No Such Thing as No Strings Attached

Watch out for well meaning family and friends when building a startup

Back Article Sep 29, 2016 By Gordon Fowler

Recently, within the context of being a co-founder and mentor at Roseville’s Glue Factory, an incubator for entrepreneurs willing to give back to the community in exchange for free workspace and guidance, I am often asked about the ins and outs of family and friends investing in a startup company.

Our standard advice always includes a cautionary tale of the “real” costs (will family want to become partners, employees or consultants?) and, of course, the reality (they know you and have money). But recent events are bringing the conversation into my own living room, and I’m discovering a few blurred lines.

My college-aged son, home for the summer, suggested an internship for himself at 3fold Communications. I wasn’t surprised by my hesitancy. I never considered 3fold a family business, and I believe nepotism is a system that can rock the boat of a great team and interfere with company operations.

We started 3fold 12 years ago on a wing and a prayer and without financial help from anybody. Now all of a sudden, I’m putting policies in place that sound like a family business. Who reports to whom? What are the expectations of my son versus my team? What if he has insights into my company I don’t really want to hear? What if his supervisor thinks he is a slacker? Will she feel comfortable telling him? Telling me? And, what if he wants in after graduation, or even more disconcerting, what if he wants to be like his old man and start his own enterprise? Should I get involved?

Looking to substantiate the encouragement we give our Glue Factory cohort to seek resources from family and friends, and reassure myself that the perils of investing in family can be minimized, I turned to Steve Fleming, CEO of River City Bank (a family owned business) and a board member for the Capital Region Family Business Center.

Fleming says taking money from relatives certainly has its advantages. To next of kin, the dreamer is a charmer! They have a natural bond and a close connection. Kitchen-table funding can even be an expression of unconditional love and support. Apparently, so true. According to Asheesh Advanti, the former CEO of Covestor, an online marketplace for investment accounts, half of private investors are friends, close family members or in the extended-family range.

Related: Family Planning

And we aren’t talking pocket change. The impact of informal investment on entrepreneurship is immense. Globally, informal investment to entrepreneurs per year totaled more than $1 trillion (U.S.) over the period of 2012 to 2015, according to Global Entrepreneurship Monitor.

Our own Glue Factory anecdotal experience tells us that crowdfunding will increasingly take the place of asking close relations for funding directly, but a ritual dating back to ancient times will always exist. If you are willing to risk commingling the professional and the personal for the sake of a good idea, here are a few rules.

Communicate

If you want to improve the odds that all will go well with your future investors, communicate, communicate, communicate. Tell your story honestly and don’t overlook the part about the possibility of failure. Your family needs to know they may not get their money back. Don’t worry: Your parents will love you no matter what, but siblings and friends? Maybe not so much. Everyone must agree on expectations.

And expectations include the unexpected. Did you consider that your business partner might want a divorce someday? And it happens; Dad smells a sinking ship and can’t help but meddle, and know-it-all Sis gives copious amounts of unsolicited advice. Now what?

Protect Yourself

Binding legal documents may seem off-putting, less friendly and are not necessarily essential. Way more important is a thorough meeting of minds, but “papering it” as a way to add some discipline is a good idea. Try out websites such as Caplinked, a sharing platform for enterprises and their collaborators, or LendingKarma, an online service that creates custom loan agreements for lending to people you know to help with structure and management of investments.

Related: Strictly Professional

Fleming will attest from his experience with the Family Business Center that when it comes to family-funding matters, there is no cookie-cutter approach. Every family business has their own story and their own personalities, and what worked in one could be a disaster for another.

Lay Out Boundaries

Now let’s assume all does go well. That is no assurance there won’t be issues with the original funders. An all-too-typical story is one where the intent of the gesture-of-love investment turns sour as success takes hold and greed rolls in. And when there is considerable value, there can be a huge gap in what’s “fair.”

“I think the most ambiguous word in the English language is fair,” Fleming says. “Everyone’s sense of it is different.” Fleming explains that there can be two ends of the fairness spectrum. There is the person with the idea, the execution and the follow through who created the value versus those who put up the capital.

Even with every detail underscored and documented, it is good practice to keep your investors up to date and informed on your progress. Don’t take your leap-of-faith family and friends for granted. Give them a call or written updates regularly. And when your business is a home run, remember who got you there but think it through: Are you a family business or a business built on family investment? The answer may come apparent when Jr. wants to intern…

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