. Or maybe the guilt simply wore you down, draining you and your company of vitality. And now you ask yourself over and over: Couldn't I have lowered my sights and socked away $50,000 myself? Why didn't I try the banks in the next town over?

But those regrets don't help you now. It doesn't even matter whether you've paid the money back. The very act of borrowing has transformed you, your family, and your business. "These loans have strings," says William Borne, who borrowed $100,000 from his parents to finance his contract-nursing services firm, Analytical Medical Enterprises Inc. "It's just that you can't see them."

By the time you do see them, you'll understand why borrowing start-up money from your parents leads to trouble. The reason is as simple as it is startling. And there's nothing you can do to change it.

Because no matter how well-intentioned your parents are, or how willingly they crack open their billfolds, there remains one truth about their involvement: Parents cannot be passive investors.

Your mistake was ever asking them to try.

It's no secret that entrepreneurs lean heavily on parental generosity. John Ward, a professor of management at Loyola University's Graduate School of Business, reports that parents constitute the largest single source of start-up capital in the country. Turning to Mom and Dad for help is a victory of instinct.

It's also, unfortunately, the downfall of many a business. The truth about family lending -- and this all too often is a secret -- is that it doesn't work.

It hardly matters whose fault that is. Parents who lend and children who borrow each nurture interests that are both perfectly reasonable and, from the standpoint of a business, powerfully destructive. There's no way around it: your parents' fiscal involvement will inhibit your ability to manage as you want -- and as your company needs. Worse, your family may be forever fractured in the bargain.

Why does parental lending fail? For reasons that, if you look -- and almost no one ever cares to -- become clear.

Your parents simply know too much. And it's not as if they could separate the entrepreneur from the kid they raised. Nor, for that matter, can you see them strictly as financiers. "If I call my son to question him about my loan, he won't treat me like an investor," complains one parental bankroller. "I'll just be his old man bugging him." In any case, your parents don't invest because they've checked out your idea and found it to be a solid concept with significant growth potential. They invest to show they believe in you.

With such urgent emotional imperatives, all the practical questions look like nit-picking. Is this a loan or an investment? What is a fair repayment schedule? What happens if -- heaven forbid -- the company goes under? Accountants and family-business types will tell you that the only hope of making a loan work lies in being very explicit about the conditions of the deal. Right. Most families can't even come clean about that hurtful comment at the last get-together.

The money you borrow takes on a certain symbolism: It gives substance to all those unspoken and unresolved issues just beneath the surface. Maybe you feel, for example, your parents owe you something for all they put you through as a kid. Maybe they feel guilty for pushing you too hard. Whatever the dynamic, it's likely to emerge only when, say, sales add up more slowly than expected or the bank doesn't kick in as quickly as you promised. To an outside investor you'd say, "Listen, we'll have to renegotiate because things haven't gone as well as I projected."

But if that investor happens to be a parent, stand back. "You let me down," charges the parent. "You don't love me," snaps the child, "and you never did. If you did, you wouldn't care so much about the money." And on it goes, disappointments and hurt feelings -- did anybody really expect hard numbers? -- leading the way. Lending money brings out the deepest, most fundamental fears. "I want my kids to love me for who I am," complain the parents, "and they love me only for my money." Likewise, kids who turn to their parents already feel like failures; if they're not careful, they end up re-creating the dependency they've spent most of their lives trying to avoid. Which is fine, says Thomas Davidow, a psychologist who works with family businesses, "if you don't mind being seven years old for the rest of your life."

And don't think that the rest of the family will escape unscathed. As with any family matter, there's no limit to how complicated and downright childish things might get. "We'll be sitting around, and my parents will compliment my brother backward and forward," says Tony Parnigoni, founder of Marketplace Promotions Inc., an Atlanta company that coordinates in-store sampling and merchandising events. "To them, he's leading the perfect life. He has a company car and a salary. And he's not in debt to them at all." Parnigoni, 27, borrowed $21,000 from his parents to finance his three-year-old company, which should post sales of $1.5 million this year. "We've decided that it's just money and it's not going to break our relationship with our child," stresses his mother, Henré. "But it's a difficult, divisive thing."

Even such determination and awareness don't alleviate the strain. A banker might cast aspersions on your ratios once a quarter, but your parents will look askance every time the subject of your company -- or your life -- comes up. A three-day weekend? The eyebrows edge upward. "You become a slave to their money," says Kenn Latzer, who borrowed $10,000 to launch Process Efficiency Products Inc., a manufacturer of industrial water-filtration systems.

