by Jeff Wuorio
When we were kids, we all had a favorite relative — an uncle or grandparent, perhaps — who was always good for two bits to buy that favorite candy bar.
For entrepreneurs, the same dynamic remains. Chances are good that you have at least one family member who'd happily invest money in your business. But taking a quarter for a Zagnut versus pocketing tens of thousands for an idea that may go the way of mood rings are two very different propositions. I've taken the liberty of asking my imaginary Aunt Nagg for (in her own words, of course) the top eight issues you should consider when thinking about a relative's financial stake in your business:
"You're treating me like a stranger!"
You bet, Auntie, and that's what I should do. Rule No. 1 in soliciting and possibly accepting investment from family members is to approach them as you would any other prospective backer, such as a loan officer. That means putting as much as possible in writing and to make certain that anyone offering money signs off on everything you put together. "Even if it's your mother, treat her as though she was a third-party investor," says Stu Kaplan, a Pittsburgh attorney specializing in family business. "If it's not in writing, someone may say later that they never heard what you said."
"Risks? What risks? You're the sharpest one in the family!"
That sort of praise may be heartening, but don't gamble family peace on blind faith. Before taking penny one, make sure that any prospective family investor understands the implications. That means a detailed business plan, including exhaustive financial particulars as well as complete disclosure of every possible way the business just might not fly. "Make sure you have a disclosure statement; even something that's as nonchalant as a three-page statement that identifies risks," says Kaplan. "It's important, because family members are more apt to give you money and demand less."
"Don't worry. Pay me back when you can."
This is the business equivalent of riding a pogo stick through a minefield. Some relatives may say they're not interested in what's in it for them, but make certain you let them know the parameters of your payback plan. That means spelling out when they should expect to receive their principal as well as the sort of return they should reasonably anticipate.
"Frankly, Jeffrey, I expected more than this."
This guilt-dripping comment follows up on the prior tip by illustrating the importance of being as conservative as you possibly can; particularly with payback projections. Five years down the line, a pleasant surprise is a whole lot more appealing than failed expectations. "Don't just be realistic; be ultraconservative," says Kaplan. "Defining these sorts of expectations can be crucial."
"Take it! Who needs food and clothing when I retire?"
Touching as that sentiment may be, but it's critical to make sure that a would-be family investor is, in fact, in a position to take on the risk of your business. (Hopefully, you're also attuned enough to know sarcasm when you hear it.) Be sure to ask questions. A relative with a good-sized cache of cash is better positioned to provide you seed money than someone whose heart may be bigger than their financial head. "For one thing, never take money that's coming out of a retirement fund," says Kaplan. "Think of how you would feel if you lost that money."
"Your cousin Jethro has a great head for numbers."
Thus enters one variant of one of the most insidious risks of family investing: the unspoken expectation. In this case, it's the relative in search of a job (often someone who can't seem to count to 20 without his shoes off). Don't be a soft touch and put some relative in charge of paper clip alignment to the tune of $30K per annum. Instead, make clear at the outset that yours is a financial relationship, pure and simple.
"I was there when you needed me and now I have to pay for my own Scotch?!"
This version is a more personalized form of unspoken expectations. It's the supposition that money somehow buys relative special privileges. Again, no matter if it's Carte Blanche at your restaurant or an assumed 50% off on everything in the store, spell things out about what you will and won't do in exchange for a financial stake. "I knew of one restaurant where an uncle who invested in the business thought that entitled him to eat and drink for free," says Kaplan.
[b]"What? My money isn't good enough for you?" [/b]
You don't have to phrase it in quite that manner, Auntie, but the reality is there may be just too many strings attached. After taking all the caveats into consideration, don't be afraid to say "no, thanks" to family investors. Accessible the money may be, but weigh all the factors carefully to be as certain as possible that, in the long run, there aren't better funding choices. "The bottom line is you have to be very careful about whom you take money from," says Kaplan. "If things go wrong, they can really wreck an entire family."