Before borrowing money from a friend, it’s best to decide which you need most.
With bank loans tough to get and credit-card debt unattractive, this American proverb can ring true with many entrepreneurs in need of startup financing.
But asking friends and family for a loan or investment can actually be a great way to go, says Jennifer Martin, principal of Zest Business Consulting, a San Francisco-based small-business consultancy.
“Investments from people you know often make you more accountable and force you to follow through—it lights a fire under your backside,” Martin says. “That’s because the potential loss is greater than if you’re unable to repay a loan from an anonymous source.”
Plenty of entrepreneurs know this to be true. In its survey of 363 CEOs and founders of technology startups, global business law firm Dorsey & Whitney learned that nearly a third counted friends and family as sources of funding. Friends-and-family financing is attractive to both parties because the money is quickly accessible, investors really want to participate, and they understand the company’s financials.
To obtain funding from friends and family, first decide if you can deal with the consequences of a worst-case-scenario. “Ask yourself, What is my comfort level in the event I cannot pay back that loan?” Martin advises.
Then, get your business plan together. Document the marketplace, any competitors, your product’s market advantage, pricing strategy and profit time line. Identify people in your support system—mentors, advisers and colleagues you will turn to for expert advice throughout the process—and how you will be accountable to them. Put in writing what benchmarks you will reach, by when, and what the consequences will be if you don’t meet them. Then detail how much money you need now and how those funds will be allocated.
“The time that you put into the preplanning stage can dramatically affect your likelihood of success and your ability to repay debt,” Martin says. “Remember, this might be your business, but your friends and family are now, in essence, your bank.”
Hire a lawyer to create a custom contract to be signed by you and the family member. Consider including ways the lender can help your business—by word of mouth or social media promotion or by offering expertise.
Try to keep a church-and-state mentality when communicating with these loved ones about business matters. “The most important part is to keep your business hats on when you are communicating about the venture,” Martin says. “It’s easy when stress levels spike to revert to old dynamics of father and daughter, or an older sister and a younger sister. The better you can be at knowing when you are relating as business partners and when you are family and friends, the better.”
Don’t ask anyone to do something you wouldn’t do yourself. “Don’t ask for money if you wouldn’t also be willing to put your own money on the line,” Martin says. “Show the person what’s on the line for you if your idea doesn’t work out.”
Martin offers these talking points to any entrepreneur approaching loved ones for a business loan or investment:
1. Tell them how much you love them and that you’ve always appreciated their support.
2. If it’s difficult for you to ask for money, tell them so. Try: “It’s hard for me to ask you this because your [support, love, friendship, etc.] is so important to me.”
3. Explain specifically what you need and the impact it will have on your business. Now speak to them as professional partners. For example: “I’m looking for a loan or investment of $30,000 in my new business. Is this something you might consider?”
4. Show them your homework. Tell them the story of your product and business. Make them excited about it. This is the sales pitch, just as you might sell a customer. Say, “Let me tell you what I have learned while doing my research about this business” and then share the high points of your business plan research, highlighting the model for success. Don’t forget to tell them how much of your own money and time you’ve already invested.
5. Specify the proposed funding terms and mention that you have contacted a lawyer to draft a formal contract if you should move forward.
6. Ask what they need to fully consider your request.
7. Ask them when you can follow up with them (then actually follow up on that date).
8. Thank them for considering your proposal, and welcome their feedback.
9. Tell them you will not be upset if they don’t offer funds—and then follow through on that promise.
Business: PlushCare, a site that provides virtual physician visits via smartphone or computer, based in San Francisco
Strategy: Raised $25,000 in a product presale, and then reached out to founders’ professional networks to raise $1 million
Results: Great initial success and rapid growth
Before we even sought funding, we tested the market with a presale through the crowdsourcing site IndieGogo. We sent invitations to family, friends and acquaintances, including technology leaders, physicians and patients (my co-founders are Stanford University Medical Center physicians), and invited them to buy a presale subscription to the service. It was much easier to ask those people than random strangers who were not aware of our perseverance and capabilities. Going the presale route was a way to raise money and to validate whether ours was a viable business model.
