Should you invest in the family entrepreneur?

Considerations for navigating the tricky waters of the familial and the financial.

Funding from family is still a primary way to get a new venture off the ground. But how do you go about it in an intentional way – without causing any relational rifts?

It turns out family is actually a primary source for funding new businesses, well ahead of loans and venture capital, often relying on their intimate knowledge of the intangibles that could spell early success. Family wealth also can cushion the blow should the business ever waver.

But it doesn’t even have to be big money. Media mogul Russell Simmons credits his mother’s early $2,000 investment with “keeping me afloat until Kurtis Blow (a hip-hop artist signed by Simmons’ new management company) broke, and I entered the record business,” he writes in his biography “Life and Def.”

So when a loved one comes to you asking to launch a new enterprise, how do you figure out if you’re able – and this is key – willing to support them emotionally and financially?

Big or small

First, make sure you’re considering it a business deal with safeguards and expectations in place. You likely love this would-be entrepreneur, but you may not want emotions to carry you away from practical aspects. Talk to your financial advisors, accountants and attorneys to get an objective view of your ability to take on the risk of supporting a loved one’s dream. An outside consultant familiar with the proposed market or industry can help vet the investment as you might with any new business deal.

There should be some strings attached, but not tied so tightly they leave no room to roam – you’re looking for a happy blend of accountability and transparency. Money tends to be emotionally charged no matter how carefully you tread. It’s important to acknowledge this when you make the investment, and note that it’s why you’ve put some safeguards in place ahead of time.

Navigating the partnership

Once money exchanges hands (either by gifting, loaning or purchasing corporate stock or partnership membership), you’ll be in a partnership. You may want to reserve the right to speak up and get involved, just as you would with a partner you aren’t related to.

If you’re loaning money, it’s a responsible strategy to secure legally binding and properly executed documents such as a written business plan, shareholder’s or partnership agreement, and a promissory note with stated interest rate and terms. Your advisor can walk you through options like convertible debt that may allow you to convert your loan to equity (at a preferential rate, perhaps, for being an early supporter) if outside funding materializes.

Just as real estate relies on location, location, location, business deals – especially intrafamily ones – rely on communication, communication, communication. That means documenting a clearly defined business plan and a legal contract that defines roles, responsibilities, incentives and protections that might mitigate some of the potential risks. Your relationship is too important to risk.

Next steps

If a family member is asking you to consider investing:

Think about how this investment would align with the rest of your investment goals.
Talk to your financial advisor about different ways to structure the loan.
Decide what type of partner you will want to be – silent or active?

Sources: griequity.com; familybusinessmagazine.com; forbes.com; theguardian.com; gobankingrates.com; lovemoney.com; elitesavvy.com; Bank of America Private Bank; Merrill Lynch; usnews.com; economist.com; hbr.org