You may find it easy to raise money from family members because, well, they love you.
Someone who loves you and believes in you may not ask the same hard questions rightfully presented by a professional lender or investor. They are more likely to give you the money you need with very few strings attached – if any.
Neglecting such due diligence presents risks to both giver and receiver. Explore these issues before you accept business funds from any relative or friend.
Debt or equity?
A relative who ‘gives’ money to you for your business may be unclear regarding the classification of the funds – and the kind of deal their money buys them. Decide how you will document any funds received before you accept them.
Debt financing is a loan, usually involving interest (although some family lenders may not want to levy interest). Define repayment terms, repayment method and, if applicable, interest. Be careful about setting it up as a secured loan, which could attach your personal assets.
• Is the money received being lent to you personally or to the business? It’s an important stipulation because money received by you personally (to inject into the business) impacts your estate, while money received professionally will affect your business. Be clear.
Equity involves share ownership in your business. Shareholder status opens up a number of issues and potential complications. For example, will your family investor receive common (voting) shares? Or, will you issue preferred shares that will return a dividend? What happens when your family member sells or transfers those shares?
When someone buys stock in your business they become a business partner. For this reason, you may prefer to qualify the funds received as a debt your business can repay. Consult your team of advisors.
It’s unlikely that your Mother will ask to see your Business Plan before she writes you a cheque. That can be a mistake, because your plan – and the ensuing conversation surrounding your plan – will help to define investor or lender expectations.
The more casual nature of family financing can create two very different sets of expectations. For example, your relative may not be experienced in business matters and might simply assume that you’ll “pay them back when you can” – which means they’re expecting a cheque the next time your company secures a sale.
You, on the other hand, may define “paying them back when you can” to comprise smaller, monthly loan repayments to begin when your company achieves positive cash flow.
Clear communications between both parties should help to clearly define expectations pertaining to repayment, and any involvement or implied rights in your business operations.
Protect your relationship
I remember an entrepreneur who accepted business funds from her father. She wisely inserted this condition in the loan papers: “Dad cannot ask about the business or his money during family occasions.” Knowing her father well, she wanted to set boundaries around the business transaction to protect the more important personal relationship.
Look beyond the individual
Right now you’re accepting funds from Aunt Rose. She’s a reasonable and kind person, who believes in you and your business vision. What if Aunt Rose suddenly dies? Now, you’re dealing with a completely different lender: her estate, which may involve lawyers, accountants, and her not-so-friendly heirs who are anxious to collect on that debt.
Money transcends relationships. Think through such scenarios and their impact on you and your benefactor.
Draw up papers
They say good paper makes for good friends.
While you might trust your life to Cousin Jim, Aunt Susan or Nana Smith, in this business context you must treat them as strangers and insist on drawing up a professional agreement to document and define your financial transaction.
Money can change everything, so it’s imperative that all parties can refer to a well-constructed agreement that is signed before any funds are transferred. A legal agreement protects your family too, because they’ll know their rights in case something happens to you or your business.
Hire a qualified lawyer to work with you to develop an agreement – and insist your family member review the document with their own independent counsel.
To explore your business financing options, speak to a Scotiabank Small Business Advisor.
Is accepting money for your business from family a good or bad idea? Please share your thoughts below.
By Roger Pierce, Small Business Expert for Scotiabank
Article originally featured on the website: Get Growing for Business. Find additional information and tools relevant to your business.