One of your best and longest friends has just approached you with an idea that they say can help to make you thousands of dollars. They’ve got a start-up business that is a guaranteed success but is missing just one ingredient — the funding to get it off the ground. That’s where you come in.
They want you to invest in helping it get started. What should you do? This being one of your friends, you’re obviously going to be a little more interested than if it was any old investment, but that’s what makes a partnership with friends or family a little riskier. Good business judgement can end up clouded by emotion.
With that in mind, here are the five basic rules of investing in a friend’s business.
See the business plan
Your friend might make it sound like a brilliant investment and if they’re a good friend you’ll believe them – but you still need to see the business plan for yourself. A good business plan should be realistic, concise and conservative. It needs to make clear how the business is going to make money and detail the potential return to investors. Look for defined figures and decide if they seem reasonable.
Calculate the risk
Reading the business plan is only part of the decision-making process. It tells you what will need to happen in order for the start-up to succeed. You now need to analyze the chances of the business going the other way and failing. Are the economic and social conditions ripe for success? Most businesses require additional funding at some point in their young lives. Is there a source for that or will the whole enterprise come crashing down at the first speed bump? Ultimately, you need to weigh how much risk there is of the business not being a success and whether it is too much of a gamble to invest in.
Work out how you’re going to invest
Where the money you are going to invest is potentially coming from can have a huge say in your decision to go ahead with the venture. If it’s from your own personal finances, then you may feel more obliged to press ahead even with substantial risk. If you’re having to take out a set of new credit cards for bad credit to fund it, then more certainty about success is needed. If you’re delving into family savings or your children’s trust funds, then it has to be a rock-solid investment.
Make sure you have influence
It might be your friend’s business you’re investing in, but you still need some say in how things are run if you’re sinking your hard-earned cash into it. Ensure that your investment comes in exchange for influence on how the business is run and major decisions that need to be taken. Without a voice, you can’t have any sort of control over what happens to your money and its potential returns.
Make it legally binding
One of the biggest problems with investing in a friend’s business is that the legal side often gets overlooked. You are friends after all, so who needs to sign a contract when a handshake will do? There are countless examples though from Steve Jobs and Steve Wozniak to Mark Zuckerberg and most of the other Facebook founders and friends who went into business and fell out. That’s why a legally binding, watertight contract is a must no matter how strong you consider your friendship to be.