By the close of our two-month campaign in early 2014, we reached the $25,000 goal, thanks to the orders from 60 people we knew. They were people we had worked with professionally, and they knew the quality of our work. They had reason to believe that their investment was a good bet.
Based on that success, we reached out to investors who were in our networks—again, no one was a total stranger. Ultimately we raised $1 million in investments from CEOs and chief technology officers from Kodak, Cisco, Splunk and Kimpton Hotels. The key was not only proving the market for our idea, but also sharing our passion for changing the world. All of our investors are personally very excited about the product, how it can help people and better the health care system—it isn’t just a return on the investment.
Thanks to this initial investment—which we were able to raise much quicker than if we had gone the traditional venture capital route—we grew very quickly. PlushCare is expected to be available to 170 million people around the United States by the end of 2015.
Founder and CEO
Business: MyMayu, kids’ boots maker, based in Vancouver, British Columbia
Strategy: Asked relatives for loans after investing her family’s savings
Results: The product is in five stores and growing steadily.
When my husband and I launched this business two years ago, we decided to live on his salary, and I would run the business. We cashed out all of our savings—$150,000—and still needed more to grow the business.
Both of us have very close and supportive families. Even though none of them are rich, we also knew they had money they didn’t need at the moment. We asked his sister and our fathers for loans. We presented them with our business plan, and we showed how the money would be spent and the profit plan.
They all readily agreed. We borrowed a total of $90,000. Even though I’m a former lawyer, we did not come up with a formal legal contract, but it is documented in our accounting system that this is a loan. And even though none of the lenders asked for interest, I do hope to repay them what we would pay in interest on the line of credit we secured on our apartment, which is prime plus 3 percent. There is no time line for repayment, although we plan to pay them back before I take a salary.
Because the repayment time line is flexible and interest-free, we’ve been able to grow this business without the pressure of outside investors. I appreciate that when I spend time with my father, he speaks to me as a daughter—not an investor who has a say in how I run the business. In just five months of completing our first manufacturing run, our shoes are in five stores, and we expect to break even within two years.
Co-Founder and CEO
Business: Flocabulary, a Brooklyn, N.Y.-based tech company that creates educational hip-hop videos for K–12 students
Strategy: Shared the story of the startup, and exhibited passion and commitment for the project
Results: Videos have been used in more than 20,000 schools around the world, and Flocabulary grossed $3.6 million in 2014.
When I got out of college, I was working as a musician and lyricist, writing music for films you’ve never heard of and ringtones for cellphones. My co-founder Blake Harrison was a writer. In 2004 we created a rap album designed to help high school kids learn SAT vocabulary words.
We started touring schools to perform our material and learned a ton about the market and what teachers, kids and parents need and respond to. That experience was invaluable. Ultimately we saw kids who had been sitting with their heads down on their desks become totally engaged in their schoolwork.
That was a turning point. We knew this had to be a big business. We initially went through a Columbia Business School program that pitched the prototype to some of New York’s most prominent angel and venture capital investors. None of them could see the potential of getting the return they wanted—100 times their investment within 18 months—and said condescending things like, “Oh, you’re so creative, you should be a musical duo.” Exactly the things young entrepreneurs need to hear to put the fire under our butts and prove all those guys wrong.
We rejiggered our business plan to something more feasible and started asking friends and family for money. But we learned very quickly that it wasn’t our projected numbers that worked; it was our story and passion. This was true for my childhood classmate who is now a successful investment banker (but I hadn’t spoken to him in 20 years) as well as our friend who is a waitress who knew us before we started the business. I called her and said, “I know you always believed in us, and I want to give you the opportunity to get involved.” She invested $5,000.
Ultimately we raised $50,000 from people we knew. The value wasn’t just the money—it felt like these people were true partners and had a personal reason for wanting the company to succeed. I never felt that when pitching VCs.
That was 10 years ago. Those friends-and-family investments got us off the ground. Last year we grossed $3.6 million, and two years from now, we could triple that.
This article appears in the June 2015 issue of SUCCESS magazine.
Emma Johnson is a business journalist, gender-equality activist, and founder of the world's largest community of single moms, WealthySingleMommy.com. Emma and her best-selling book, The Kickass Single Mom, and her organization, Moms for Shared Parenting, have been featured in hundreds of national and international media outlets.