Raising Entrepreneurial Capital

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1

Introduction

John Vinturella and Suzanne Erickson

This chapter introduces many of the concepts that will be further developed in later chapters. We describe the environment of small and start-up businesses. We explain the difference between the so-called small business and entrepreneurial ventures, as well as the importance of those businesses to the economy. We discuss characteristics of small and start-up businesses and their owners. We provide data on success rates for new businesses and the opportunities offered by fractional entrepreneurship. We discuss various forms of business organization and the impact those forms may have on later decisions and options. Finally, we begin the discussion of the various sources of financing that start-ups can and should use, including bootstrapping and new options made available by social networks. The chapter ends with a brief but necessary look at the reasons for business failure.

Keywords

Entrepreneur, C-corporation, sole proprietorship, capitalization, partnership, bootstrapping, fractional entrepreneurship

Getting Started

This book is about financing the entrepreneurial venture. Why devote a whole book just to financing? Financial choices, especially ones made early on, can affect future growth opportunities and strategic options. To avoid precluding desirable strategic actions later on, the entrepreneur needs to carefully structure the business from day 1. Many potential entrepreneurs have a great idea for a business, but without a sound financial road map to execute it, the idea will remain simply an idea.

In this book, we consider financing issues at all stages of the venture’s life, from the birth of the company through its growth, the sale of the business or its shutdown. We consider internal financial management and risk management as strategies to garner or conserve resources internally. We look at franchising as an entree to entrepreneurship that involves somewhat less risk than the traditional method of start-up.

This book is intended to be a guide that will increase the odds of success for the potential entrepreneur. To that end, the book is detailed and more experiential than theoretical. It is based on standard financial theories, but it also benefits from the experiences of many entrepreneurs and from lessons learned the hard way. Our hope is that the book will provide useful, practical advice to aspiring entrepreneurs in the all-important task of funding their new businesses.

It is important at the outset to distinguish between entrepreneurial ventures and other types of small business. Broadly speaking, new and/or privately held businesses can be divided into entrepreneurial ventures and the so-called lifestyle businesses.

Entrepreneurial ventures can be defined as new business start-ups with high growth aspirations. Typically, the entrepreneur is passionate about an idea or product, is willing to bear substantial risk to see his or her vision brought to market, and is willing to work incredibly long hours to realize the vision.

Entrepreneurship can be defined as the pursuit of opportunity without regard to resources currently controlled.¹ In other words, the idea is key, and the entrepreneur will figure out a way to bring the idea to fruition. In corporate finance, the firm is managed for absentee owners, the stockholders, and wealth maximization; in any privately held business, the goals of the business and the entrepreneur are intertwined.

Many successful entrepreneurs insist that they are motivated not by the money, but by the challenge, or the game. These are called serial entrepreneurs. Once the start-up reaches some sort of equilibrium or steady state, the thrill is gone for these entrepreneurs, and the next start-up beckons them to a fresh challenge.

Contrast this vision with that of the much more prevalent lifestyle business. Lifestyle businesses can vary from a hobby turned into an income-producing sideline to the many sole proprietorships and family-owned businesses, all with very different growth aspirations and goals. For these businesses, a good living or independence is the goal and driving force behind the business. There is no plan to take the business public or sell it to a larger company. Significantly for the purposes of this book, there is no plan to grow the business faster than the internal resources will allow. If all growth is funded internally, financing the business becomes much simpler, and financial management is the primary strategy for financial success. Financing the lifestyle business would lead to a very short book, and most of the topics would be covered in a standard working capital text. For that reason, our focus in this book is on the faster growing entrepreneurial firm. However, many of the lessons in the chapters on internal financial management and risk management apply to the lifestyle business as well.

To increase their probability of success, entrepreneurs must understand what actions they can take to increase the odds and what hurdles may prevent a venture from succeeding. In this chapter, we will focus on the faster growth entrepreneurial venture and discuss how the choice of organizational form is related to growth and to the firm’s need for capital. We will also discuss bootstrapping, i.e., creative sources of funding to get the venture through the early times and beyond. The chapter will close with a look at the rest of the chapters.

The Typical American Business

A good starting point for understanding small businesses is to consider a profile of the average American business. Prof. Scott Shane summarized data from the Census Bureau’s 2007 Survey of Business Owners (SBO) for Small Business Trends (January 3, 2011). Here are some of his findings²:

The vast majority (78.8%) of U.S. businesses have no employees. The only sector of the economy where the majority of businesses has employees is accommodation and food services, in which 61.5% of businesses have employees. The average business generates over $1.1 million in sales, has more than four employees, and pays an average compensation of over $41,000.

