Entrepreneur's Journal: Raise money from friends, family and fools?

Posted Aug 3rd 2008 2:00PM by Tom Taulli
Filed under: Small Business

Like many others, a friend of mine is having troubles with her business. And, to keep going, she needs an infusion of capital. However, because of the credit crunch, she can't get a loan.

So what are the alternatives? Well, she is thinking of raising money from friends and family (F&F). In fact, she thinks she can get about $100,000 or so -- which is enough for her current needs.

But, of course, she's concerned about the process. What if she is late paying back the loan? What if the economy suffers for a long period of time?

Well, here are some things to consider:

Act as if you're preparing a pitch to a venture capitalist: No doubt, you can get into a lot of trouble if you get F&F funds on an informal basis. Simply put, you are vulnerable to misunderstandings.

Take Tony Seba, who started PrintNation.com. To launch the business, he raised $500,000 from his mother and brothers.

However, he pitched his deal in a professional way. For example, he put together a business plan and investor presentation (which took several months). He also assembled the necessary legal documents.

Be clear about the risks: For the most part, F&Fs are not likely to have much experience regarding early stage investments. As a result, you need to be frank about the risks.

The failure rate for early stage businesses is high. And, even if there is success, it can take quite a long time.

"Make sure that your investors can live without the money," said Janine Popick, the founder and CEO of VerticalResponse. "You don't want to get a call a year later from an investor who needs the money back."

And, Janine thinks it's important to have skin in the game. "I invested my own money in VerticalResponse," she said. "I also went without a salary for two years."

Third Party Administrator: If you structure a loan, there are companies that can facilitate the process, such as Virgin Money. For example, such firms provide standard forms as well as repayment plans and reporting services to credit agencies (this can help build your business credit). Moreover, there will be eligibility for tax benefits (such as interest deductions).

Actually, the founder of Virgin Money, Asheesh Advani, has written a great book on the topic: Investors in Your Backyard: How to Raise Business Capital from the People You Know. It's a tremendous resource for anyone who is thinking about raising capital from F&Fs.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Edgar Online Guide to Decoding Financial Statements. He also operates MergerBook.com.

Tags: Raising Capital, RaisingCapital

Print this

Reader Comments (Page 1 of 1)

8-04-2008 @ 3:24PM

Deb said...

Dear Tom: In 55 years I have never read such hogwash; downright horrific advice. My oldest and dearest friend of 26 years asked me for a $5,000 loan over a year ago to save her troubled business. I haven't heard from her since I said no, I'm sorry. If the bank won't give you a business loan there must be a damn good reason why not. You have dispensed some very dangerous advice and you should immediately withdraw this article. Shame on you!

8-04-2008 @ 4:11PM

cash said...

Couldn't agree more w/ Deb's comments. Good chance of losing a good friend over money. Even if it's spelled out. Most small business don't even have the first step, a business plan.

Tom, the part I would agree w/ you on, is having some skin in the game. How about holding a second on the house as collateral and if they don't have enough equity. The your risk to reward is out of wack.

Now if it's a son or daughter, brother or sister give it as a gift and if you get it back, maybe you'll do it again. I usually test the waters with small $ amounts first. Then when they ask again, I'll have a track record to say yes or no.