Financing from family and friends

1. What is financing from family and friends?

You may want to ask relatives and friends for support when you need additional business funding.

This can work well, but often arrangements with family and friends 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. Think about whether you need a loan (for immediate, short-term funds) or want to sell shares (for longer term or permanent funding).

2. The process

If you decide to accept a loan or investment from friends or family, you should approach it as if it were a formal finance deal. This will involve:

  • presenting your business plan
  • preparing a business case
  • taking professional advice
  • creating a formal, written agreement

Before approaching a friend or family member, you should create or revise your business plan so you can demonstrate your plans for the business and their investment in it. Make your proposal with the same considerations as you would for any formal lender or investor. The friend or relative will need to know how their money will be used and the bigger picture for your business. Make them aware of all risks and worst-case scenarios.

You need to make a business case that will persuade them to finance your business.

3. Sources of help

You should both get professional advice if the amounts involved are substantial. This will help you both consider factors objectively, without feeling under pressure and to reach a decision that you feel comfortable with. Many accountants will also advise on the issues and will draw up an agreement.

If you and your funding provider(s) agree to proceed, formalise the arrangement with a written agreement. This will help prevent future misunderstandings and provide a solid basis for the business relationship.

A loan agreement should cover the loan size and terms, the repayment plan and interest rates. Investment agreements are more complex and should include the amount invested, the allocation of profits and shares, roles and responsibilities of both parties. You should seek professional advice to help you draft any written agreements.

4. Pros and cons

Pros

  • they may be more flexible than other lenders
  • they may offer loans without security or accept less security than banks
  • they may lend funds interest-free or at a low rate
  • they may agree to a longer repayment period or seek a lower return on their investment than formal lenders
  • they know your character and circumstances
  • you may be able to provide a less detailed business plan as they already know the business

Cons

  • misunderstandings can damage the relationship
  • 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 and not your business
  • they may want to get more involved in the business, which may not be appropriate

5. Common mistakes

It may be tempting to have an informal agreement with your friends or family who are financing your business, but this can lead to confusion. To avoid any future issues, you should:

  • 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
  • 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