Requirements for Being Considered a Small Business

Previously, the Small Business Administration (SBA) had defined a small business as one with fewer than 500 employees. Now the requirement is based on North American Industry Classification System (NAICS) codes, which classify businesses as to type, in considerable detail.³ The criteria for each type may be based on either annual sales or number of employees. Where number of employees is specified, 500 is still the most frequently used definition.

Examples are:

SBA adds that [a] small business is not dominant in its field of operations….

Small Businesses’ Role in the U.S. Economy

Over 99% of employing organizations are small businesses, and more than 95% of these businesses have fewer than 10 employees. The reality is that most Americans are employed by a very small business that has little in common with the tiny sliver of the business demographic represented by corporate America⁴ (Figure 1.1).

Figure 1.1 Employing organizations by company size, %. Source: Huff Post Business, April 14, 2012, by Kristie Arslan. Ms. Arslan is the executive director of the National Association for the Self-Employed (NASE). http://www.huffingtonpost.com/kristie-arslan/five-big-myths-about-amer_b_866118.html.

Here are some numbers to consider:

• 95% of the nation’s small businesses are really small.⁵ More than 77% of small businesses consist of self-employed entrepreneurs and 18% of small business are microbusinesses with fewer than 10 employees.

• 56.3% is the share of total employment for businesses with fewer than 500 employees in the United States (the average from September 1992 to December 2009).⁶

• 65% (or 9.8 million) of the 15 million net new jobs created between 1993 and 2009 were by small businesses.⁷

• 552,600 (estimated) new employer firms opened for business in 2009.⁸ Many of these new jobs are also new companies; the start-up rate in 2010 was the highest it has been in 15 years, according to the Kauffman Index of Entrepreneurial Activity.⁹

Understanding the Characteristics of Small Businesses

The following findings are from the Census Bureau’s SBO. The sample used is large enough (about 2.3 million businesses responded) that these observations may be considered representative of all small businesses.

Of all budding entrepreneurs, 30.6% required start-up capital of less than $5000. In general, capital commitments for start-ups were modest: 10.4% were actually started with a credit card, although they may have also used other sources of capital, and 10.7% financed their start-up or acquisition with a business loan from a bank or financial institution. Instances of massive amounts of start-up capital are relatively rare; only 1.5% of these firms required $1 million or more.¹⁰

Most businesses are started by people who dig into their own pockets for at least some of their start-up capital, said Census Bureau Deputy Director Thomas Mesenbourg. "This is true for both firms with employees and those without them. Furthermore, more than one in five (20.8%) of respondent businesses used no start-up capital at all."¹¹

Here are other highlights from the report:

• About 2.1% of all firms operated as a franchised business. Franchising is said to be a way to be in business for yourself without being by yourself. Franchising is covered in Chapter 9.

• E-commerce sales were reported by only 6.6% of firms. In the increasingly online marketplace, this seems to be an opportunity for many businesses to increase sales.

• For 7.9% of all firms, exports made up at least some of the sales. See Chapter 12 for a discussion of what it takes to be a successful exporter.

• About 28.2% of firms classifiable by gender, ethnicity, race, and veteran status were family owned. These family-owned firms accounted for 42.0% of classifiable firms’ receipts.

Examples of Opportunities for Self-Employed Entrepreneurs

As stated, more than 77% of small businesses consist of self-employed entrepreneurs. The IRS states that, generally, you are self-employed if any of the following apply to you¹²:

• You carry on a trade or business as a sole proprietor or an independent contractor.

• You are a member of a partnership that carries on a trade or business.

• You are otherwise in business for yourself (including a part-time business).

Let us look at some prospective fields for the self-employed. For example, just in the construction trades, these entrepreneurs can be contractors, plumbers, electricians, carpenters, insulators, drywall installers, wallpaper hangers, painters, and landscapers. These in turn support other positions for the self-employed, such as suppliers for the building crafts, architects, home theater installers, and security systems.

Many businesses are spawned from novel ideas. One such business consists of a storefront and carts selling gourmet popsicles. Another creative entrepreneur invented the mutt mitt, a plastic bag in the form of a glove, providing a no-mess way to clean up after dogs. One entrepreneur started an indoor trampoline park, another a shop selling oversized eyeglasses. Many have turned hobbies into successful businesses. It will be interesting to see how well the self-service dog wash in our neighborhood will do.