That's assuming the money isn't lost forever. One entrepreneur couldn't face his parents for nearly six months after filing for bankruptcy protection. "When they gave me those funds, it was an expression of their love," he says. "They were intelligent enough to know they could lose it, but their focus was elsewhere." More than a year after his company folded, he still struggles to overcome the feeling that his father thinks less of him. "I guess I now think that if you have to use your parents to do the deal, something is wrong with the deal. It is telling you something," he says.

You'd be wise to listen. Because with their money, your parents are extending their control over you and your company. For bailing you out -- yet again -- they'll feel entitled to something. You won't know exactly what until after you've taken the funds. "You drive faster than your parents, and if you make them ride in your car, they become uncomfortable," says Bert Bourgeois, whose parents lent him $15,000 to help him start an investment bank. "The same could be said of using their money. They are used to having it in a bank. Until you pay them off, you can't have a sense of autonomy. There is a kind of emotional collateral."

And you will feel it. Maybe at family gatherings, when people make comments: "Hey, I hear they set the kid up in business." Or perhaps in less predictable -- more unsettling -- ways. Like waking at dawn, with your eyes popped open and your stomach aching over the realization of the added responsibility. It happened to William Borne.

Morning after morning in 1986 Borne used to wake up at 5:00 a.m. with the same awful pictures spinning in his head. He saw his father, Reynold, sitting in the kitchen of the home he had built with his bare hands, fidgeting while his son spoke. Borne still remembers the look of helplessness and anger that came over his old man as he realized what his boy was after. So does Borne's father. "You work and scrape every penny so you can look forward to early retirement, and then -- boom -- your son asks you to loan him everything you have," says Reynold today. "I just stared and said to myself, How can my son ask me for this?" Reynold Borne had spent 32 years blending gasoline, loading barges, and pumping pipelines. About a year earlier, picking the asphalt off his work boots for the last time, he had cashed in his company stock for about $170,000. He was counting on the interest income from that, along with his pension, to tide him over until Social Security would kick in, three years later. Then his son, desperately strapped for cash, asked him for a $100,000 loan. "I was afraid of the answer I might give," says Reynold.

After a few minutes of deliberation with his wife, Audrey, Reynold regained his composure. Of course they would help their son; how could they not? This wasn't about money anyway. As the Bornes saw it -- and as so many parents do -- their son had placed before them a referendum on their love for him. They were damn well going to vote yes. "I've seen Bill go after things," says Audrey. "He does not fail."

If only business were so simple. But having gone to his family for a cheap loan, Bill found himself paying a dear price, feeling frozen and terrified as he watched the sun rise. "I was now responsible for my parents' livelihood," says Borne, whose company is based in Baton Rouge, La. "You wake up, and it's the first thing you think about. It popped into my brain all the time, anytime a client was lost or a hospital closed, anything that would threaten me. I did a lot of second-guessing." There were times, Borne concedes, when he wished he could live under the comparatively simple strain of imagining a banker's stern face or the disapproving frowns of a group of private investors. So much, it seemed, remained unspoken. "You take the money and then you can't get it off your mind," he says. "It slowed me down. It prevented me from opening new offices. If a bank takes a hit, that's just the cost of doing business. But for my parents, this was an unnatural risk."

It always is.

The trouble is that what's safest for your parents' money and what's best for the company you are trying to build may be incompatible. And the effects of that clash can't be escaped. Take your parents' money, and you accept their involvement to whatever degree they impose it. Even if they merely toss you the money and walk off, you'll be left holding the guilt -- which sounds perfectly manageable until you add it to the other strains of growing a start-up.

But what's worse than such emotional baggage is actual interference, either indirectly or directly. Most parental lenders, for perfectly legitimate reasons, will want to pull strings. Many will want to be there.

Interference in Absentia

Some parents try hard. They really do. Few could be as aware of the risks of lending money as psychologist Lucy Scott is. "A loan puts dollars on what is really an emotional issue, and makes it evident," she says. "Money is the language of power."

Her sensitivity to such struggles helped her minimize the difficulties when her daughter asked her for start-up money about four years ago. Scott was understanding, empathetic, and undemanding. The result: she merely crippled her daughter's ability to manage, undercut her self-confidence, and curtailed some of the enjoyment she might have gotten out of starting Primal Lite Inc., in Berk-eley, Calif. "Growth is really about jumping off a cliff," says Sue Scott. "But for me, every decision weighed heavily. I had this sense that my mother's money should be very protected."

