Small Business Getting Funding From Friends and Family: The Do’s and Don’ts

Should you ask your besties and relatives to invest in your business? Sure, but consider these things first.

By Elaine Pofeldt Illustration by Nathalie Lees
PUBLISHED 01/17/2023 | 15 MINUTES

Stephanie Schupp didn’t intend to start a business when she began buying furniture and decorative items for the house her family was renovating in Kansas City, Missouri. Her business found her. 

“All of a sudden, friends and family started saying, ‘Your couch is beautiful. Where can I buy this?’” recalls Schupp, who was purchasing home goods returned to big-box stores like Pottery Barn from liquidators. 

She started placing larger orders for friends and family and charging them a shopping fee. At the same time, she built a following on Instagram and set up an e-commerce site. 

Then one big problem arose. “Our garage became full,” she says, and they needed to move the items into a local warehouse—which required a $10,000 security deposit. 

Schupp and her husband turned to their parents and an uncle, the chief operating officer of a large corporation, for advice. 

“This uncle is a businessman and not the type of person who gives handouts,” Schupp says. “So when he said, ‘You’re onto something really brilliant. You need to protect this,’ it became more legitimate, and our families wanted to help.” 

The couple, who run The Schupp Collective, got a low-interest loan of $10,000 from their parents and gave it back in regular payments every month. Throughout the repayment process, they kept the lines of communication open with their parental lenders. “We always showed them what our sales were and what our progress was,’’ Schupp says. The business, which launched in December 2020, has successfully expanded to two warehouse locations and now has a robust client base.

Proceed With Caution

According to research from crowdfunding platform Fundable, 38% of startup founders raise money from friends and family, with the average investment being about $23,000. For some founders, this means taking a loan. Others sell shares in the company, known as equity, with the idea that the shares will appreciate, and their backers will profit from their investment. 

And it’s not just during the startup phase that this type of financing can come in handy—it can also help when entrepreneurs need money to navigate a crisis. A survey by the Federal Reserve found that in response to financial challenges imposed by the pandemic, 38% of Black-owned firms, 34% of Asian-owned firms, 32% of Hispanic-owned firms and 18% of white-owned firms borrowed from family and friends. 

(White owners, who got approved for Paycheck Protection Program emergency loans at higher rates, were more likely than Black or Hispanic owners to take out debt or obtain funds through grants, crowd funding and donations.)

Although friends and family financing is common, it can create an emotional minefield. Money can be a sensitive subject in general, and backers who don’t have much business experience may not fully understand the risks of helping a startup, despite your best efforts to educate them. “I’ve seen many instances in which relationships are fractured because of money,” says Dave McLurg, a Scottsdale, Arizona-based serial entrepreneur and investor. “You can lose the money and the relationship.” 

Even in the best of circumstances, taking financing from friends and family can change the tone of the relationship. “It definitely makes family dynamics more complicated,” says Gershon Morgulis, who advises small business owners in New York City. 

So how do you win those much­needed funds from your biggest supporters without the risk of everyone unfriending you? Here, entrepreneurs and financial experts outline the steps you should take for success.

Determine Your Idea’s Viability

It’s easy to get excited about a new business concept, but before you start fundraising, do some research to see whether it has legs. 

Connect online or in person with potential customers to ask whether your product or service will solve a problem and if they would be willing to buy it. Doing a pilot—such as making a small batch of your product and selling it at a local venue or online—can also give you valuable insights into whether your business idea will have any takers. 

For example, Taylor Smith, the co-founder of Broma, a maker of organic almond butter spreads, started selling her product at outdoor markets in 2019 before the official launch of the Manhattan, New York-based company in 2020. “We wanted to see if it was something people were interested in buying and eating,” she says. 

You’ll also want to make sure the business will generate enough money to pay back lenders, McLurg says. If there’s a gap between what you want to sell and what prospective customers want to buy, it doesn’t mean your idea will never fly, but you may need to fine-tune your approach.

Create a Formal Business Plan

Once you’re confident your idea has potential, create a basic business plan. Small business-focused organizations such as SCORE or the U.S. Small Business Administration (SBA) offer free templates.

Typically, a business plan will include an executive summary, a company description, an analysis of your potential market, information about your management team and its credentials (even if you’re the whole team), a description of your product or service, a marketing plan and the amount of money you want to raise. 

You should also include realistic financial projections. Entrepreneurs tend to get carried away on this front, so it’s a good idea to work with seasoned business advisors or financial experts to develop attainable numbers that won’t mislead future backers. 

And be sure to have your business plan fully developed before you start your money hunt. This way, you can make a strong impression from the get-go.