The Internet has spawned many small businesses, many of them home based. You can place ads for affiliate marketing, in which you promote other company’s products and services on your web site; when a sale is made through a click on your site, you earn a commission. Many people have based businesses on eBay, selling items that are frequently also bought on eBay.

The Home-Based Alternative

Home-based businesses (HBB) make up 51.6% of all U.S. businesses. Only 6.9% of these HBB had $250,000 or more in receipts, and 57.1% of HBB brought in less than $25,000.¹³ Over two-thirds of all sole proprietorships, partnerships, and S-corporations are home based. Over 90% of HBB are sole proprietorships.¹⁴

Other highlights from the 2007 survey are:

• 58.2% of women-owned businesses were home based; for businesses owned by men, the figure was 49.1%.

• 54.4% of nonminority-owned businesses were home based, whereas 46.5% of minority-owned firms were home based.

• 55.4% of veteran-owned businesses were home based.

Is Fractional Entrepreneurship the Way to Start?

Many budding entrepreneurs cannot leave their jobs to start a business with its uncertain financial rewards. These entrepreneurs need the income and benefits of their day jobs until their venture become self-sustaining. Getting loans and/or investors is extremely difficult for a start-up, particularly when much of the initial spending is for living expenses.

Part-time ventures, also known as fractional entrepreneurship, may be the right option in this situation. With new technologies making it cheaper to start a business and a widespread need to earn additional income during difficult economic times, more and more of those who work for others are beginning to explore businesses with the potential of leading to full-time self-employment. In addition to retaining a steady income and benefits, this path also gives entrepreneurs more room to make mistakes or to take more risks. Fractional entrepreneurship allows them to build their businesses at a rate that they can manage. To succeed with this approach, however, one must have tremendous discipline to dedicate enough time to advancing the business in the midst of many competing time demands.

Paul Kedrosky, a senior fellow at the Kauffman Foundation¹⁵ (a nonprofit organization that focuses on entrepreneurship), suggests that the reason the business creation rate hit a 15-year peak in 2009–2010 is because of the many ‘jobless entrepreneurs,’ … who launched companies because they faced unemployment during the recession. He distinguishes these from the part-time ventures of the employed who make use of the fractional entrepreneurship model.

These are often people who are highly successful in their own right, with normal jobs who, on the side, are entrepreneurs, says Kedrosky, who’s working on a report on the topic. Fractional entrepreneurship took off around 2007, he says, partly because of the birth of online services like Etsy.com, which make it easy for small businesses to set up shop online.¹⁶

Options for Part-Time Entrepreneurship

The most promising options for a part-time venture are likely in online businesses. Many online businesses take little more than a computer, a broadband Internet connection, and a printer to get started. Total investment for this basic setup can be less than $1000, and the monthly fee for the Internet connection can be as little as $5.

With more than 100 million active users globally (as of Q4 2011), eBay is the world’s largest online marketplace, where practically anyone can buy and sell practically anything.¹⁷ eBay began as an auction marketplace: People didn’t simply shop on eBay. They hunted, they fought, they sweated, they won. These days, consumers are less enamored of the hassle of auctions, preferring to buy stuff quickly at a fixed price.¹⁸

Amazon.com is the leader in online sales of fixed-price goods.¹⁹ Individuals are allowed to set up accounts and list products on Amazon for free, though there is a per-sale charge. Sellers with a large number of products may elect to pay a monthly fee to list as a pro merchant on Amazon.

Etsy²⁰ is another one of many sites where items for sale can be listed. Items allowed to be listed must be either goods handmade by you, vintage (20 years or older), or commercial supplies. On the site they describe the process in three steps: list the item(s) for a fee; get paid by the customer; and ship the customer order.

Many services can also be delivered online. Are you a web designer, computer consultant, freelance writer, or graphic designer? Many users of these services know that they can be effectively performed over the Internet. For example, the coauthors of this book collaborated though they were more than 400 miles apart in the United States, and their publisher contact is in Oxford, United Kingdom.

Beware of HBB Scams

According to the Better Business Bureau²¹: "If you do a Google search on ‘work from home,’ 99.9% of results will be schemes to try to rip you off. The Federal Trade Commission warns us to be wary: … the reality is many of these jobs are scams. The con artists peddling them may get you to pay for starter kits or certifications that are useless, and may even charge your credit card without permission…. Others just don’t deliver on their promises."²² The FTC suggests that we watch out for claims such as:

Be part of one of America’s Fastest Growing Industries

Be the Boss! Earn thousands of dollars a month from home!