Dismissed by bankers and shunned by venture capital groups, Sue approached her mother feeling "quite beat up." She simply laid out her woes, hoping her mother would follow them to the inevitable conclusion. It worked. "I want this to work for you," Lucy responded. "What do you need?" Came her daughter's tentative reply: "Do you think, possibly, $5,000?" That was in August 1986. By January 1987 they had played the scene eight more times; Sue had dipped into her mother's savings for a total of $45,000. "I was quite willing to give it," says Lucy. "There are trade-offs and risks; I'm concerned in a realistic way that I will need that money to support myself in my old age. But to not give her the support she needed when she needed it, that would be impossible to live with." The Scotts didn't bother committing the loan to paper. "I felt she was doing her business in a very solid way," says Lucy. "What more can you ask of someone?"

But parental interference needn't be direct to be damaging. "My mother was in my mind all the time," says Sue. Often she found herself wavering, wondering whether her mother would approve of something but feeling that she ought to make the decision on her own. Early on she wanted to hire a publicist because she felt customers needed to be educated about the company's products, strings of decorative lights in the shapes of animals and objects. "For a company of no size," she imagined her mother saying, "do you really need a publicist?" Though Sue went ahead with it, she says, "I perhaps took a little longer than I might have otherwise."

As Sue saw it, Lucy's loan entitled her mother to an explanation of every move -- from her justification for visiting suppliers in Taiwan to her hiring of a new production manager to the new computer system she installed. "I never asked for her approval, but she would pick up and send back innuendos," says Sue. "She was telling me it was OK." Still, the anxiety had a corrosive effect. "I was always terrified that she'd say, 'I want the money, and I want it now,' " says Sue.

The nature of her loan, Sue found, forced her to subject every decision to a nearly impossible test: Is this worth risking Mom's retirement? The Primal Party, for instance, is an annual bash for anyone associated with Primal Lite. Last year -- with the loan still outstanding -- Sue planned to entertain 300 people in the company's 5,000-square-foot warehouse. "I was very concerned that Mom would see the band coming and she'd think that money ought to be going into her pocket," says Sue. "Guilt was running amok in my mind." The band, nevertheless, played on. Mom was there. "If she didn't worry about it at all, then I would be worried," confirms Lucy.

Given the sacrifices she imagined her mother making, Sue felt she'd better suffer too. "I would have allowed myself more living expenses had the money come from a bank," she says. Flying to Tucson to visit friends, she fretted, "I ought to be writing a check for $200 to my mother instead." New clothes, a home -- they got deferred in the bargain as well. There was no escaping her debt to her mother; at family gatherings, someone might ask Lucy about investing in a real estate deal, and Sue would wonder whether funding Primal had robbed her mother of other -- wiser -- opportunities. "I'd run back to the company, examine spreadsheets, and stay up all night worrying," says Sue. And when she reports her company's revenues -- $2 million this year -- she does so apologetically. "I know Mom is thinking, When am I getting my money?" says Sue. "I have to explain why I don't have it to pay back. She'll say, 'Yeah, Sue, right.' Then she'll change the subject."

Primal recently obtained a $100,000 line of credit, and Sue has begun paying her mother back. "It makes me feel like an adult," says 36-year-old Sue. She kicked off her payments last December by surreptitiously slipping a $1,000 bill inside a Christmas card. "I thought, Gee, this is great, keep more of these coming," recalls Lucy. "I didn't expect it."

"But then," she adds, "I don't ever tell her what to do."

Interference by Proxy

It's absurd to suggest that all entrepreneurs who borrow money from their parents find themselves tormented by the voices in their heads. Not at all. That particular fate is reserved for the fortunate ones.

Usually parents who part with money -- especially in the amounts, and with the risks, that start-ups involve -- want more influence in how it is spent. That does not mean, necessarily, that your mother will harangue you about that copy machine you've leased (though she may) or that your dad will feel strongly about how much you are paying that new office manager (he probably will). They are parents; they can manipulate matters in a far subtler way.

Martin Schlossberg, for instance, wanted to use his money not just to help his son launch a business but also to bring his children closer together. His intentions were perfectly laudable; he wanted to see his son and daughter thriving in the same sort of business that had served him -- and two generations before him -- so well. "I thought it would be good for them," he says. No one stopped to consider, however, the possible effects his manipulation might have on managing the business, or the toll it could take on the people involved.

