Family Business: The Pros and Cons of Getting Funding From Loved Ones If you're thinking about getting friends and family to loan you money to fund your business, read this first.

In the book, Write Your Business Plan, the staff of Entrepreneur Media offer an in-depth understanding of what's essential to any business plan, what's appropriate for your venture and what it takes to ensure success. In this edited excerpt, the authors discuss two close-to-home sources of business funding.

When you're looking for money for your business, it may seem that investors are scarce. But the real problem may be that you're not looking in enough places for potential financiers. You may find investors as close as your immediate family and as far away as professional venture capitalists on the other side of the world.

Investors come in many shapes and sizes, as well as with various needs and intentions. Odds are you can find someone to help you with your financing needs if you cast your net wide enough.

Your Own Resources

Your own resources, savings, investments and other valuable assets are the beginning of your financing efforts. One reason to write a business plan is to provide reassurance that you're making a sensible investment. Remember, you'll be investing serious nonfinancial assets in your business: your time, effort, hopes and reputation.

As for your own financial assets, make sure the money isn't already earmarked for tuition or part of your necessary family spending, such as your mortgage, rent and the like. If you're in debt, it's also advisable to get out from under it before starting a business, though you can start writing your business plan while getting your financial affairs in order.

Even though you'll hopefully be investing assets from investors, you should be prepared to invest some of your own money in your venture. Rule of thumb says if you want other people to invest in you, then you also have to invest in yourself. Why should other people take a gamble on your business if you won't?

The most likely source of financing is the group of people closest to you. Spouses, parents, grandparents, aunts, uncles and in-laws, as well as friends and colleagues, have reasons to help you that arm's-length financiers lack. For that reason, they may back you when no one else will.

One seldom-noticed aspect of asking family and friends to invest in your venture is that other investors (especially bankers and venture capitalists) often ask if you have approached friends and family to raise initial capital. If you say you haven't, they'll ask why not. If your deal is so appealing, why wouldn't you let your friends in on the ground floor? If you say yes but they couldn't come through for you, at least the banker or VC will know you tried.

Money from family and friends has backed many successful business ventures. Here are a few:

• Albertson's Inc. Co-founder Joe Albertson borrowed $7,500 from his aunt to make his $12,500 contribution to the partnership that began the grocery store that grew to have sales of more than $2 billion a year.
• Pizza Hut Inc. Co-founders Frank and Dan Carney borrowed $600 from an insurance fund left by their late father to start the pizza chain.
• Eckerd Corp. Jack Eckerd raised $150,000 from family members to purchase three failing Florida drugstores, the cornerstone of a company whose sales would one day top $9 billion a year.

Friends and family may not be able to raise millions of dollars, but they can provide long-term financing for highly speculative endeavors that more mainstream financiers wouldn't touch.

If you're financing your venture with family money, you may think all you need is a smile and a polite request to raise what you need. In the short term, that may work and produce the funds you need to start out. But over the long term, even family-financed enterprises will benefit from having a business plan.

Such a plan shows family members who are putting up the money what they can expect for their contribution. And it helps keep the entrepreneur—you—mindful of responsibilities to the family members who backed you and on track to fulfill your obligations.

Pros and Cons of Family Funding

On the positive side, family and friends will let you know if your idea appeals to them. Typically they'll also give you the time and a less stressful environment in which to present your plan. Family members may be more readily available to lend a helping hand when you need one and may be there to take over the business down the road.

The flip side is that you're closer to your family and friends. Losing the money of someone close to you can create a lot of tension between you and your family or friends. Family members and friends may also want to get more involved and try to oversee aspects of the business or push you to make changes that other investors would not. They may even expect to be on your management team, which wouldn't be the case with a bank.

To make investor agreements work with friends and family, you need to spell out everything clearly and make sure you can separate your business from your personal relationships. This isn't necessarily as easy as it sounds. You need to go into any such deals playing some defense and making it clear that people may lose their investments. Provide plenty of warning, and if they insist on being part of your business, make sure there are boundaries set out in advance that everyone can agree upon.