Arrow-right Camera
The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Family Help Has Unique Problems

Paul Willax Staff writer

The typical small business receives about 40 percent of its required start-up capital from the founding entrepreneur’s family members. But there are unique problems and pitfalls associated with keeping such financing “all in the family.”

Q. I’ve invested all the liquid funds I can afford in my new machine design and repair business, but just as things are about to take off, I find that I’ve exhausted my working capital. My father and my brother-in-law have indicated that they might be willing to invest in my company. Is this a good idea? If so, what’s the best way to do it?

A. Many successful companies have been boot-strapped this way, including The Limited Inc., Gateway 2000 Inc., and Walgreen Co. However, there are a number of special precautions to be attended when dealing with family members.

Make sure you are scrupulously candid in your description of the business opportunity and its prospects.

Provide as much information as you can about the nature of the enterprise, its anticipated markets, competition and the trends in the industry.

A business plan should be prepared and explained, in detail, to the potential investors. Have a firm idea of how much capital you really need and be able to show investors how it will be used. Pro forma profit and loss, and statements and cash flow projections can be helpful in this regard.

Above all don’t paint an overly optimistic forecast. Remember, your relatives (especially momma ) are inclined to place greater trust and confidence in you than the typical off-the-street entrepreneur. Because of your blood ties, they’ll be inclined to assume that you wouldn’t let them get hurt under any circumstances. But business is business, and a large share of start-ups do, unfortunately, come to naught.

I can’t over-emphasize the importance of conveying realistic expectations to family members. After all, if the business does not do as well as they’ve hoped, you’ll still have a lot of family reunions and Thanksgiving dinners to attend and you don’t want to be the turkey.

Relatives have more frequent and easy access to you than do outside investors, so they will always want to know what’s happening (and give you advice). Be prepared to spend a lot of time keeping investors up to date.

When disseminating information, even “informally,” make sure that all investors get the same story, especially if some of them are non-relatives. It might be wise to schedule shareholder meetings a couple of times a year to keep them uniformly informed.

Also ensure that the immediate family members of the investor get information about the venture, its opportunities and its risks. Disgruntled spouses of family members who invest can be the most retributional in unfortunate circumstances, especially if they had to give up a vacation or a new car because of losses they will attribute to you.

Be sure to let everyone know what role, if any, they will play in the business. Don’t let them perceive themselves as operationally involved “partners” if that is not what you intend. You must let them know, up front, what you expect and what they can expect.

If relatives’ contributions are to be investments instead of loans, it will be necessary to incorporate the business and sell them shares of stock. Since there will not be a ready market through which they can liquefy their investment, if they need cash, you will want to effect a buy-sell agreement that will specify the means by which you, the firm or other investors will be able to acquire outstanding shares. This agreement should specify the earliest date at which they be able to effect a redemption - give yourself plenty of time to get the business cranking - and it should provide a formula for determining the value of the shares in the future.

Importantly, this buy-sell agreement should cover ALL shares outstanding and should allow you or the firm to reacquire all shares at a formula-determined price at, or after, some point in the future. The formula should reflect the true value of the enterprise at any given point in time so that investors will be properly rewarded when they cash in their equity stake.

xxxx