Strings Attached? What to consider before investing with friends and family

 Many startup founders may turn to friends and family as a first source of funds when they are getting off the ground. If considering whether to accept funds from, or invest in, the business ventures of friends and family, it is important to consider the tough questions upfront. Money can be a taboo topic, and wherever close relationships are concerned, it has the potential to create uncomfortable situations. To avoid unnecessary tension, here are several things to consider before forming a financial partnership with someone you’re close to.
Before offering a check to a friend or family member, consider the following:
Good ideas do not necessarily equal good execution. Believing in a business concept is one thing; having confidence in the individual’s ability to deliver on that idea is another. Make sure to dig into the nitty gritty around how the company plans to get from Point A to Point B and, more importantly, what (if any) backup plans he or she has in the event that things don’t play out as hoped.
Quality investors offer more than a checkbook. The best investors can share experience and guidance in addition to a check. As a potential investor, ask yourself what you can offer the founding team beyond cash (such as access to your network). Are you looking to take a more hands-on approach to supporting the company, or do you prefer to remain a passive investor?
Nothing is certain. Just like in life, a startup’s journey can involve many detours. Some new businesses may require several rounds of additional investment in order to keep the doors open. Others may pivot from their original idea and use your funds to tackle an entirely different opportunity. What expectations do you have in regard to the financial return? If the company fails, will your relationship with the family member or friend suffer? Consider the worst-case scenario and how it will affect your finances as well as your relationship before writing a check.
Before accepting a check from a friend or family member, consider the following:
It can be too easy. When you turn to outside investors for funding, you can expect every aspect of your business plan to be challenged. This might sound like a pain, but it can also help you refine your business model to improve your chances for success. When someone writes a check simply because they want to help you or feel compelled to because of family ties, you may lack the same level of scrutiny.
Professional venture capitalists offer more than money. Venture firms and small business incubators are professionals who have learned what to avoid and where to focus and thus are often able to provide invaluable business connections. If your investor lacks an entrepreneurial or investment background, you may miss out on the incremental value of expertise beyond capital.
There can be tax consequences. A relative may decide to give you money to start a business in the form of a gift, a loan, or an investment. Each approach may involve different tax consequences depending on the terms of the agreement. Seek out advice from a Financial Advisor or tax professional to help ensure you are considering all implications and have the proper documentation in place.
It can cause friction in the family. If your parent or other family member makes a sizeable investment in your company and it doesn’t work out, it may reduce the size of their estate, or their ability to help other family members financially, causing tensions. Another source of potential friction is that as a shareholder, a family member may now have a say in how the venture is run. This should be discussed and agreed upon in advance.
While investing with friends and family can be complicated, a Financial Advisor who is familiar with your specific circumstances and goals can help you navigate these issues before making decisions that can affect not only your finances, but your relationships as well.
Article by Morgan Stanley and provided courtesy of Morgan Stanley Financial Advisor.
Brian Jacobs is a Wealth Advisor in Valencia, CA at Morgan Stanley Smith Barney LLC (“Morgan Stanley”). He can be reached by email at brian.jacobs@morganstanley.com or by telephone at 661-290-2022.
Brian Jacobs may only transact business, follow-up with individualized responses, or render personalized investment advice for compensation, in states where he is registered or excluded or exempted from registration/ http://fa.morganstanley.com/brian.jacobs