Steven Strauss Column: Family Funding
September 22, 2011
Question: I am one of the out of work people everyone is talking about. After a year I have basically decided that my odds of getting another job are pretty slim. I’m 52. My brother has offered to lend me $10,000 to start a business. Of course I want to take him up on the kind offer, but I am scared. How does one handle these family loans properly? I have never run a business before.
Answer: Begin with at least some funding from friends and-or family members. Having done that myself, I can say from experience that it is a path fraught with both danger and possibility.
On the up side, consider my favorite friends and family lending story:
In January 1980 the unemployment rate is 7.5% (and soon to go above 10%) and inflation is an even more striking 13%. It was, as they said at the time, “the worst economy in 50 years” (sounds familiar, I know). Against this economic backdrop, two out of work journalists had an idea one night that changed their world and that of their closest friends and family members.
Chris Haney and Scott Abbot loved to play Scrabble and that night, after pulling the game out of the closet, they realized that one of the tiny alphabet tiles was missing. So they hopped in the car and headed off to the toy store to buy another Scrabble set. And that is when it hit them – they had bought a lot of Scrabble games over the years. They figured that plenty of other people had too. So what they decided was that they needed to invent a new board game, and they even had what they thought was a crackerjack idea for one.
It did not deter them that they were not entrepreneurs (yet) or that there had not been a new board game for adults invented in years; Scrabble and Monopoly were about it back then. The two friends really thought they had a winning idea on their hands. But even so, being broke and unemployed, going from idea to fruition seemed almost impossible. How could they start a business with no money?
They needed investors.
Unfortunately for them, given their circumstances, getting a bank loan would prove to be almost impossible. Finding an angel investor also seemed unlikely. But what they did have was a super idea, a lot of enthusiasm, and a great network. They knew their best hope was to approach friends and family.
So Haney and Abbot drafted a simple business plan and approached their extended network. Eventually, they cobbled together about $60,000 from 32 friends, family members, associates and colleagues, each of whom received a 1% share of the new business.
It took two years to get it to market, but the game Haney and Abbot invented soon became a national obsession, with no less than Johnny Carson raving about it on The Tonight Show. The game? A little something called Trivial Pursuit. (Side note: Can you imagine owning 1% of Trivial Pursuit for a $2,000 investment?!)
Although most friends and family investments are far more modest, it is nevertheless not hard to understand why people turn to this source of capital: Ready money, smiling faces, great terms, and sweet deals are hard to beat.
But the risk of course is that if you are too casual about the arrangement (and many entrepreneurs who receive family funding are), you can cause stress to yourself, and worse, to the people who believed in you. It can sever relationships. If you are able to repay the debt on time and in full as agreed upon, then all will be fine. But it is when someone cannot or does not that problems arise.
The most important thing then is to be prudent and professional.
Don’t ask for the money unless you have a realistic plan for paying it back. Don’t ask for the money unless you really do plan on paying it back. Don’t ask if the investor cannot afford to lose it all. Don’t ask for more than you need. Don’t borrow the money with a “Don’t worry bro, I will get it back to you someday” attitude. If you treat the investment as the business deal it is and not as a personal favor, then all should go well.
And if you don’t, well, don’t say you weren’t warned.
Today’s tip: One report I saw recently stated that the total amount of investment stemming from venture capitalists, state funds, and angel investors is roughly $20 billion a year. The amount from friends and family is about three times that, approximately $60 billion a year.