Decide on the Best Money-Raising Approach

Before you reach out to friends and family for financing, consult with advisors to determine whether it makes sense to borrow money from your supporters or to sell equity. You can turn to your local Small Business Development Center or SCORE for free advice or set up an appointment with an accountant or an attorney who specializes in small businesses. Knowing the pros and cons of each approach is important. 

If you accept a loan, you’ll most likely have to pay some interest on the money unless your loved ones cut you a break. But you’ll be obligated to start making payments on the debt at whatever date you agree on. This is money you can’t invest in growing the business, and the debt can make the business less profitable. 

The advantage of taking out debt is that you won’t have to give away an ownership stake in the business in exchange for the money. Consider using a lending platform such as Pigeon Loans or ZimpleMoney to create a formal loan arrangement. Make sure you and your lenders get tax advice, as loans can have tax implications, and sometimes it makes more sense to treat them as a gift, which is what Schupp’s family did. (A donor can give up to $15,000 a year per person as tax-free gifts under lRS rules.) 

If you sell shares, you won’t have to pay the money back, but you’ll own less of the business. Selling shares when your firm is in its early stages and hasn’t achieved its highest valuation means you’ll have to give away more of the business than you would if you waited until the shares are worth more. That’s especially true if you later go after formal financing from private backers and venture capitalists in Series A and Series B rounds or further. 

“Many founders barely have anything left of their business after the B round,” says Genevieve Bos, an Atlanta-based serial entrepreneur and investor. “They gave away too much too early.” 

You’ll also need to communicate with shareholders regularly, whether it’s through quarterly sit-downs or written updates. “Once you bring in $1, they are a shareholder, and the shareholder has rights,” McLurg says. “That becomes something else you have to manage in your business.” 

ln addition, you’ll have to hire an attorney to draft a term sheet and other documents to stay compliant with securities laws. “What if you get hit by a bus and that money is not accounted for?” Bos says. “You don’t accept a penny without a legal agreement.”

Think Through Which People to Approach

Although it may be tempting to reach out to everyone you know for funding and let them decide whether they’re comfortable with backing you, that can be risky, especially if some of those people have little business experience or limited funds. 

“The people in your life who truly want you to succeed and are in a financial position to lend and invest are the only people you should be approaching,” says Samantha Terline, who runs Cedar Park Group, a construction and medical staffing firm on Long lsland, New York. “If this is coming out of their grocery money or nest egg, that’s a huge problem.” 

Terline and her spouse took a loan in the low six figures from a close relative who runs a business in the same industry. They plan to pay him back when they close on an SBA-backed loan. 

For her part, Bos says she will only raise money from accredited investors and people with an individual annual income of at least $200,000 or a household income of at least $300,000 and a net worth of over $1 million either as an individual or with a spouse. 

“l don’t raise capital from anyone whose life would change in a material way if they lost every penny,” she says.

Janine Yancey, an employment attorney and founder of Emtrain, which helps companies improve and measure workplace social dynamics—sought funding from those who knew her industry. And like Terline and Bos, she focused on those who had the means to lend. 

“You only want to take a loan or equity investment from people who can afford to lose it,” she says. “Early-stage companies are a high-risk situation.”

Start Slowly and Set Clear Expectations

Maintaining good relationships with your besties and loved ones when you’re fundraising begins with how you ask for money. Before she starts raising money for a new startup, Bos says she casually mentions her idea to family and friends to see whether any are interested. “I’m not asking for money,” she says. “I’m socializing the idea to see if there might be interest.”

If she thinks her listener is truly interested, she asks if they would like to have a more formal 30-minute conversation where she can provide more details on the concept. “You don’t want them to feel put upon or like there is a bait and switch,” she says. 

Smith stays in close touch with the friends-and-family investors who backed her almond butter company. She says she communicated frankly about the risks of investing in a startup and made it clear that they might not see a return for five to seven years, if ever. 

“You have to set the expectation that this is not a sure thing, even if you are 100% confident in your business,” she says. “You have to make sure the people you see at the holidays are not going to be angry with you.”

That said, you do need to balance that out with being the business’s biggest cheerleader—or it will be hard to raise any money at all. “You have to make other people believe in your dream as much as you do,” Smith says.

Elaine Pofeldt is an independent journalist who specializes in careers and entrepreneurship. She is the author of The Million-Dollar, One-Person Business, and her work has appeared in Fortune, Money, CNBC and more.

Millie content is licensed from Dotdash Meredith, publisher of Millie, Real Simple, InStyle, Investopedia, The Balance and more.

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