January 1, 2011

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Article

Borrowing from the Family

Get it in Writing, Even from Mom

Pamela Ostermiller Olson

January 1, 2011

It was 1984 and tanning salons were popping up in strip malls across America, when a family member of mine decided to jump on the trend. The idea was great, the timing was perfect and the location was prime, right across the street from Utah County’s only mall. The problem was lack of financing and the only resource at the time was family. After hearing all the pros (and not very many cons, evidently), a few relatives pitched in. Less than a year later, for reasons still unmentionable at the dinner table, the business failed and invest- ments were lost, along with valued relationships. If only the situation had been based on a little more communication, everyone could have been spared some angst and resentment. Fortunately, there are ways to borrow money from friends or family for your startup while maintaining peaceful Sunday suppers. For many, this type of funding is the sole option. “Let me just start by saying—and we do a fair amount of this type of work, helping young companies get funded—that I would never discourage anyone from getting money from family members for their business,” says David Rudd, a partner in the Business and Finance Department of the law firm Ballard Spahr in Salt Lake City. “It’s how some of the most successful companies get started.” See the Big Picture Rudd says the key to success is to start with clear expectations. “The problem with a lot of entrepreneurs is that they think they have invented the new mousetrap. They don’t focus on the risks, problems and downsides.” You need to do your homework before you leave the gates. “Know the market, your competitors, proprietary position and future funding requirements,” Rudd says. “Nothing’s worse than finding out later that the market isn’t big enough to attract enough business.” The next step is to identify your sources, the players or the Five Fs: “Friends, Family, Fools and Former Friends,” says Kent Thomas of CFO Solutions. Evaluate who in these categories you would really want in the middle of your business. You can’t have former family, Thomas says, so ask yourself, do you really want Uncle Bob dropping by for monthly sales meetings? Do you trust your brother-in-law enough to hand him internal business documents? Put it All on the Table Open communication is the foundation of a business relationship with anyone, especially friends or family. “Be honest. Give full disclosure,” says Thomas. “You have to do this if you want to borrow from a bank,” and it should be just as open and official with one of the “Fs.” Thomas says that the more information you provide, the better partner you’ll have. “Be realistic about risks and establish responsibilities.” Sign on the Dotted Line Just because you are borrowing money from your oldest pal doesn’t mean you should just shake on a deal. “You need to have an agreement in place. You need documentation, then get it signed and in writing,” Thomas says. “After an agreement is in place, communicate frequently and be open. They’ve trusted you. Show that you are trustworthy. I recommend a monthly email with financial statements. A one-page brief email is sufficient.” That would NEVER Happen to Us One of the biggest pitfalls to borrowing money from one of the five “Fs” is that you never expect things aren’t going to work out. Those who assume that a relationship is stronger than the ramifications of a business failure experience a similar denial to those who think they’ll never get in a car accident. It can happen to anyone. The difference is that in business you can ensure that provisions are made. If you have all of the paperwork in place, then everything is covered just in case the business fails. Feelings can’t be hurt if all bases were covered. “If this loan or investment would damage a relationship, don’t do it,” says Thomas. “[Investors should] consider it a gift. But don’t do it if you can’t afford to lose it.”
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