Borrowing money from your loved ones can be awkward. Learn how to make it less so with this guide to getting start-up capital from those closest to you.

When starting a new business one of the biggest concerns is how to get enough money to go into business. You may have questioned the wisdom of going to the people who are closest to you for your startup capital. Many entrepreneurs wrestle with this issue before going into business. Examining the issue from all sides will allow you to make the best decision for all involved.

Benefits

Taking money from friends and family for your start up is not without its benefits. Even when the economy is strong it can be hard to get a small business loan. You can bypass the bank completely by getting money from those closest to you. Another benefit of getting money from non-commercial sources is that you can often negotiate far better terms than you would get from even the best bank loan. Friends and family will also potentially be far more forgiving if you cannot make regular payments on your loans.

Potential Problems

Going to the people closest to you to start your business is not without pitfalls. There is the very real potential that you will not be able to pay the money back in a timely fashion. This can put a strain on personal relationships -- a problem that you do not have when you borrow money from the bank. If the loan is done formally and on paper you could end up in a protracted court battle with someone that you were formerly very close to. Few things are more stressful than having to treat a loved one as a creditor.

Playing It Safe

There are ways that you can protect your relationship with friends and family who provide you with start-up capital. If you prefer to go to family and friends you should take precautions to ensure that your business relationship does not damage or ruin your personal relationship.

  • Be Formal: Many people make the mistake of not doing business in a business-like manner. This is more important when taking money from those closest to you. It established clear boundaries and separates the personal from the business. Draft legally binding letters that acknowledge your business’s debt to the investors. Give one of these letters to everyone who makes an investment in your business, no matter how small.
  • Pay Interest: Paying interest to your investors creates a further atmosphere of business, as opposed to personal relationships. When figuring out what to pay in interest, consider not only what a commercial lender would expect back, but also the money that you save in fees and penalties to vendors that you must pay late. This allows you to offer investment in your business as an attractive option.
  • Paying in Equity: Another way to make your business an attractive investment option (as opposed to a favor to a friend) is to pay off in equity. This allows your investors to buy a share of the profits, rather than loaning you a certain amount of money that you must repay later. This option can strike a good balance between formality and familiarity -- just make sure that it’s a legal and formally documented agreement.
  • Early Payback: Give your investors the option to get their money back at any time. This allows your investors peace of mind. They loan you money, but they can get it back any time that they are feeling uncomfortable with the loan. This may not be the best option -- or even possible in some cases. If, however, this is an option that you can afford you should consider it as a sign of good faith to those who have placed their faith in you.

Starting Your Business

Starting a new business is always a difficult proposition. You may be uncomfortable taking money from the most important people in your life. You can, however, find ways to make this less painful and protect your valued relationships. Treat business transactions with friends and family with the right level of formality and you will find that they are far less painful than dealing with banks and other commercial lenders.