Here are some comments posted on the Internet from clients of one vendor:

It is a scam. They tell you that you can make 300 percent profit. You buy products from vendors and re-sell them on your website or eBay. But if those [products] could sell for 3 times what they cost, [the vendor] would do it themselves. So you end up buying a bunch of junk that you cannot re-sell. And then you might get surprise bills from [the vendor] for stuff you never ordered. That is when you realize that they are cheating you. Here’s what the vendor says you get when you join their program:

• A company that has been around for over xx years.

• The freedom to set your own hours, be your own boss.

• The opportunity to make huge profits from home.

• The chance to be your own boss.

Apparently be your own boss is such a draw that they mention it twice.

Here are some more claims that should arouse skepticism:

• No experience, or degree needed.

• The opportunities that are listed below has [sic] been checked out. [by whom?]

• So, do you want to wait for months, or would you prefer to make money at home just 5 min from now?

• Limited number of positions, check availability now.

• Make $7487/Mo without selling anything.

Are any home business offers legitimate? Sure, but it takes a lot of due diligence to identify them. Following are some resources that can help:

• To find ownership information for a vendor, http://www.domaintools.com/.

• To see whether there are any better business bureau complaints, http://www.bbb.org/us/Find-Business-Reviews/.

• To keep up with scam reports on various products, http://www.ripoffreport.com/.

Characteristics of Business Owners

The Census Bureau estimates that about 27.1 million businesses were in operation in 2007. Nonminority firms owned 83.4% of these businesses, with the rest distributed among various minority groups (Figure 1.2).

Figure 1.2 Small business owners by ethnicity. Source: Survey of Business Owners, 2007, http://factfinder2.census.gov/faces/tableservices/jsf/pages/productview.xhtml?pid=SBO_2007_00CSA01&prodType=table.

Firms with fewer than 500 employees represent 99.9% of firms, and 80.1% have no employees. Women own 28.8% of all businesses (Table 1.1).

Table 1.1

Number of Businesses by Ethnicity, Number of Employees, and Gender

Source: Census Bureau, Survey of Business Owners, 2007, http://factfinder2.census.gov/faces/tableservices/jsf/pages/productview.xhtml?pid=SBO_2007_00CSA01&prodType=table.

For 50.5% of business owners, their businesses were their primary source of income. About 77.1% of owners reported that they founded their businesses, and 15.8% of owners reported that they purchased them. Another 7.3% of owners reported they acquired their business through an inheritance, in a transfer of ownership, or as a gift.

Are you becoming a business owner for a more leisurely lifestyle? About 62.9% of owners reported working 40 or more hours per week in their business; the same was true for 34.3% of owners of nonemployer firms.

Business owners were more educated than the general population: 50.8% of owners of respondent firms had a college degree. About 36.5% of owners were 55 or older, with another 29.6% between the ages of 45 and 54. On the other hand, 31.7% of owners of firms were between the ages of 25 and 44, and only 2.2% were younger than 25 (Figure 1.3).

Figure 1.3 Business ownership by age of owner, %. Source: Census Bureau, Survey of Business Owners, 2007, http://factfinder2.census.gov/faces/tableservices/jsf/pages/productview.xhtml?pid=SBO_2007_00CSA01&prodType=table.

About 13.6% of the owners were foreign-born. Among selected ownership groups, 55.9% of Hispanic owners (who can be of any race) were foreign-born, as were 82.3% of Asian owners, and 74.9% of owners reporting some other race or nationality, such as Brazilian, Cape Verdean, Sudanese, or multiracial. Owners had the option of selecting more than one race and are included in all races they selected.

Industries Entered by Small Businesses

A 2003 Federal Reserve survey examined the distribution of small businesses by industry (Figure 1.4).²³ Note that the two industries with the largest participation are business services and professional services. Combined, these services represent 45.8% of all businesses. Services is a broad category and can represent many businesses, from industrial cleaning services to web designers. Service businesses are attractive as start-up firms because they generally require less capital at the outset than other businesses and can often be operated from home.

Figure 1.4 Small business by industry category, % (2003). Source: http://www.federalreserve.gov/pubs/bulletin/2006/smallbusiness/smallbusiness.pdf.

