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4 Landmines to Avoid When Taking Money from Family and Friends

Author: Stratton Date: September 03, 2013

Sometimes, financial investment from the people you love is the only option when launching or expanding your business. Don’t make these mistakes.

When it comes to funding, many small business owners start close home. At least 15 percent say they have received financial backing from family in the past, according to the most recent Citibank Small Business Pulse.

Like other lenders, family and friends likely will expect a return on their loan. This means they will need to be convinced up front that they are making a safe investment.

Make sure you avoid these six major mistakes when seeking funding on the home front:

Mistake 1: Failing to make an investment yourself.

Potential backers need to see that you have confidence in your own plan. Why should they pitch in before you've gone as deep as you can on your own? "Do not ask your friends or family members for money for your business unless you have completely exhausted your own funds and sweat equity," says Ian Aronovich, CEO of GovernmentAuctions.org.

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Mistake 2: Downplaying the risk.

"Friends and family aren't a bank. You’ll most likely want to remain connected to them regardless of the outcome with your business," says Jennifer Martin of Zest Business Consultants. This requires candor. "They need to know the truth about the risk they are taking, and you owe it to them to be brutally honest. Since statistics show that half the small businesses that open don't make it past the first five years, despite your best intentions, any money they lend you comes with a risk." Make no bones about it, adds Chuck Tanner, president of furniture outlet Baxter Studio. In other words, "Before you invest money, please understand that if you lose all of your money, you will probably end up hating me as a person."

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Mistake 3: Operating on a handshake agreement.

Document your emerging financial relationship with a promissory note—a promise to pay back the money lent to the new business with the terms that you mutually agree to. Hire a pro to handle this and other legal details. "I urge a small business owner to get their business law attorney on board at the onset of a new business so that all of the legal issues are understood and agreed on. Some of the issues that I find are overlooked include: leases/rental agreements, trademark registration, employee contracts for people that may be vital to the start-up, licenses and permits, as well as writing up that promissory agreement," says Denise Beeson, a business consultant in Santa Rosa, California. Family members need to see that all these details have been attended to before they will agree to pitch in.

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Mistake 4: Letting the business infringe on the personal.

Set the expectation up front regarding how this relationship will run. "The relationship that we are entering is a business relationship that revolves around money. The personal relationship as we have known it will no longer exist," says Tanner. "I will be available during office hours to check on the status of your investment, but not after that time nor during parties, family events, holidays, evenings or weekends."

Loans from family and friends can work. Many a successful business has launched on the backs of loved ones. If you've covered all the bases, and everyone is still willing to listen, it's time to make the pitch.

Related content to include: How to Ask Family and Friends to Invest Kickstarter Alternatives Success Stories Everything Your Mother Taught You Is Terrible Business Advice Mixing Business with Friendship: How to Make It Work Starting a Business When You’re Broke

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