Too close for comfort - Accepting start-up money from family or friends can be a delicate business.
By Tom McKaskill

Few entrepreneurs in start-up companies have sufficient personal wealth to fully finance their new venture. After they have exhausted their savings and mortgaged everything they can, they usually call on friends and relatives to put some money into their "sure thing". But everything has a price, and even money from those close to you comes with its problems. Family and friends may not have the same financial requirements as an independent investor, but they can be just as demanding.

New ventures are not without their risks. Research shows that only 4% of businesses go beyond $2 million in revenue and very small businesses have the highest failure rates as they lack the resilience to withstand bad luck or poor management. So the chance of the new venture losing money invested by relatives and friends is high.

One consideration that the new-venture entrepreneur should face up to is the effect of the venture failing. What happens when the venture fails and relatives have invested life savings into the business, having been sold on the dream of owning part of the next Microsoft?

Few non-business people appreciate the risks involved in starting a new company. Everything appears attractive in the beginning when things look so easy and people are sold on the idea of their young relative creating a monster company. But when it fails and they accept that their relative simply never had the experience to make it work, will they be happy just to write off the investment, or will this be a lifelong problem between them?

The same could be said of close friends. Being work colleagues or social friends hardly qualifies people to undertake the stress and rigour of going into business together. What happens when their talent and experience proves not to be at the level that is required, or they do not want to commit the time, or they want to have the final say on all the decisions? Then you have a dysfunctional team that is probably going to make the business fail or you are going to have to break up the team by forcing someone to quit. If they have money invested in the venture and still own equity, how are you going to buy them out or deal with their ongoing equity interest?

Many start-ups involve couples, business colleagues, school friends and relatives. Not all of them will appreciate the time and effort that must be put into the venture to get it to a reasonably profitable, sustainable state. There are many stories of partners working long hours, taking low salaries and doing activities for which they are not trained. Not everyone going into the venture is capable or willing to put in the effort and time it takes to get something up and running.

Money from close relatives may come with other constraints. If the investor is working in the business, they could feel like a partner and want to be involved in the decision making on a regular basis. This can work in very small businesses but it becomes problematic once the business expands.

As more staff are added to the business, often a more formal organisational structure is required.

At this point, the question of who is the boss and who makes the decisions becomes a debatable issue that can lead to conflict. With independent people, this can be more easily resolved. But when the other person is your spouse or cousin or best friend, the issue is not so readily resolved.

At the same time, family investors who do not work in the business may feel a need to interfere if they see something they disagree with, even without understanding the situation or the business requirements. So the wife of the cousin who sees differences in remuneration or workloads may feel compelled to express criticism to the aunts and uncles. This means that the managers are spending time defending their actions to people outside the business who may have no idea of their pressures.

Common to many new ventures involving married couples are the problems that arise when they start a family or go through a divorce. When one owner or manager needs to take time out for a family, this can create tension and assertions of unfairness and inequality. When a divorce happens, it may be impossible to continue a close working relationship. The issue of ownership and involvement can become very messy, often resulting in the failure or sale of the business.

Few ventures get off the ground without money from family and friends, but be aware of the associated problems and raise those issues as soon as possible. Most people will accept a sound business case for change. But you may have to accept some unintended hostility or bitterness if you have not set the expectations correctly.