How to Fund Your Business Through Friends and Family Loans and Crowdsourcing You want to cast a wide net when raising funds. Here are two great sources to help build momentum.
- Learn quick tips to help you win funding.
- Delve into direct funding sources that invest directly in your business.
- Examine your own resources first.
- Friends and family funding can unlock interest from other investors.
- Make sure you have a written plan for managing friends and family loans to avoid misunderstandings and conflict down the road.
- Explore the many powerful platforms to raise funds through crowdsourcing.
This is part 4 / 10 of Write Your Business Plan: Section 2: Putting Your Business Plan to Work series.
Before we dive into the different types of funding, keep these quick tips in mind to help you win the funding you are searching for:
Spend extra time working on the executive summary. Because bankers and professional investors receive so many business plans, they sometimes go right to the executive summary for an overall view of what your plan is all about. If you can't seize their interest in your executive summary, go back to the drawing board and try again.
Make sure your business plan is complete. You would be surprised at how many business plans are submitted with important data missing. You need to double- and triple-check to make sure all of the important components are included. Even when using business plan software, people skip sections or decide an area is not important. Leave nothing to chance. A well-written and complete business plan gives you a higher chance of success and better odds of getting the financing you are seeking.
Be able to back up anything you have on paper if asked for more details. While the business plan should have all the answers, investors, bankers, and venture capitalists are shrewd and ask questions that may not be answered in the plan. Be ready to answer anything they can possibly throw at you. Expect the unexpected and prepare for it.
Direct Funding Sources
When you're looking for money, it may seem that investors are scarce. But the real problem may be that you're not looking in enough places for potential financiers. You may find investors as close as your immediate family and as far away as professional venture capitalists on the other side of the world.
Investors come in many shapes and sizes, as well as with various needs and intentions. Odds are you can find someone to help you with your financing needs if you cast your net wide enough.
Direct funding sources invest directly in your business. These include funds from individuals, banks, government agencies, and various levels of professional investors. Indirect funding sources provide trade credit and financing mechanisms such as extended terms on purchases. These are important sources of working capital, but they do not put funds directly into your business.
Your Own Resources
Your own resources, savings, investments, and other valuable assets are the beginning of your financing efforts. One reason to write a business plan is to provide reassurance that you are making a sensible investment. Note that you will be investing serious nonfinancial assets in your business: your time, effort, hopes, and reputation.
As for your own financial assets, make sure the money is not earmarked for tuition or part of your necessary family spending, such as your mortgage, rent, and the like. If you're in debt, it is also advisable to get out from under before starting a business. But you can start writing your business plan while getting your financial affairs in order.
Even though hopefully you will be investing assets from investors, you should be prepared to invest some of your own money in your business venture. Rule of thumb says if you want other people to invest in you, then you also have to invest in yourself.
Why should other people take a gamble on your business if you won't?
Friends and Family
The most likely source of financing is the group of people closest to you. Spouses, parents, grandparents, aunts, uncles, and in-laws, as well as friends and colleagues, have reasons to help you that arm's-length financiers lack. For that reason, they may back you when no one else will.
One seldom-noticed aspect of asking family and friends to invest in your venture is that other investors (especially bankers and venture capitalists) often ask if you have approached friends and family to raise initial capital. If you say you haven't, they'll then ask why not. If your deal is so appealing, why wouldn't you let your friends in on the ground floor? If you say yes, but they couldn't come through for you, at least the banker or VC will know you tried.
Related: 4 Ways To Finance Your Business
Willingness to take a risk doesn't make friends and family foolish investors. Money from family and friends has backed many very successful business ventures. Here are a few:
Albertson's Inc. Cofounder Joe Albertson borrowed $7,500 from his aunt to make his $12,500 contribution to the partnership that began the grocery store that grew to have sales of more than $2 billion a year.
Pizza Hut Inc. Cofounders Frank and Dan Carney borrowed $600 from an insurance fund left by their late father to start the pizza chain.
Eckerd Corporation. Jack Eckerd raised $150,000 from family members to purchase three failing Florida drugstores, the cornerstone of a company whose sales would one day top $9 billion a year.
Friends and family may not be able to raise millions of dollars, but they can provide long-term financing for highly speculative endeavors that more mainstream financiers wouldn't touch.
