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How to ask friends and family to invest in your business

If your small business needs funding, there are several options. Many people first think of loans or lines of credit from traditional lenders, such a

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If your small business needs funding, there are several options. Many people first think of loans or lines of credit from traditional lenders, such as banks and credit unions. But do not forget to ask friends and family! About 10 percent of small business financing takes place this way, according to a recent survey of small business trends we undertook.

Asking family and friends to invest in your business has several benefits. They are likely to be more flexible in terms such as the repayment schedule and interest rates. Obtaining funding is likely to be cheaper, without application fees to a borrower. The requirements of a traditional lender such as a bank can be strict in ways that many small business owners find challenging, such as three years of business history and a three-year forecast to get started, or an excellent credit rating. Family and friends are likely to be more flexible in the history and forecasting area, and they are unlikely to want a credit score!

At the same time, however, asking family and friends for small business financing can be challenging. As a business owner, you will need to prepare business documents that are similar in some respects to those that a lender would use to assess a loan. You will need to make a pitch, just as you would with investors or lenders you do not know.

Some of the challenges are unique to friends and family. You do not want to damage the emotional ties and relationship. You will have to choose wisely which friends and family may be good sources of funding and interested in supporting you. You will need to make sure that both they and you feel treated fairly. You will need to communicate clearly, both when you ask and during the funding period.

Here’s a best practice guide on how to approach money from friends and family for your business.

Prepare a business plan

You will need to give friends and family a business plan, just as you would other investors and lenders. The business plan should include at least a mission statement, a description of your business and products, an overview of why you think the business will be successful (your unique sales proposal and any market and competitor analyzes), and financial statements.

Your financial statements should include any existing balance sheets, income statements and cash flow statements for the past three years. It should also include forecasts for at least three years. Your friends and family need to see how much your products cost, what your revenue projects are, and more.

The business plans must be prepared professionally. You can do it yourself, of course, but “professional” in this context means that they must be typed, appropriate and clearly formatted – not just verbally, and not scribbled on a napkin! Your family and friends need to think carefully about your business and the impact of your request on their lives. To be able to do this, they need a copy of the business plan for your pitch session and to refer to it as they make their decision.

How do you pitch?

What is the best way to present? Have your business plan prepared and reviewed first.

Second, spend time thinking about your question – sharing the pitch when asking for funding and giving your reasons. Here are some steps towards asking.

1. Determine how much funding you need

It is far too common for small businesses to initially charge too little. Think carefully what what you need, price it well and consider any consequences. For example, if you need office equipment, does that mean you will end up needing more space, and therefore have to pay more rent or buy a space?

Your pitch will need to include how much you need from potential investors, and for what purpose. Is it working capital, working cash or money for expansion? The clearer and clearer the goal, the greater the chance that it will be convincing.

2. Decide what form you want the funding to take

There are three forms that money from family and friends can take: 1) a loan, 2) an investment, in which they own shares in the business, and 3) a gift. There are big differences between the three.

With a business loan, you will have to repay the money. You will have to repay the money at mutually acceptable terms (interest rate, length of loan, when and how much you will pay). To make the loan official, you will need to create and sign a promissory note (you will need to hire an attorney to help you with this part). The advantage of a loan is freedom; you have full control over your business.

With equity investments, the funding you receive translates into some degree of ownership in your business (in other words, in exchange for equity) for the friend or family member. They may want some control in running the business or a say in the business decisions in exchange for the equity stake.

A gift is money free and clear, with no obligation to repay it. However, gifts must be documented for tax purposes for both the giver and the recipient.

3. Choose a time and place for the pitch

Do not suddenly ask for funding on friends and family! Set up a mutually good time and place. It can be after a family gathering, after a dinner outside, or in your conference room, depending on what is comfortable for all parties. Make sure they know that you will be putting them on a funding idea, and make sure they know approximately how much time it will take to hear the pitch and ask questions.

4. Answer all questions

You ask family and friends to set up money and spend time supporting you. It’s only natural for them to have questions about the business and your plans. Answer all questions completely and thoroughly. If you do not know the answer to some, be honest. Tell them that you need to gather more information on the topic yourself. Then find the answer and come back to them.

5. Think of contingency plans

It is very common for family investors to ask about contingencies just like professional investors. What happens if, for example, you do not meet your sales forecasts? What happens if commodity prices skyrocket? It is understandable that they have these concerns, as it is possible that you will not be able to make loan payments or keep your business going as you planned.

So have some contingency planning in place. For example, if you had to skip a loan payment, how would you make up for it? How does this affect the repayment terms? Will you pay more over the life of the loan? You must assure them that they will not lose any money or equity that they contribute.

Which people should you approach?

You need to carefully choose family members and friends to approach. You also need to know which not to approach.

First, the people you are approaching should be in a position to help you financially. Although you may not always know the details of their financial circumstances, choose people you seem fairly wealthy and established with. Your fixed-income ousus or your younger sister who just had twins and bought her first home last year may not be candidates for family loans because they may have little left over once they take care of their own financial needs . But your roommate who is now a hedge fund manager, or a great-uncle who just sold his own business? They can be excellent candidates.

Secondly, they should also be interested in helping you. They may be emotionally close to you or people who have been in your life for a long time who encourage you and want to see you do well. If you have challenging relationships with a family member, they are probably not the best candidates, even if they are financially capable. It is said that choosing professional investors is like getting married – the relationship is that long and serious. Same goes for getting loans from friends or asking family for money: you do not want to run the risk of straining the relationship.

Third, look for people who might be interested in the business itself. For friends or family members, it may be an opportunity to see how a business works, how products are made, and so on. They do not have to work with you, but it can help if they find the process interesting. This is an additional thing for them, in addition to loan payments or equity.

Get it on paper and make it official

While you may have personal relationships with these people, obtaining funding from them should be placed on a business basis. By doing so, the personal relationship protects against things that may go wrong, such as feelings of guilt or feelings of being treated unfairly!

For that purpose, you need to get details of any funding you get on paper and make it official in the form of a promissory note. When you get a loan, you need a contract that specifies the amount, the repayment schedule and the interest rate, if any. If they will have equity, you will need a contract that specifies how much they own and what their rights and responsibilities are, if any.

If the funding is a gift, it has tax implications for both you and the donor. The Internal Revenue Service will require documentation that it is a gift and not a loan.

It is wise to consult with attorneys and accountants throughout this process.

How Guidant Financial Can Help Small Business Owners Get Funding

At Guidant Financial, we know how important funding is for small businesses. We offer a multitude of financing solutions and advice, tailored to your needs and business sector. Contact us today to get started.

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