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The Right Way to Ask Your Parents to Finance Your Business

December 10, 2013
URL: http://www.entrepreneur.com/article/229395

Alex Genadinik, 33, borrowed $20,000 from his mom last year to launch Problemio, a startup that makes mobile apps for small businesses. Carlo Cisco, 26, has taken $150,000 in convertible-note investments from his relatives since 2012 to expand Select, his New York City dining, travel and entertainment discount club. And over the past five years, Andrew Angus, 34, has borrowed from his mom $500,000 (half her net worth) to keep up with the exponential growth of Switch Video, his animated-video production company.

Family Money
Pros and Cons

Positive

Highly likely to say yes
Better financing and equity terms
Faster access to cash

Negative

Parents meddling in the business
Smirks fromindustry insiders
Lifetime of guilt if startup tanks

None of these transactions came without consequence or regret. "It might be the easiest money to get," Cisco says, "but it's probably going to be the most important money that you ever have, because you're not going to want to let them down."

If you plan to spend Thanksgiving dinner hitting up Mom and Dad for startup cash, first listen carefully to what these 'treps recommend.

Invest your own money first. Cisco, a former Groupon staffer, burned through $40,000 of his savings to launch FoodFan, a restaurant-review website that was the precursor to Select. A $100,000 convertible note from investors helped him forge relationships with restaurants and create an early version of his platform. By the time he asked his family for cash, FoodFan listed 850,000 restaurants and 50,000 menus. "We had an incredible brand name and a massive amount of data," Cisco says.

Next, hit up strangers. Third-party validation from outside financiers can strengthen your pitch to the 'rents. Angus, who launched his business in 2006 in Collingwood, Ontario, says a $250,000 loan from Canada's Centre for Business and Economic Development helped him sell his mother on his plans. Mom opened a home-equity line of credit to pay off Angus' loan at a lower rate, and she now has a convertible-note investment in the company, to be paid back in five years with a 6 percent annual interest rate.

Cisco seconds the suggestion to tap outside investors. He turned to relatives only after several angel investors offered him amounts ranging from $25,000 to $100,000 each in exchange for 6 to 10 percent equity--slices of the pie he felt were too big to give away. Through convertible-note loans from his family, Cisco held off on negotiating a price for his company too early. When he finally did raise an additional $150,000 from outside investors, his family's stake in the company converted to straight equity.

Get it in writing. Genadinik admits he regrets the "very, very informal" loan agreement he made with his mother last April. There was no timetable, no interest rate, no contract, nothing. Roughly six months later, his mom wanted her $20,000 back. Although Problemio had revenue by then, Genadinik didn't have the cash lying around. Rather than ruffle Mom's feathers, he took out a short-term microloan and sold $15,000 in stock to pay her back, incurring unwanted interest and costs in the process. Lesson learned: Sign a contract with family financiers so that expectations are crystal clear.

Don't ask for too much. If Switch Video fails, Angus' mom will lose her home, and he'll have to help her find a new place to live. Fortunately, business is thriving, with more than $2 million in annual revenue and customers such as Facebook, IBM, HP, Microsoft and American Express.

Select founder Cisco cautions against borrowing more than your parents can afford to lose. "You do want the amount to be enough that you have a shot," he says. "But you don't want it to be so much that someone has a problem if it doesn't work out."

Remember, you will have to face these people for many Thanksgivings to come.