Martin offered his children, Peter and Lisa, the money to open a needlepoint-supplies store. The only condition was that they had to be partners. "I was surprised the money came with strings," recalls Peter. "My dad was having a good time putting the whole thing together."

Almost from the start Martin was the only one enjoying himself. "It wasn't clear who would do what," says Peter, then 28, now 43. "There was some friction between my sister and me." Even as they were drawing up the incorporation papers, Lisa recalls, "He kept referring to it as 'my store.' I was the baby sister, but I wasn't willing to take a backseat." With every decision, they vied for power: the lettering on the signs, the color of the yarn, the division of departments. One morning Peter came in to find Lisa gone. The store had been open roughly six weeks. "I was leaving to save our relationship," says Lisa. "Unfortun-ately, it wasn't saved."

For a time their parents tried to bring about a reconciliation. If the kids could just hold on until the company grew, Martin argued, they could each stake out a territory. But, says Martin, "splitting up was their decision. It just didn't work." Peter had papers drawn up buying out Lisa's shares and had them sent to her for her signature. "It made me sick," she says. He paid her over two years. "I died with every check," Peter says.

In the 15 years since Lisa left, Wild & Wooly Needle-crafts Inc., based in Falls Church, Va., has enjoyed good times (it appeared on the INC. 500 in 1984) and bad (it filed for protection under Chapter 11 last year). Though brother and sister live only 15 minutes apart -- their children sometimes play together -- Lisa, 37, admits, "We have never discussed what happened. There's still too much pain. This is my big brother after all. But there were words spoken that I still hear ringing in my ears." When they see each other at family gatherings two or three times a year, they are nothing more than cordial.

"I went to her wedding, but we certainly don't have a close relationship," says Peter. "It wasn't worth that."

Interference in Person

Still, the ultimate reason not to borrow your parents' money goes beyond the possibility of a painful feud. What you risk is a split that offers no hope of reconciliation. If that happens, you will lose something vastly more precious -- and irretrievable -- than anything a bank could have claimed. No loan is worth the price that Jeffrey Ullman paid.

Jeffrey's parents, Estelle and Sanford, fronted him $10,000 to start Great Expectations Inc., a video dating company in Encino, Calif., in 1975. There was some disagreement over how to structure the deal. His father, a pediatrician, thought he and his wife should keep 51% of the stock. "I was afraid Jeffrey would be too much of a spendthrift," confesses Sanford. Estelle, however, contended that Jeffrey deserved controlling interest because the company was his idea. Her logic, argued forcefully and passionately, won out.

The Ullmans followed their money to the new business. Dr. Sandy, as Jeffrey's father is known, became the gentle figure in a bow tie who, after a day of seeing patients, shopped for office supplies and took out the company's trash. Estelle became far more actively involved. Working without pay for nearly two years, she acted as a receptionist and a video interviewer. She also dispensed free advice. "Go and lose 25 pounds," she'd whisper to a client. Sixty-year-old men often got warned to look for women their own age. She consoled people whose videos weren't generating any responses and -- explicitly against company rules -- even indulged in some matchmaking. Upon first look, Great Expectations seemed like an archetypal family business: Jeffrey's mother even had adjoining offices with his sister, Dyan.

But as the company grew, so did the tension between mother and son. It irked him that she had 30-minute chats with customers, that she talked business out in the open, that she'd sometimes discourage people who she thought wouldn't do well. "They argued over every damn thing," recalls Sandy. Jeffrey believes that his mother "wanted this to be a mama-papa business. She wanted to keep it kind of small, and I viewed that as sabotaging our growth." Unrelated factors contributed as well; Estelle and Jeffrey's wife did not get along. "Just a little look or a tone would set us off," recalls Jeffrey.

Each wanted the other to change; neither did. They even tried working together without talking. But finally, recalls Sandy, "it just upset her too much. She was doing a lot of crying. She felt Great Expectations was her baby."

On paper, it was -- at least 49% of it. And Estelle often voiced her wish that she had demanded controlling interest in return for the investment. "We had given him that higher percentage," says Sandy, "but my wife regretted it." No question, concurs Jeffrey, that it would have "eased things" had his parents not owned that stake. By September 1980, with the company having grown to five offices and about $1 million in revenues, Jeffrey and his mother had fought to a standstill. "It was a rather violent breakup," says Sandy, 74. "It was a very emotional and traumatic thing." Jeffrey recalls, "I said 'Name your price' and they did and I paid it. It was more than I had, but I paid it."