Global Entrepreneurship

Entrepreneurship is, of course, not limited to the United States. In 2011, the Global Entrepreneurship Monitor (GEM) conducted its 13th annual survey of the rate and profile of entrepreneurial activity around the globe.²⁴ GEM interviewed over 140,000 adults (18–64 years of age) in 54 economies, spanning diverse geographies and a range of development levels. Based on this survey, GEM estimated that 388 million entrepreneurs were actively engaged in starting and running new businesses in 54 countries in 2011. Of early-stage entrepreneurs from around the world:

• 163 million are women.

• 165 million are between the ages of 18 and 35.

• 18 million sell at least 25% of their products and services internationally.

GEM uses the term total early-stage entrepreneurial activity (TEA) to combine two stages in the development of an enterprise: the stage in advance of start-up (which it calls nascent entrepreneurship) and the stage directly after start-up. By this measure: TEA increased significantly from 2010 to 2011 in many economies and across all levels of economic development—emerging, developing, and mature. In fact, TEA rose 25% among 16 developing economies with China, Argentina, and Chile boasting above-average rates in 2010 and even higher rates in 2011. Twenty mature economies experienced, on average, a nearly 22% TEA increase over both years. The United States and Australia showed substantial increases in 2011 from already high TEA rates in 2010. Intent to start businesses is highest in emerging economies. The people in these economies are most likely to see opportunities and believe in their ability to start a business. They also hold entrepreneurship in high regard.

Thanks to an uptick in entrepreneurship worldwide, we now have nearly 400 million entrepreneurs starting and running businesses in the 54 economies surveyed, said the report’s lead author, Donna Kelley, Associate Professor of Entrepreneurship at Babson. Even better news is that over 140 million of these entrepreneurs expect to add at least five new jobs over the next 5 years. These figures and growth projections affirm that entrepreneurial activity is flourishing across the globe and that entrepreneurship, as an economic engine, is the best hope for reviving a weakened world economy, she said.²⁵

Creative Sources of Capital: Bootstrapping

Part of the fallout from the Great Recession of 2008 has been an overall decline in funding availability for new business. The recession led to an increase in risk aversion for banks, venture capitalists, and angel investors alike. Banks have increased credit standards for lending and venture capitalists, and angel investors have raised the bar by demanding more proof of concept, evidence of sales, and evidence of scalability before investing.

Lack of start-up capital can be a primary inhibitor to success. The problem of financing is most pressing for new company start-ups and for firms that are experiencing rapid growth. A lack of financing does not necessarily doom a business to failure, however. Each year Inc. Magazine identifies the 500 fastest growing companies in America, the Inc. 500. Growth is calculated as the 5-year average growth in revenues. Figure 1.5 shows the breakdown of start-up capital, by ranges of amounts, invested for the Inc. 500 in 2002.

Figure 1.5 Amount of seed capital, by %, required by Inc. 500 CEOs.

For the 2002 sample, firms started with less than $1,000 (yes, there were several) were just as likely to be profitable as firms started with more than $100,000.²⁶ Firms started with more than $100,000 reached higher levels of dollar sales and hired more people, but they were less likely to be profitable than firms started with between $1,000 and $10,000.

Bootstrapping is the art of minimizing expenses and generating cash flow. The Internet has made it much easier to launch a business today with little start-up capital. Templates for business plans and web pages can easily be found and downloaded for free or at little cost. Payment processing can be outsourced to PayPal or Google Checkout. Internet-based businesses can be started from a home office, alleviating the need for rental office space. Social networking sites can be used for marketing for no cost. The Internet has truly made business start-ups much more accessible to everyone.

The rule of thumb for most start-ups is to have enough cash on hand to sustain the business for the first 18–24 months of its life. We have all seen the restaurant that opened and closed 6 months later—great empirical evidence of the impact of insufficient start-up capital.

Unless you, the founder, are well known, with a track record of starting and running successful businesses, no formal sources of capital are likely to invest in your business in its early stages. Banks have always required an operating history to reduce their risk and are even more risk averse today. Venture capitalists (Chapter 5), with their high market share and growth aspirations, are simply inappropriate for the vast majority of start-ups.

Even after start-up, entrepreneurial ventures are constantly in the market for new capital. Experienced entrepreneurs realize that growth requires capital and that the financing of growth is best done in stages. The best financing choices require that the entrepreneur remain flexible, raise as little as possible in each financing, and stay abreast of the latest trends in funding.

Adequate capital is needed to start up a business and to provide cash to cover the costs of doing business. These costs can include equipment, inventory, accounts receivable, and sufficient working capital to allow for operating losses on the way to becoming a profitable enterprise. Sufficient capitalization can also provide for early expansion opportunities and for acquiring cost-saving equipment.

