The following excerpt is from the staff of Entrepreneur Media’s book Finance Your Business. Buy it now from Amazon | Barnes & Noble | iTunes
Have you heard of “FFF” money? FFF stands for family, friends and fools. Many new entrepreneurs receive the initial funding for their businesses from people close to them, causing these relationships to start sliding toward disaster. Over his 15-year career as an entrepreneur, Josh Steimle borrowed from all three groups, making him an excellent source for what to watch out for when borrowing FFF money.
Although some of these funding arrangements have happy endings, all too many end painfully, with consequences ranging from unfortunate to disastrous. Before considering FFF money as an easy way to start your business, consider the following.
Money changes people
Nobody starts out in a marriage saying, “How can I use money to ruin this relationship?” But many couples seemingly do. Financial disagreements are the number one predictor of divorce in the United States, according to one study. The person you dated and were madly in love with before you married can become another person entirely when finances enter the picture.
Money changes people in business relationships as well. Finances will cause contention when there isn’t enough when there’s too much, and at every point in between, no matter how great a person you are or the lender is.
The borrower is a slave to the lender
Many have said that the day you take a loan from someone, you become that person’s slave until you pay off the last cent. The lender may claim that they don’t mind and just want to help you succeed.
But wait until you take a vacation in Hawaii, buy a new house or car or even choose a more expensive dish at a restaurant than they do. Then the lender might start thinking, “Wait a second. I gave this guy a loan, and he’s spending money on this instead of paying me back?”
Your business may fail
Most small businesses do. Think yours will be the exception? So do the roughly half of U.S. business owners who shut down their companies within the first five years of doing business.
What’s your plan if your great idea doesn’t work out? Will you feel OK telling investors you’re sorry you lost their money or will you feel obligated to turn investments into loans and pay them back? In the latter case, what will be your plan for paying the loans off?
Given the risks, what can an entrepreneur do to reduce the chances of a family loan harming a personal relationship?
Much of Steimle’s initial exposure to entrepreneurship came from his father’s granting him a $1,000 loan when he was in high school so he could launch a retail skateboard business. That experience and others left him with mixed feelings.
Tips on avoiding trouble
Here’s some advice Steimle gave his dad that he feels can be broadly applied to anyone considering borrowing from a family member or friend:
1. The dynamic should resemble that at a bank, not one between relatives. Repayment should be required. Payment terms can be flexible, but the borrower shouldn’t be let out of the loan. This is…