Why do small businesses raise money from friends and family?
Small businesses face many challenges and one of them is obtaining funding at the beginning
Small businesses face many challenges and one of them is obtaining funding at the beginning.
We noted that 42 percent of entrepreneurs go to family and friends to raise money. Annually this figure is $50 to $75 billion for U.S. startup companies, which is about three times greater than funding from either angel investors or venture capitalists.
A further breakdown has shown that 82% of funding will come from either an entrepreneurs’ own savings or from friends and family. A number of reasons can be attributed to this avenue and here’s a few.
Immediate Funding Right Away
To raise money, going to family and friends can result in immediate funding. By approaching these connections, the entrepreneur knows they will already have available funding and he can avoid going through extensive financial background checks and voluminous paperwork.
Small businesses may also lack some business savvy and by going to family and friends they may be more comfortable talking about the opportunity and asking for money.
Only Available Funding at the Beginning
For some small businesses, funding from family and friends may be their only source at the start as sometimes banks and government grants may not be available to them due to a lack of credit, a business track record or an established business model.
It is family and friends that will fund the small businesses at this time. Entrepreneurs will then focus on creating their products, services, business models, offices and business plans.
You already have a relationship with family and friends: they believe in you and your vision
For many entrepreneurs, their small businesses have been a dream for quite some time and a passion. When this is the case, they have likely been speaking about this with family and friends, gaining their support and sharing their vision.
Family members as potential sources of funding may include parents, grandparents, aunts and uncles, neighbors as well as childhood friends.
By receiving funding from this group, they are investing in the entrepreneur’s small business because they believe in him. They also know his desire to succeed and his work ethic.
Family and friends invest in people, not necessarily small businesses.
Lower or no interest on the loan
By going to family and friends, they may charge a lower interest on a fundraising loan as they know your current financial situation. Small businesses will also be able to avoid fees and penalties by structuring through families and friends.
In some situations, the money may even come as gift, further decreasing extra costs and excluding interest. The loaner may have an interest to give additional funding in the future and become a partner.
This can provide small businesses with an opportunity to put more money into the business right away while paying off the loan and not worrying about financial constraints.
Lower attorney fees
By receiving funding from family and friends, the structure of the loan may be less complex and require less documentation. It is important to have an attorney review this but by setting it up in a simpler manner, future changes may be less intensive and costly.
Regardless of the amount borrowed from family and friends, it is still important for small businesses to have a business plan and proper documentation as well as act in a professional manner.
Have these reasons further spurred your interest in borrowing from family and friends? Here’s a success story that may inspire you.
Nike Started with Family and Friends
Philip H. Knight, co-founder and the current Chairman of the Board for Nike, Inc., got the idea for his business when he wrote a business plan for a Stanford MBA class assignment in the 1960s. He dreamed up a company that would sell shoes to athletes through the paper, “Can Japanese Sports Shoes Do to German Sports Shoes What Japanese Cameras Did to German Cameras?”
This assignment was to answer the question of whether or not a shoe could be designed and manufactured for less with better quality than the current market leader for athletic shoes, Adidas.
Knight was so inspired by the assignment he then went to Japan and met with Onitsuka Tiger Co executives, a manufacturer of fake Adidas shoes. He said he was the head of a fictitious company named Blue Ribbon Sports and that he wanted to distribute Tiger shoes back in the United States. Tiger officials accepted his pitch and sent samples to him after Knight said he would give them a big order once after he showed them to his business partners (but no, he did not have any).
When he returned home, Knight borrowed $500 from his father to start his business and pay for shoe samples. Keep in mind this was the 1960s and in today’s dollars and cents, this is equal to about $3,700.
After Knight received the shoes, he sent some to his old running coach Bill Bowerman, hoping he would purchase them and show the shoes to his runners.
It turned out even better: Bowerman gave Knight $500 and the two became partners in 1964.
The rest you could say is history.
There are many positives for small businesses to obtain funding from family and friends. Please let us know if you’re interested in learning more and how TrustLeaf can help your meet your goals.
