By Peter Mastrantuono
Your daughter or nephew has just asked you for financial help to open or expand a business. Your heart says “yes”, but your head wonders if it’s the smart thing to do.
There are a number of factors to consider and questions to ask if a family member approaches you about funding his or her business venture. Among them are:
Are You Going In as an Equity Owner or a Lender?
If a relative is seeking help in the form of a loan, you need to discuss the terms of the loan, such as interest rate and length of the loan. While a loan has the advantage of providing you current income, you still want to make sure that their business prospects indicate an ability to pay the interest and return the principal when due.
If they want you to come in as an equity owner, you should understand how they see your role in the business as a part owner. Do they want or expect your active involvement in decision-making? Do you want that level of involvement? Are they expecting you to be a silent partner? Are you comfortable with standing to the side? What is the exit plan to pull out your equity investment?
Approach the Decision Like Any Other Investment
Just as you would research a public company’s products, growth prospects and the market in which it operates, you should similarly evaluate a family member’s business’ chances of sustained success. Make sure it’s a viable business idea.
Require a Business Plan
Many great ideas have failed for lack of planning. Ask for a business plan. Determine if there is a sound understanding of the economics of the business, operational needs, and marketing. The absence of a business plan or a poorly thought-out one is a warning sign that a business may founder.
Does the Family Member Have As Much to Lose?
The most successful entrepreneurs are those who have staked everything on having to succeed. You don’t want to invest your hard-earned savings into a business in which the owner has little to lose if the business fails. The odds of your investment succeeding increase the more your family member is desperate to succeed.
Determine Your Downside Risk
The question to ask yourself is “Can I afford to lose it all?” New business failure rates are high, so you should expect that there is a strong likelihood that your entire investment will be lost. If such a loss endangers your financial security, you may want to pause on making such an investment.
It can get worse. If you become personally liable from civil suits or creditors, losses could exceed your investment. Make sure the business is structured to protect your personal assets, and consider personal liability insurance.
For many individuals, investing in a relative to support his or her dream defines what family is all about, with financial factors taking a back seat. However, if financial considerations are important to you, you may want to sit down with your financial advisor to determine the potential implications to your financial situation of investing in a family member’s business.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.