Raising Capital: Family Can Help but Beware
Growing up, we are constantly cautioned against borrowing money from friends and relatives, yet more and more small-business owners are looking around the dinner table for funding in these tough times.
In fact, 21% of the members of National Small Business United, the nation’s second-largest organization of small-business owners, rely on friends and relatives to raise start-up capital, according to a 1991 membership survey conducted by the Gallup Organization. Seventy percent of NSBU’s members used their personal resources, while 37% were lucky enough to obtain some form of bank financing.
With skittish bankers tightening their lending requirements, borrowing from people you know becomes an attractive option. Already a common and popular practice among Korean-Americans and other ethnic groups, entrepreneurs of all kinds are tapping personal contacts for funding.
There are risks, however. The biggest one is that you might jeopardize your relationship if you are unable to repay the loan or your business fails.
The best advice is this: No matter how enthusiastic friends and relatives may be about offering financial support, don’t accept money from anyone who cannot well afford to lose the money. It is also essential that the loan or investment be treated like a business deal and be fully documented to protect everyone from misunderstanding. You should also decide whether a loan or an equity investment makes more sense for both sides.
Corinne and Steven Kachigian are a young couple that relied on their families to launch their business. They turned to their parents, brothers, sisters and uncles to raise the $100,000 they needed to launch their Dilijan Liquid Spice Co. in Ringoes, N.J.
Armed with a proprietary method of infusing spice essence into soy oil and a business plan written with help from library books, the Kachigians collected their seed money from seven relatives in chunks ranging from $5,000 to $25,000.
“While outside investors were interested in a fast return on their money, family members were interested in investing in our potential,” said Corinne, a former industrial designer. “If anyone had any reservations, or felt it would affect our relationship in any manner, we didn’t want them to be part of it.”
Every year, the family stockholders are invited to attend an annual meeting and make suggestions, but they have no real say over how the company is run. Corinne and Steve hold most of the stock, putting about 70% in family hands. Twenty percent is owned by the company that manufactures the liquid spices and 10% remains unsold.
“The family might disown us, but they can’t fire us,” Steve said. Every relative who invested in the company did so without any promise of ever seeing their money again or receiving dividends.
“They may be able to cash out if the company is acquired, but there are no promises,” Kachigian said.
Dilijan, named after the Kachigian’s ancestral village in Armenia, has flourished since the Kachigians’ relatives invested in their dream. This year, Dilijan expects sales of its 13 spices to reach $300,000, putting it at the break-even point.
The Kachigians were inspired to create a line of liquid spices after unsuccessfully trying to re-create a tasty restaurant meal at home. About four years ago, Corinne began working on the concept with a company that developed the patented technology. Steven kept his full-time job in the food industry until joining her in the business about 18 months ago.
The liquid spices, including garlic, chili, dill, basil, oregano and thyme, measure like their dry counterparts. They have a two-year shelf life, can withstand microwave cooking and are instantly absorbed by food. The spices, first embraced by the food service industry, are now available in supermarkets across the country.
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With President Bush’s blessing, Small Business Administration Administrator Patricia Saiki recently asked Congress for an additional $1 billion to increase the SBA’s 7(a) guaranteed loan program to $4.1 billion.
Saiki said the SBA needs the additional funds to meet a sharp increase in demand for guaranteed loans and to repackage loans made to small-business owners by failed banks. Under a pilot program in New England, the SBA is helping troubled institutions shift loans to healthier ones.
