It’s unlikely there would be disagreement about this one, right? If a friend or family member has advanced cash to help your business through expansion or a cash flow glitch, it’s either debt or equity. It will always be obvious which, right?
Well not necessarily.
Here is a scenario that rears its head regularly – particularly in entrepreneurial ventures:
Your venture is in its early stages, and needs cash. You have exhausted your own resources – and the business is not yet an attractive proposition to the bank. Enter what many people call the “Three F’s” – friends, family and fools.
Your Auntie Margaret wants to help you out – and she generously agreed to advance $50,000 to your business. You graciously accept, bank Auntie Margaret’s cheque – and proceed down the rocky road to success.
Time goes on, and a few years later your venture may have been wildly successful – or otherwise.
Here’s what can happen next:
Just after you have successfully sold your business to a large competitor for several million dollars, you get the call from Auntie Margaret saying “Remember back when I invested in half your business? Well when do you think I can expect my share of the sales proceeds?”
Or in an alternative reality …
Just after you have closed the doors and liquidated the company after losing everything and grudgingly accepting that the venture was misguided or “ahead of its time”, you get this call from Auntie Margaret: “Remember back when I lent YOU $50,000? Well it’s gathered quite a bit of interest now – and maybe it’s time you started making me some monthly repayments.”
Either way, there has probably been a serious misunderstanding of the nature of the investment.
Friends and family are a major source of business finance – in fact US Angel Investor Bill Payne reports that in the USA, friends and family of business owners invest around US$60 billion per annum into businesses.
It is likely that a proportionate amount is invested into ventures by friends and family of business owners in New Zealand. And a characteristic of these advances is that they’re often not documented – and often the terms are not even agreed verbally, much less committed to paper.
So my message is this:
Make sure any investment by friends, families or fools is clearly documented – and that all parties are very clear about whether the investment is a debt or equity, as well as the terms of the investment. Is the investment a personal loan from Auntie Margaret to you personally – or is she lending money to the business? Does she expect her investment back if the business fails? Is there any interest payable? When does Auntie Margaret expect to see her money back? Has she invested in shares in the company which will see her rewarded if the business is succesful – but will see her walk away with nothing if it fails?
A one page signed agreement is often all you need to save a lot of anguish later.