The infamous FFF words in this space may be an option to some. In some cases, friends, family and fools loans may be the only source of funding available when other types of loans aren't. There’s nothing wrong with starting a business with money from family and friends, and let’s be frank, they would know you better than most, so they would probably be a lot more flexible than banks or investors, however, some precautions should be taken.
Some world famous brands such as Walmart, Motown Records, GoPro, and Amazon wouldn't exist without the good old family loan. During the late 1970s, Mr Dyson's first cyclonic vacuum cleaner wouldn't have been possible without a loan from Mrs Dyson.
Let’s dive into the pros and cons of this type of funding and how you can prevent Sunday lunch turning into an investor update or even worse, destroying these relationships.
Pros and cons of FFF loans
Pros:
No lengthy forms and DD unless there
Low or no interest rates
Flexible payment terms
If you pay it back, they can always vouch for your reliability and credibility
Cons:
It’s family - your relationships are on the line should anything go wrong
Cannot build a credit rating/history that can be used with institutions
Amounts loaned may be limited and lower that a bank loan
Reputational risk as this is personal to those who you are borrowing from
Guidelines to help you navigate this FFF waters as it can get choppy
Do you treat it as a loan, investment, or gift?
Misunderstandings, on both sides, are not uncommon. This is not guesswork - you should be cautious not to assume that this is a gift or donation to you. For all intent and purpose, treat them as investors and creditors. Make sure all parties know what the situation is – especially other family members who might think you’re about to blow their hard earned money or inheritance on a pipe dream.
Investment vs. loan: When it comes to friends and family, it's hard to believe that they will not give their 2c worth as to what you should be doing. Sometimes, if they have the right experience, this works well. Other times, not so much. Be clear, for your own sanity as to whether you will treat this as a loan that will be paid back or if you will be giving them a share in your business.
Loan vs. gift/donation: If they are loaning you the money - have a repayment schedule. If it’s a gift - put it in writing that it’s not repayable. Your donor, depending on a number of variables, may become liable for certain taxes. Consult a tax specialist to ensure both you and your family/friends are covered and will not be adversely affected.
Pitch to them as you would to a bank or investor
Be professional and treat this as if your life depended on it.
Some people may not understand what you are doing, so show them why the business you are pursuing is a good idea for them to invest in.
Be clear about how much you are putting in yourself and don’t expect them to give you all the money you need.
Be clear with them about how much you need and why, i.e. how will you be spending it. Even if they don’t ask, be transparent and take them through your budget so they can see you intend to spend their money wisely.
Let them into your thoughts about how you will grow the business and how you plan to repay them.
Manage their expectations – explain the risks and show them best and worst case scenarios, i.e. that they can lose all their money.
Make sure they understand they can’t get their money back quickly if a family emergency comes up
Create a repayment plan and stick to it. If you can’t give them regular payments, tell them why and how you will make it up.
ALWAYS put it in writing
Loans in business are not just a financial obligation, it can lead to other legal consequences - e.g. people pass on and their beneficiaries may come knocking on your door demanding the money. It’s always best to keep a formal record of the agreement. Whatsapp messages are insufficient. This will help you avoid misunderstandings at the outset, and it can be used to resolve disputes if they arise.
If it’s a loan, document the following:
The amount they are lending to you.
The rate of interest. If it is zero, clearly stipulate that it’s interest free.
The period of the loan, including the payment start date, and the final date for settling the loan.
Be specific about the repayment terms – will it be regular amounts or a lump sum when the business reaches a certain stage.
If you have provided security, what was it and will you need to top up at some point. If so, how will the topup be determined?
Are there penalties for late or non-payment – such as increased interest rates, changes in loan terms, adding extra fees, taking security, or initiating legal proceedings?
There are a number of templates on the internet. For extra peace of mind, get a lawyer or accountant involved and take a look.
It will be much more complicated if it is an investment and they should be issued shares. The document must specify how many shares the investor will receive and whether or not they are permitted to participate in business decisions. In addition, it should specify whether or not they will be liable for any business debts or lawsuits. I highly recommended that an accountant and lawyer be involved in the writing of one of these.
Always follow through
This speaks to your credibility and ethics as a person. Do what you said you’ll do and do more. When times are good, tell them and show them by meeting your obligations. When things are moving in the other direction, it will get stressful - keep your friends and family updated. You don’t want them hearing from an unrelated party to the transaction like Uncle Steve or Aunty Flora. As complicated as it gets, keep it simple:
Make your repayments on time. If you’re treating yourself to spa treatments but not servicing your debt, you can be assured that they are not going to be happy. Seeing the money coming back to them will make them less resentful or angry when you spend some money on yourself.
Make sure you communicate how often you will update them about the business, how much you've repaid, and any obstacles you may face.
Treat them professionally and with respect. Relationships with friends or family lenders can provide good evidence to professional lenders later on.
How can we help you?
So we can’t help with the FFF round, as we are not friends, family nor are we fools! At idea stage, we encourage you to join our partner Founder Institute - The world's largest pre-seed accelerator.
But…if you are a tech startup that’s ready for funding, we have kicked off enrolments for our Funding Program. First session is scheduled for 9 Jan 2023. Over 14 weeks, we will determine your level of investability, run a quick DD, define your fundraising strategy and kick off your journey. If your business has paying customers and has found a reasonable level of product market fit - Apply here.
Published for the first time on https://investable.business.
Disclaimer
We do not provide accounting, tax, business, or legal advice. The information provided in this guide is for informational purposes only. Before taking action based on any of the provided content, it is recommended that you consult your own professional advisors.