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Family or friends aren’t good bankers

Know the Score

Posted: July 12, 2008 1:31 a.m.
Updated: September 12, 2008 5:04 a.m.
 
For start-up entrepreneurs, hitting up family and friends is the most common way to get started but it’s often the riskiest. This method, however, accounts for more than 70 percent of all venture dollars for start-ups.

Take the example of a fellow entrepreneur I know who sat behind his desk at a marketing firm and daydreamed of owning his own business. In 1992, he finally took the plunge, and at the age of 31 he quit his job and bought a dry cleaning store that he eventually built into a chain of seven outlets. To make it happen, he borrowed $45,000 from his father-in-law, who was a physician. With financing in place and 10 years of marketing experience he thought he was set, but then the whole “business casual” trend caught on and people stopped wearing suits. His revenue fell to $60,000 a month, far short of his original projection of $110,000. In addition he owed $14,000 in monthly payments to the bank. He propped up the business with credit cards and began missing loan payments, and the loan officer’s phone calls went straight to his father-in-law who’d have to write a check from his own funds.

Eventually this young man felt he had no choice but to sell the business, pay his debts and move on.

There was one investor that he couldn’t repay though, and that was his father-in-law. He was understanding about “winning some and losing some” since he’d dabbled in real estate on his own, so he didn’t blame my friend. The young entrepreneur, however, felt that it ended up putting a strain on their relationship.

In situations like this, entrepreneurs have to realize that turning relatives into creditors is putting personal relationships in jeopardy. It’s the highest risk capital you’ll ever get. The venture may succeed or fail, but either way you still have to go to Thanksgiving dinner.

A classic mistake made by entrepreneurs is hitting up friends and family before a formal business plan is in place. You should approach it as if you were wooing the most jaded banker. This means providing a formal financial projection and evidence-based assessment of when your loved ones will see their money again. This reduces the likelihood of unpleasant surprises. It also lets your investors know that you think of their funds as a serious investment.

Before you ask for the money, think about how to structure the arrangement. Are you willing to pay equity, or would you rather pay interest on the loan? Many times investors want an ownership stake in your business rather than just making a loan. Many entrepreneurs prefer debt rather than sharing ownership. It’s cheaper over the long haul and involves no loss of control, and you can deduct the interest as a business expense.

Here are some things to include in your business plan presented to your investors:
n Be clear about your purpose. Your executive summary should be clear and concise and be clear on the value and mission proposition.
n Calculate the return on investment. Investors want to know how they will make money and how much. The ROI can get lost in 23 pages of spreadsheets, so provide a range of ROI figures and explain what variables will affect the numbers.
n Size up the competition. Entrepreneurs seldom back away from a fight, yet when doing a business plan the shy away from rivals and this may signal to your investors that you don’t know the marketplace. Take a few pages to assess your rivals and sort them into those that could become acquisition targets and those that could become acquirers.
n Call in the editor. Shakespeare probably didn’t turn “Hamlet” in to the Globe Theater without having a few of his drinking buddies read it, and neither should you. Your instinct may be to keep things “close to your vest” but a group of trustworthy advisers can give you great feedback. The more input from smart people, the better.
n Think big. Don’t shy away from portraying your idea in epic terms. Just be cautious not to leave your investors feeling that your grand plans are impossible to carry out.
n Have fun. Business plans tend to be stodgy documents, but there’s no reason you can’t have the same enthusiasm for crafting yours as you do for running the business. Don’t write it sloppily or carelessly, but treat the plan as a key piece of sales material and keep it exciting and compelling.

The wrong investors can suck up an amazing amount of your time and force you to divert resources away from building your business. Remember to stress to your investors that your business plan is just a “plan,” and the chances are they may never see their money again. On the other hand, the business may thrive and you’ll be happy you invested. Remember, “Nothing ventured, nothing gained!”

Maureen Stephenson is a local author and owner of REMS Publishing & Publicity, which is based in Santa Clarita. Her column represents her own views, and not necessarily those of The Signal.

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