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The advantages—and perils—of friends and family money. by Bill Clark | Tuesday, November 2, 2010

In a time when bank loans are hard to come by for many startups, borrowing from friends and family looks alluring. Sure, hit up Uncle Bud – he's loaded!

The way most individual investors' stock portfolios have been performing lately, it's also not hard to imagine finding a relative or friend who might be interested in the returns a successful business might offer. After all, they may feel they're throwing money down a hole in stocks right now.

There are even online platforms that make it easy to present yourself as a serious borrower when you tap friends and family for a loan. Sites such as ZimpleMoney and Virgin Money allow you to track what you've paid, your interest rate, and the months until payoff.

This feels a lot more legit than scribbling an IOU on the back of a napkin. Certainly, if you ever go the friends-and-family route, you should be responsible about it and make sure you have a signed contract outlining the terms and interest rate of your loan, so all parties have a clear understanding of the loan repayment plan. Formalizing the loan may also allow you to write off the loan cost as a business expense.

Still, any financial expert you talk to about friends and family money will tell you that new technology tools or no, this option still ranks dead last in terms of desirability on any list of funding options. Most advise you to turn to friends and family only as an absolute last resort.

Why? In a way, friends and family loans are the riskiest kind of borrowing you can do. There's no other type of loan a small business owner can take out where they could end up friendless and estranged from family members. With other borrowing methods, you might end up broke, but at least you'll be able to commiserate with your buddies.

Before you take friends and family money for your business, ask yourself how you'd feel if you fell behind on your loan payments. You can just imagine the tension at that next family Thanksgiving dinner.

Now imagine the worst happens: Your business doesn't make it. You go bankrupt and can't pay back the loan at all. Now you're not invited for Thanksgiving dinner any more.

This scenario demonstrates why, if you need to turn to individual investors for business funding, you want to work with knowledgeable, accredited investors such as those you'll find here on the Microventures Marketplace. These investors understand the risks of investing in small business and know how to evaluate an equity investment proposal. Your relatives don't.


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