It's common for owners of small and start-up businesses to look to relatives and friends for support when they need additional business funding.
This can work well, but often these arrangements are informal and based purely on trust and verbal assurances. Any confusion about the agreement could damage personal relationships, so it is important that both parties are clear about what any investment will involve.
Before you approach a friend or relative for funds to support your business, be clear about what your requirements are:
- Loan: If your business needs immediate and relatively short-term funds, a loan may be most appropriate. Decide whether you can afford to pay interest, or whether you are seeking an interest-free loan. If you do pay interest there will be tax implications for both you and the lender.
- Investment: If the business needs longer term or permanent funding, you may want to consider giving your investor a share in the business. If you choose this option, think about whether you need an active partner or shareholder.
There are clear benefits to approaching family or friends, rather than conventional sources of funding, for a loan or investment. Generally, they will be flexible. On a practical level, they may offer loans without security or accept less security than banks. They may also lend funds interest-free or at a low rate.
However, transactions of this nature can be complex. Any misunderstandings about the arrangement can damage relationships. It's a good idea to approach friends and family in the same way you would a formal lender:
- Be clear about your own expectations - specify how long you need the money for.
- Detail the repayment level you can afford.
- Spell out how many shares or what profit the investor will receive - and when any returns will be paid.
- Clarify whether an investor will have any financial liabilities for your business activity.
- Draw up a formal written agreement.
For more information see financing from friends and family.