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Asking Friends and Family for Financing Heed our warnings before you play this dangerous game.

By Stever Robbins

Opinions expressed by Entrepreneur contributors are their own.

Q: I need to learn how to approach friends and family for startup financing. Can you provide a short list of resources or references for me?

A: Look out! You're walking an emotional tightrope mixing friendship and business. You're raising money from friends and family because they know and believe in you as a person. The personal connection lets them ignore the business uncertainty and give money anyway. But there's a reason that banks won't lend to you: you might really fail.

Friends and family who aren't sophisticated businesspeople may not understand the implications of what they're doing. If they are investing equity, they are risking their money forever. If they are investing debt, they are also risking their money forever. Two years down the line, they may need that retirement fund only to realize it's gone. It's then that emotions clash, and friendships are often the first casualty.

Before you ask for money, you must manage the tightrope walk. Show them the 100-foot drop to either side. Pound the risks into their heads. Have them pretend the money is completely lost, and find out how they'd feel. For their sake and the sake of your relationship, don't let them invest any money they can't afford to lose--even if they claim they're willing. And never let someone invest who refuses to consider the possibility that you may not succeed. If they don't realize that you might fail for reasons completely beyond your control, then they don't belong in a high-risk business venture.

The worst-case scenario is that you might not be able to pay them back. And think about that from their perspective for a moment: Suddenly they've become a bill collector. Yuck. I've been there myself, and it sucks. Do I want to threaten my friend with forcing him into bankruptcy because he's stopped repaying his loan? It's lose-lose. If he gives in, the fight has killed the friendship. If he doesn't give in, I must spend more money taking him to court. Shudder. Even if the friendship survives, the emotional roller-coaster takes a severe toll.

From your perspective, you may be more lax repaying friends and family money. It's easy when times are tough to think, "It's just Mom. She'll understand." But what about your long-planned Hawaii trip to keep yourself sane? If you don't go, you're seriously risking a stress-induced breakdown. But if you do go, how is Mom going to feel when you tell her all about your wonderful vacation, while you're both keenly aware that you could have spent that money paying her instead?

If you're intent on raising money from friends and family, proceed with your eyes open. And one excellent path to take is to structure the money as a loan and use CircleLendingto administer the loan. CircleLending administers loans between you and friends, but they keep the business and emotions separate. You list the loan and the loan agreement with them (so there will be no confusion later about terms). They receive the payments, send statements, etc. If a payment is late, they become the "bad guy." Your friend doesn't have to become the Terminator to protect their investment. It helps you, too. You'll take a printed statement from a collection agency much more seriously than a note from Mom saying, "Honey, I really could use this month's payment..." And if you do default on the loan, CircleLending will help your lenders with collection agencies, mediation or selling the loan to a third party who can then try to collect.

Raising money from friends and family seems attractive: potentially good rates, lenient credit standards, and a chance for your friends and family to share in the wealth you create. Just make sure to manage the downside, and find any way you can to keep the love and affection firmly separated from the business transactions.

As an entrepreneur, technologist, advisor and coach, Stever Robbins seeks out and identifies high-potential startups to help them develop the skills, attitudes and capabilities they need to succeed. He has been involved with startup companies since 1978 and is currently an investor or advisor to several technology and Internet companies including ZEFER Corp., University Access Inc., RenalTech, Crimson Soutions and PrimeSource. He has been using the Internet since 1977, was a co-founder of FTP Software in 1986, and worked on the design team of Harvard Business School's "Foundations" program. Stever holds an MBA from Harvard Business School and a computer science degree from MIT. His website is a http://www.venturecoach.com.

The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.

Stever Robbins is a venture coach, helping entrepreneurs and early-stage companies develop the attitudes, skills and capabilities needed to succeed. He brings to bear skills as an entrepreneur, teacher and technologist in helping others create successful ventures.

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