Financing comes from two basic sources: debt and ownership equity. Debt is money that is borrowed and that must be repaid, with interest, on some predetermined schedule. Normally, a lender does not receive any ownership interest in the business. Borrowing money at the very start of a new business will create an additional and regular cash requirement to make the debt payments and may put an unsustainable drain on the company’s cash flow.

Common equity represents the exchange of funding for partial ownership of the company. Such funds represent money invested in the firm without any requirement of repayment date or terms. Even though equity capital does not burden a new business with loan repayments and interest charges, it may reduce the founders’ control and will reduce their share of proceeds from the business.

Before seeking external sources of capital from investors or lenders, an operating business should thoroughly explore all reasonable sources for meeting its capital needs internally. For example, a business can generate capital internally by accelerating the collection of receivables, disposing of surplus inventories, increasing the amount of earnings kept in the business, or cutting costs. A business may be able to conserve capital by outsourcing or using free online resources. With a lower cash requirement, the business’s ability to secure external financing will be improved. Furthermore, the ability to generate maximum capital internally, as well as to control operations, will enhance the confidence of outside investors and lenders. With more confidence in the business and its management, lenders and investors will be more willing to commit their own capital.

A large part of bootstrapping an organization is doing more with less. If possible, run the business out of your home initially. Amazon.com, Microsoft, Martha Stewart Enterprises, and Hewlett Packard are just a few success stories that were started out of the entrepreneur’s home. Successful entrepreneurs become expert at bootstrapping. Even if this effort fails to generate all of the needed capital, it can sharply reduce the external financing requirement, resulting in less interest expense, lower repayment obligations, and less sacrifice of control. In hindsight, one of the worst things that happened to many dotcoms during the bubble years of the mid- to late 1990s was receiving too much money too soon. As counterintuitive as that sounds, too much money does not force fiscal discipline on the firm. Many millions of dollars of venture capital went to finance extravagant office space, high salaries, and other perks for budding entrepreneurs. A shortage of capital can be a good thing if it forces the business to be efficient and creative.

Initial Sources of Capital

You!

The first person to turn to for capital is you. Before approaching others, entrepreneurs should exhaust their personal sources of capital. Personal sources include savings, a second mortgage, borrowing against stocks or retirement funds, personal lines of credit, and personal credit cards. If possible, the second mortgage and the line of credit should be in place before you leave your full-time job. For the 2002 Inc. 500 fastest growing companies, 87% of the CEOs surveyed used personal assets to start their business.²⁷

A service business requires very little capital to get started and is therefore preferable to a more capital-intensive business for cash-strapped entrepreneurs. Perhaps you can provide a service to generate cash flow and then expand into product sales or other types of production later on. Successful entrepreneurs wear many hats to conserve capital. In the beginning, the entrepreneur is likely to be the chief strategist, chief salesperson, CEO, and maintenance person. The VP of marketing and the CFO should be hired down the road, not at the inception of the business. Whenever possible, work should be outsourced rather than hiring people to do the job in-house. The key is to conserve cash by doing more with less: the control of resources, not the ownership of resources.

Friends and Family

Most entrepreneurs turn to friends and family after exhausting their personal sources of funds. Two words of warning are in order regarding friends and family capital. First, treat the agreement professionally. If you must accept funds from family and friends, do it on a business basis by putting the agreement in writing. Check with a lawyer if you want a binding, legal agreement. You may also get a sample business loan contract form from a bank or lending institution to use as a basis for a written agreement that both parties find acceptable. Be sure to provide relatives and friends with the hard facts about your business venture, emphasizing the risk involved. Make sure to spell out the terms and conditions of the investment: the repayment time frame for a loan or the number of shares granted for an equity investment.

Second, think worst-case scenario. How would you (or your friends and family) feel if the business failed and their investment was lost? If your friends and family cannot afford to lose their investment, they should probably not be investing in the first place. Likewise, if you do not want to jeopardize a friendship or relationship, look elsewhere for money.

Be sure to check with a lawyer before you accept money from anyone in your new venture. The number and type of investors may be limited. Those limitations will come back to haunt you in later rounds if you have not paid attention to rules and regulations in the earliest stages of financing.

Despite the dangers, family and friends’ money is the most common form of financing for start-ups, after personal resources, and the most accessible for small enterprises. Family and friends’ investments provide more than 10 times the total amount of traditional venture capital monies. This is also the most common financing method for early-stage companies that need to boost performance or enhance balance sheets prior to obtaining more formal secondary