Friends, family and fools

Ah, the three F's of raising startup capital: Friends, Families, Fools. They'll provide probably the most favourable, fast and bureaucracy-free bit of funding you'll ever get your hands on. But loans from loved ones can also come so riddled with potential problems everyone naively overlooked in their hurry to make it happen that the derogatory third part of the moniker is more than justified.

Because while turning to your inner circle might seem like the most obvious thing to do to give your business a kick-start, if you're not careful it could cause a lot more damage than a failed business ever would.

For many business starters, of course, there's no choice. Recent times have pushed more than a few commercial investors to tighten their belts. The number of small and medium-sized business turning to friends and family for cash is six times as high as it was in 2008, according to a survey by Close Invoice Finance. One in 10 are now using their very closest contacts as their bankers.

Whether or not you've had the luxury of choosing to go to FFFs, you need to know how to handle the process.

Why it works

Don't let the recession-induced rise in FFF-lending trick you into thinking it should be a last resort. There are massive advantages to taking a loan from someone you know rather than from a professional lender.

It's almost always quicker and easier to get cash from someone you know. They're likely to grill you a lot less than an angel or bank manager who knows nothing about you and who values profit margins and instant results more than personal ambition.

Heather Wilkinson got a £5,000 loan from her parents to kick-start her community interest company Striding Out, which supports young entrepreneurs through coaching, training and events. She just went to them with a business plan and evidence from meetings she'd held that elicited positive responses, and told them about a grant she'd been awarded.

"They thought [the idea] was very relevant and that there was an opportunity at the moment, and they trusted me that I was making the right judgement to give it a go based on that," she says.

She didn't need to provide security for the loan, because of their 'trust relationship', and neither party wrote anything down, except to show where the money had come from in the company accounts so her parents could take it back at a later date.

They didn't even draft out repayment terms. Instead, Wilkinson made her accountancy-savvy mother financial director, so 'she knows what's coming in and what's coming out, and she just takes a bit when she knows there's enough of a buffer'. Tying repayments in with cashflow being another huge bonus that borrowing from FFF allows, but a bank simply wouldn't.

The 'personal buy-in' that brings with it more lenient repayment terms, though, can also pile on added pressure. "If it was £5,000 that an investor lost I think I might be less bothered, because it's not as emotionally attached, and if you walk away you might not have to see them again."

The flipside of that, of course, is that you ultimately have the chance of sharing any profits with your friends and family rather than detached investors. And doesn't that sound a whole lot more appealing?

The risks

Of course, it's not all low-interest loans and deadlines up for debate. The old maxim of not mixing business with pleasure has become an institution for a reason.

The greatest risk of all is to your relationship. If your business fails - and 72% do in their first five years - you could well end up losing a friend, or having to face a bitter legal battle.

Those are worst case scenarios - but it does happen. It can be such a heavy weight on a relationship that even when things are going more or less as well as they could - as they are for Wilkinson - it's not going to be as straightforward as you'd like. "The problem is it brings the worry of the business and the cashflow into your family," she says. "It can cause arguments."

Much as you and the lender know, trust and like each other, when money gets involved, everything changes. No matter how much you try to avoid it, talk of the business will start seeping into your social life with them. For an innocuous 'What have you got planned for the weekend?' read 'I'm due my next dividend or repayment'.

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