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7 Questions to Ask Before Investing in Your Friend or Relative’s Start Up

Jun 01, 2016
It can be so tempting to get swept up with a friend or family member’s idea that you can forget to carry out your own due diligence. Helping a friend or relative can be very lucrative and supportive, if it works. But if it does not work, you need to be prepared for the risks and to ask some tough questions. 

1. Is the Money You are Giving to be a Loan or A Share of the Share Capital?
In other words, what are you getting in return? If it is a loan the terms of repayment (such as when, how much, and upon what targets being met) can be a good starting point; and of course preferably in writing. If it is to be an investment whereby you get shares in return, how much are you getting and with whom are you entering into a business with? You will be tasked with decision making, so you need to make sure you are happy with the team of people you will be working with in the future. 

2. What are the Risks?
This can depend on how much you are investing. Essentially you need to be comfortable that IF the business does not work out you are comfortable losing the money that you put in. Do not forget that a company is a separate legal entity in its own right, so if you invest in it and it goes bust, the chances of you getting your money back will be slim. 

3. Is there a Business Plan? 
Carry out your own due diligence and really dig around your friend or relative’s business ideas so you know the challenges the start up faces. Without doing this, you could be unaware of a gaping great hole in a business that is fundamentally flawed from the 
beginning. Ask the difficult questions, press.

4. What Exactly is your Money Going to be Spent On?
A good start up should have an idea as to what they need the money for. Is it for the marketing of a new product which they cannot afford as the development process just simply took too long, or they are generally looking for their next stage of funding for expansion? By investing, you will be able to dictate or negotiate the terms in which the start up can use the money for, which could also give you a piece of mind that your money is being used for a specific purpose. 

5. Is Providing Investment the Best Way You Could Help? 
If you are concerned as to the financial risk, consider offering your own specialist skillset in exchange for shares. This way you are not financially stumping up the cash, but equally you could renegotiate in the future once you are happy the business is flourishing. 

6. Is this Business Already Generating Cash?
You need to ensure that you are investing in a serious business idea that is generating cash. Without cash, the business will be unable to repay you if it is a loan, or even expand if it cannot get itself off the ground. If you are investing in the development of the product, be aware of how much your sum of money is contributing, how far the business has to go and when that should be achieved. If it is simply to give a cash injection to expand a business, be clear of how your money will increase the cash flow. 

7. What is the Plan?
Be clear on what the scale of the operation is, and how you can exit the company in the future if you want to and if you can take out your funds. Establish if you see this as a long or short term investment and this will help you plan for the future and deciding on if to say yes or no to investing. 
 
For more information or to find out how we can help you, please contact Nicola Lucas by email or call 01279 755777.

Nicola Lucas

About the author

Nicola Lucas

Nicola is a member of our Business Law Team handling all the commercial requirements of her clients such as shareholder agreements and negotiating on commercial ...

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