Related: 8 Ways To Fund Your Start-Up
Even Families Need a Plan
If you're financing your venture with family money, you may think all you need is a smile and a polite request to raise what you need. In the short term, that may work and produce the funds you need to start out. But over the long term, even family-financed enterprises will benefit from having a business plan.
Such a plan shows family members who are putting up the money what they can expect for their contribution. And it helps keep the entrepreneur— you—mindful of responsibilities to the family members who backed you and on track to fulfill your obligations.
Pros and Cons of Family Funding
On the positive side, family and friends will let you know if your idea appeals to them. Typically, they will also give you the time and a less stressful environment in which to present your plan. Family members may be more readily available to lend a helping hand when you need one and may be there to take over the business down the road.
The flip side is that you are closer to your family and friends. Losing the money of someone close to you can create a lot of tension between you and your family or friends. Family members and friends may also want to get more involved and try to oversee aspects of the business or push you to make changes that other investors would not. They may even expect to be on your management team, which would not be the case with a bank.
In order to make investor agreements work with friends and family, you need to spell out everything clearly and make sure you can separate your business from your personal relationships. This is not necessarily as easy as it sounds. You need to go into any such deals playing some defense and making it clear that people may lose their investments. Provide plenty of warning, and, if they insist on being part of your business, make sure there are boundaries set out in advance that everyone can agree upon.
Potential Pitfalls of Friends and Family Funding
Family members offer tempting capital sources. But emotions can interfere with judgment when dealing with relatives and can lead to hurt feelings as well as possible lawsuits and other entanglements. Minimize the risk of such misunderstandings by fully documenting terms, possible interest rates, and other details for loans and equity investments from family.
If you do not document the terms of such loans in writing, the IRS can either treat the loan as permanent capital or impose a stiff interest rate on the loan. Neither of these options is desirable.
A rather recent entry into the world of procuring funds for projects is crowdfunding. This is a means of gathering funds from a diverse group of investors using Internet technology.
The idea is broad based with some investors on crowdfunding sites getting rewards for investing money while others become investors with a stake in the business. As a result, some of these sites are, like PBS, seeking support from generous people with a passion for a type of business or short-term project or for a cause behind that business or project. Other sites are looking for investors in more full-blown long-term business ventures.
Statista, a leading provider of market and consumer data, reported that the overall industry raised more than $13.6 billion in 2021, and is forecast to more than double to nearly $29 billion in 2028.
Adam Chapnick, former head of Indiegogo, notes that an abbreviated business plan works best for most crowdfunding sites. "Make a big fat business plan—then throw it away," says Chapnick, adding that it is important to go through the process of creating a business plan and then necessary to simplify it and make it quick to convey for crowdfunding.
MicroVentures starts off with a snapshot questionnaire to which you can attach a business plan if you so choose, but it's not required. Like Indiegogo, it would also look for the abridged version of your longer plan.
There are more crowdfunding services coming of age, with new parameters and guidelines, many of which meet specific niche groups. Rules are changing, in part because of federal and SEC regulations and in part because the crowdfunding services are seeing new ways of doing business. For example, Kickstarter, the early trendsetter in this industry, which has raised over $300 million for over 1,800 projects, will give the new business venture the money that has been raised only if the total amount requested has been reached. Therefore, if you request $10,000 to start a business, and you raise only $7,500 from interested parties, you get nothing. Other services, though, would give you the $7,500. Kickstarter is also more selective about what projects end up on its website, looking for more "trendy" ideas to keep the company in the limelight.
By reviewing the various crowdfunding websites, you can determine which one might be best for your efforts. Look at what the investors will get in return. This can be anything from a gift, not unlike pledging money to PBS; a return on the investment with interest; or, on equity investment crowdfunding websites, a share in the business.
Also, keep in mind that many people invest in crowdfunding ventures with their hearts and/or emotions. It is a daring means of investing, but one that drives many crowdfunding investors to put money into something in which they personally believe, such as an environmentally sound business. Of course, there are downsides to crowdfunding, such as putting an idea out there that can be easily stolen or having backers that offer money only while not giving you either the network you need, good business advice, or second rounds of funding. There is also a lot of time spent on marketing to raise your funds. In addition, the SEC is closely watching this new investment opportunity, so you need to be abreast of the latest rules governing crowdfunding.
While Kickstarter and Indiegogo are more frequently used for creative projects, business owners have found success with AngelList.com, MicroVentures.com, or CircleUp.com. But there are so many more that you can find by searching online for "crowdfunding for business."