Posted by Neha De
April 8, 2021 | 4-minute read (647 words)
Starting a new business can be fraught with many struggles and challenges. Not only you have to make people believe in your vision, but also make a profit to sustain yourself and the business. Any new company will need a cash inflow, which creates a sticky situation: Do you take the route of sourcing cash and capital from your family and friends? Or should you get working capital from an outside organization like a venture capital fund?
There are many pros and cons to taking money from your family and friends to run your business, and we’ve broken down a few of those below.
Easy Money and Low Interest
Money sourced from your family, friends or peers can be easy to procure, and will likely carry low rates of interest, if any at all. However, you must determine the terms of the situation. Is it in the form of a gift? A loan? Or is it an investment in your business in exchange for equity? These points need to be noted and answered in the very beginning to prevent issues and animosity later on among close ones. In addition, create a contract that spells out all the terms and conditions so everything is on the table before anyone signs on the dotted line.
Creation of a Financial Record
The money that you source from people you know does not typically help your business get a credit history or financial track record, which is an important part of any growing or established business. At a certain point in time, it will be necessary for you to share your growth and spending analytics with banking institutions to get their trust and get further cash infusions if needed in the future. In some cases, this may require you to have a strong credit rating from a banking institution, which you likely wouldn't have following a family and friends round.
Most of the finance or capital given to businesses carries along with it certain perks and privileges, that are specific to that particular product. For example, money from a VC can open up relationships and networking opportunities that you might not otherwise have had. These benefits and perks are only accessible when you take money from the traditional route rather than from friends and family.
Relationship With Traditional Institutions
If you take a loan from an institution, you’ll be working toward making your business' credit rating better. The fact that you are maintaining a bond with your institution and securing a strong history with them will help make you more attractive to the bank.
Know the Risks Involved
Whenever you take money from your family or friends, there will always be a certain amount of risk involved. They may or may not lose all their money and get nothing in the way of return. Always make sure that you have given your investors a sound business plan with all the possible risks spelled out, and also carry out a legal document so you can fall back on it when the time comes. Money can be won or lost. However, relationships can be frayed when money is involved.
Consider this same scenario with traditional banking institutions. They’ll first look into all the pros and cons of the business. If they see a risk and still go ahead with it, that means they are willing to risk that money, and will not be as fazed as family members would be if you lose it. Your credit might take a beating for sure, but that’s different than straining a relationship with a close family member or friend.
These are some of the pros and cons of sourcing money from other channels rather than institutions. No matter which route you choose, make sure you check the terms and conditions of the funding source and that everything is in writing.