He never finished paying. Whatever the underlying issues, he and his mother had no way of confronting them. They tried avoidance; for a year and a half they didn't talk. Estelle came back to work for the three years before she died. "There was a little bit of patching up, but not much," says Sandy sadly. For Jeffrey, the family nearly disintegrated -- relations with his sister are "very, very strained," he says -- although he has had plenty of work to distract him. Great Expectations has become a $46-million business, with franchised centers all over the country. "We got on each other's nerves," says Jeffrey, 40, who dedicated a room to his mother in his new offices. "She spent so much time arguing about small things that she throttled its growth. Or I blamed her. We were never the same."

Is any start-up money worth suffering that irreparable a loss?

You decide. Make up your mind before you conclude that banks or venture capitalists or private savings won't get you off the ground. Weigh the possibilities -- against the monetary and emotional costs -- then recheck your projections, grab your business plan, and head where you think the loans come cheapest. Maybe it's someplace where the collateral is higher than you'd like or the interest rate seems downright abusive. For your sake, it ought to be a deal in which you can truly assess the risks; remember, events rarely proceed as planned.

If impatience wins out, you may find yourself standing on your parents' doorstep. They will give you the money, if they can. You might not have to sign anything, but the casual contract between you and them will include unspoken emotional clauses. What are they? You won't know, exactly, until you have broken them. When that happens, your family -- loaded down by its own particular past -- will reveal its true fragility. It may collapse on your company. It may shatter some valuable relationships.

Only then -- and every Christmas or Thanksgiving or birthday thereafter -- will the true advantage of a bank or a venture capitalist or an informal investor become apparent. With nonfamily backing, whatever the financial cost, the business gets the chance it deserves. And you get the opportunity to prove yourself as an entrepreneur. It still won't be easy; start-ups never are. But if it doesn't work out -- if you should fail or give up -- all won't be lost.

You can always go home.


One family's recipe for happy parental lending

Any relative who approaches Bruce McGrath for a loan might suddenly develop a new fondness for the local banker. "He's very, very vigilant about getting everything down on paper," says daughter Janet McGrath. "He doesn't just say, Yeah, great. He wants to see all the figures, and he lets you know you are definitely working within a budget."

Bruce, who owns a $25-million Pontiac dealership in Cedar Rapids, Iowa, invested in his 29-year-old daughter's retail business last year. He has also worked out deals with his son, son-in-law, and brother. "I'm certainly more liberal than a bank," claims Bruce, 52, "but I do have strict parameters as to how I will consider investments."

Strict and very thorough. Ask him for a loan, and Bruce McGrath will send you off to be evaluated by a psychologist, who will report back on your aptitude for business. Then he wants to see some convincing paperwork: a business plan, cash-flow projections, monthly budgets. "I handle it like an investment, not in a fraternal way," he says. "It's hard to be objective, but in a family, communication can get difficult."

He speaks from sad experience. Back in 1975 he borrowed $140,000 from his father to buy the dealership from him. Five years later, when he went to pay him back, the business was booming, and his father felt that the deal was no longer fair. The elder McGrath died shortly thereafter, leaving "a lot of these things never resolved," according to Bruce. Other family members carried some resentments. "It wasn't open warfare," says Bruce. "It was an issue lying beneath the surface, and it kept relationships from being as good as they could be." Finally, two years ago he hired a psychologist to conduct family meetings and help sort out the emotional issues. "There was more resentment and a lot more concern and misunderstanding about these arrangements than I thought," he says. "At the bank, a deal's a deal. But even if you pay a family loan back exactly as agreed upon, side issues come up."

To prevent that sort of emotional ambush -- "I felt I had been mistreated by my brothers and sisters," says Bruce -- he set up a formal system for evaluating business propositions. In addition to providing half the funding for his daughter's home-accessories and jewelry store, he has put his son-in-law in two businesses -- "one went kaput" -- and his brother in a car dealership. Bruce has also worked out an arrangement so that one of his own sons, Michael, can buy him out. "We have a written agreement, and there are no personalities involved," says Bruce, who has three other children still in school. "I'd love to put them all in business," he says. "I'm ready when they are. And they know exactly what they have to do."