Advantages and disadvantages of raising finance from friends and family
There are clear advantages to approaching family or friends, rather than conventional sources of funding, for a loan or investment.
Family or friends:
- Will be flexible. On a practical level, they may offer loans without security or accept less security than banks.
- May lend funds interest-free or at a low rate.
- May agree to a longer repayment period or lower return on their investment than formal lenders. They may also seek a lower rate of initial return than commercial backers.
- Already know your character and circumstances and so are less likely to need a detailed business plan.
However, there are also some disadvantages to family or friends financing your business. Transactions of this nature can be complex. Any misunderstandings about the arrangement can damage relationships.
There is a risk your investors may offer more than they can afford to lose, or that they will demand their money back when it suits them but not your business. They may also want to get more involved in the business, which may not be appropriate.
Tips on approaching friends or family for finance
It's a good idea to approach friends and family in the same way you would a formal lender:
- Be crystal 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.
- Think twice about approaching a friend or family member if other sources of finance have turned you down. Analyse the reasons for this and review your business proposition. Remember that if your business fails, lenders and investors may lose their money.
- Pass on the reasons that others gave for turning you down.