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n most cases, friends and family are not the optimal sources of operating funds for any number of good reasons. But when you need small amounts of high-risk equity to start a business or to keep your business afloat, they are often the best sources.
If they have the funds and believe in you and your business, they can act quickly when time is of the essence. This is just what you must have in a cash flow emergency. So, if your survival depends on it, ask your friends and family for precisely what you need to survive. Make them a deal that you can live with and one you can follow through on. Allow enough time for you to actually develop the funds to pay them back or to buy back the stock issued. Do not make any promises that will be hard to keep in the next several years. (Distressed markets have an oversized element of the unknown. Both you and the person you are asking for funds should recognize this fact.)
Debt, in the form of a loan, may be the terms you use for discussion. Just know that these funds will be the equivalent of equity, since they will have no call on the company’s assets. Do not let anyone think you are making them a partner unless you really are, and they can contribute. You do not need the distractions and they do not need the heartache.
Make sure you want to go down this path before you start. If it is the right choice, make the best advance you can and keep it as businesslike as possible. Be as transparent as you can be about the business needs for the funds. Advise the “investor” how and when you will update them on the progress you expect to make once you have the funds.
How much can you ask for from a friend or a member of your family? That depends on their personal financial position. If they have a business, you might approach them with an arrangement that involves that business. The size or the strength of their business will dictate the amount that can be invested. Try to have a good idea about their company’s assets, debt structure, and value before you make an inquiry.
If the source has personal funds, you will want to have some understanding of their total assets. Try to ask for no more than 5% to 10% of their total assets. At that level, it will not be an insignificant a decision for them. But, in that range, it should not impact their lifestyle or future prospects. You do not want to financially impact a person in your family or a close friend beyond that limit.
You can certainly combine “loans” from multiple members of this group. It is normally best, however, not to mix friends, as investors, with family members who provide funds. No matter how hard you try, there will always be a difference between family and friends. Even if you make every effort to communicate effectively and treat everyone evenhandedly, there is too much risk of a misunderstanding when you have both friends and family as funding sources.
Do not ask for funds if the person has to take them from a retirement vehicle. Those funds are for retirement and not investments of this nature. You might find the need to “tap” your own retirement funds, but that big decision is only going to impact you. So, even if they offer, do not accept funds that cross this line.