When starting a small business, the biggest hurdle is typically startup money. There are four basic sources for seed money: personal savings, investors (debt or equity), a startup business loan (typically from the SBA), and friends and family loans/investments.
For those that don't have substantial personal savings, the most common (and typically the easiest) source of money is friends and family. According to the University of Michigan study of entrepreneurs, "The lion's share of initial startup capital comes from individual savings, friends and family." In fact, a friends and family loan often surpasses other types of loans as the most beneficial of business loans for startups.
There are a variety of ways to structure your friends and family round, but one of the best is a simple term loan. Here are four reasons why you may want to consider funding your own business venture with a term loan from friends and family.
1. Friends and Family Believe in You and Your Idea
Banks often just look at the numbers, and if they don't believe in you or your idea, they won't give you money. Early stage investors and angels, by contrast, may only care about the idea--but getting a meeting can be daunting... and you still have to nail the pitch if you do. Additionally, there are many other factors why banks and investors may not take a chance on you, such as whether or not you have collateral or how your business plan is presented.
But friends and family are more inclined to want to help you get your business up and running, and they can give you funds in the form of a gift or as a term loan, which has its own benefits when compared to a traditional small business loan.
2. A Friends and Family Loan Has More Forgiving Terms
Banks need their money returned to them, on the schedule they set forth, no excuses. Investors typically demand aggressive returns, and they typically give themselves the power to remove you if you don't hit their return targets.
A friends and family loan typically has more forgiving terms. The APR will typically be much lower, and the payment schedule less aggressive. Also, so long as you don't appear to be wasting the investment of your friends, they will probably let you be a few days late on a payment now and then.
3. You Don't Have to Give Up Equity or Collateral
Banks often want collateral in return for small business loans for startups. If your business isn't asset-heavy, that typically means your house. A good rule of thumb is that if your business assets aren't worth 100% of the loan value, they'll typically want some other type of collateral.
Investors, on the other hand, will want equity in the business in addition to a return on their investment. Plus giving up equity to investors means a whole lot more paperwork and reporting, especially if you have passive minority shareholders. You'll also need a competent securities lawyer, and those typically aren't cheap. Overall, be prepared for your investors to be very involved in your business. After all, they did give you their money on faith, so, of course, they are going to take a serious interest in how you're using it.
A friends and family loan is usually not that strict. While your friends and family might be seriously angry with you if their investment in you fails, they typically won't try to seize your house and possessions. Similarly, the legal requirements for borrowing money are far less strict than those for selling equity in your company, so you can avoid many of the legal fees.
4. You May Have Found Potential Future Business Partners
If certain friends or family members have loaned you money for your business, you may find that their advice can also come in handy. Working together can pave the way for a future business partner, someone who can help you grow your business.
Pro Tip: Protect Your Relationships
Although friends and family can certainly be willing to help you financially with your startup capital, sometimes the old saying that "friends and money don't mix" rings true. If things go wrong with the business or you aren't so quick to pay back what was loaned to you, you might find yourself on the outs with those who were once so good to you. Do yourself (and your friends and family) a favor and check out our tips for how to protect your relationships in friends and family loans.