Warren Tracy is a decent, honest guy who feels like a liar and a thief. In 2008, he borrowed $400,000 from friends to help his business, Busted Knuckle Garage, a 13-year-old gift company in Phoenix, survive the recession. To date, he has been unable to pay the money back. The guilt is eating away at him.
"I feel like a failure to my friends," Warren told me. "I feel weak in front of my wife. How many times can you continue promising your creditors that you're 'close'? It shatters your confidence and can reduce you to a pile of mental rubble."
Each year, friends and family invest more than $60 billion in U.S. startups, providing almost 40 percent of the seed capital for early-stage companies. That's a lot of money--and a lot of stress on cherished relationships. Things change when money enters the picture. After all, the adjectives usually paired with cash are cold and hard.
I am intimately familiar with this situation. During the 1980s, family members invested more than $1.5 million (including $1 million from my mother) in Stonyfield Yogurt, my husband Gary's business. These were the people we loved: the people whose fortunes we least wanted to imperil. Gary never lost confidence. But to me, it felt false urging our investors to keep on believing, even as my own doubts grew.
It can be even harder with friends, who don't owe you unconditional love and forgiveness. When you seek money there, you risk losing emotional support, which is also critical in tough times. "I haven't heard from one guy in 18 months," Warren told me sadly. "How do you interpret the sound of silence? I have to call one of my investor friends tomorrow, and I dread telling him to hang in there. You feel like a chronic liar, not the honest guy who's doing whatever he can to make it work."
And Warren is working hard to put things right: trying to increase sales so he can free his personal relationships from the shadow of debt. Busted Knuckle licenses its automotive-themed brand to makers of garage décor, apparel, and other products, which it also sells. Six months ago, Warren began creating new product lines and courting new customers. For example, he developed a full line of "Made in U.S.A." signs, clocks, and thermometers that he hopes to offer through gift stores in national parks.
In hindsight, though, Warren would have done it all differently. "I'd take equity, not debt," he said. "And I'd look for investors who were business savvy, who could help me build the brand, who could raise the probability of a victory."
I would add this from my own experience: If the cash comes in as equity, make sure it's accompanied by a signed minority shareholder agreement. You'll need that even if--especially if--the investor is Mom. Explain that a clear, written understanding is the best way to protect a relationship of great importance to you both. It's also a good idea to stay in regular contact with investors, providing quarterly updates on the company's status, inviting their input and treating them like the partners they are.
The most important thing, though, is to be dead clear from the start that your in-laws or college roommates may never see their money again. Grownups understand risk. Real friends will feel worse only if you beat yourself up for letting them down.