Most businesses need to raise extra capital at some stage to fund the increase in necessary equipment, staff and resources required for business expansion and growth.
If you don’t want to borrow from a bank or other lender, a popular alternative is to borrow what you need from friends or family. Someone who loves you and believes in you may not ask the same hard questions that a professional lender or investor will. They’re more likely to give you the money you need with very few strings attached, if any.
However, borrowing from family or friends has its own risks, especially if you’re unable to pay them back. Another alternative is bootstrapping, by finding saving wherever possible by eliminating any unnecessary overheads, needless expenses and nonessential assets, and making smart decisions to try and generate cash flow before your business acquires too many costs.
Borrowing from friends and family
When you decide to borrow from friends or family, it’s essential that an agreement is drawn up that clearly lays out the terms of the loan. Both parties should have a full understanding of what it involves, from what the repayment terms will be to agreeing not to discuss business at family gatherings. That’s why it’s important that a lawyer is involved in the process, so that everything is crystal clear. You want to preserve your relationship with them and the best way to do this is to make sure they understand what they’re getting in to.
There are two common methods for this kind of borrowing:
You’re given the money, and you pay it back when you can. Are they lending to you personally, or to the business? It’s an important stipulation because money received by you personally (to inject into the business) impacts your estate, while money received professionally will affect your business. Make sure you’re clear.
You’re given it and pay it back with interest like a bank (lender gets slightly more than the deposit rate, you get it cheaper than borrowing from the bank).
In either case, the family lender might want some shares in your business. It’s important to state this in the lending agreement.
Define the expectations of your lenders
Family and friends may ask to see your business plan before writing you a check, but possibly won’t. You should send them a copy anyway, and make sure when and how you will repay them is documented so there is one set of expectations. It’s also useful to outline any involvement or implied rights in your business operation.
Get legal advice
Hire a qualified person to work with you to develop an agreement and insist your family members review the document with their own independent counsel. Money can change everything with relationships, so it’s imperative that all parties can refer to a well-constructed agreement that’s signed before any funds are transferred. A legal agreement protects your family too, because they’ll know their rights in case something happens to you or your business.
Bootstrapping
If you don’t want to borrow money, or you haven’t been able to interest investors, don’t give up. You might still be able to raise capital (or get what you need) for your business growth plans by bootstrapping your business. To find extra cash you could:
- Reduce your salary to lower the drain on working capital. Look at the bare minimum you’ll need for your own living expenses and cut your salary to that amount.
- Sub lease any spare space to another business, or sub lease from another business temporarily to save committing to or paying for an expensive lease.
- Employ part time staff or have family help out in the early days to reduce employee costs. Find employees that may work for less if they can access a profit or equity share.
- Defer any payments for as long as you can to suppliers, in the expectation that you can use these funds for growth.
- Access stock/raw materials on consignment (only pay once it’s sold) to lower upfront inventory costs.
- Hold inventory virtually via a wholesaler or drop shipping company to reduce paying for and holding excess inventory.
- Save on marketing dollars by partnering with other business in joint promotions.
- Share office space with other like-minded businesses to reduce office rent.
- Sell any business assets that are under-used and lease them back when you need to.
Anything you can do to reduce the drain on your capital will free up cash, to maybe remove the need to borrow it, with the aim for the business cash flow to eventually kick in and get you going.
Summary
Borrowing from friends, family or bootstrapping requires due diligence and for you to be prepared. If you agree to borrow from friends or family, make sure that they understand the terms of the loan and have those terms clearly laid out in a legal agreement.
When bootstrapping, know what you need the extra funds for, and how much you’ll need. You can then identify where the best savings can be made to meet those funding goals and prepare your business for operating on a shoestring until you’re up and running.