5 things to consider before investing in a friend's business
5 things to consider before investing in a friend’s business

Ben & Jerry’s was founded by childhood best friends. Four college buddies founded Warby Parker. A long friendship turned partnership brought Clear to TSA security lines across the United States. A shopping spree between two friends launched size-inclusive clothing brand Universal Standard.

Yes, there are stories of successful business partnerships between friends. But for every Ben and Jerry, there are countless Janes and Joes ticked off to their college roommate to stiffen them up on a business loan.

Mixing business and friendship can rock a relationship. So if a classmate, co-worker, or childhood friend asks you to invest in their business, you need to look at it from all angles.

Think like a professional investor

Don’t let your personal relationship cloud your business judgment. Evaluate the request as if it came from a stranger.

Does the company offer anything unique? Does it meet a market need? Does the founder have business acumen? Do they have industry experience?

“A professional investor always wants to see where the ‘Aha’ is,” says Dileep Rao, clinical professor of entrepreneurship at Florida International University. “Is this likely to become a big business? If the potential is huge, it makes financial sense.

You also need to know the terms of your investment and what you are getting in return. If your friend asks you for a Business loandiscuss the repayment schedule and interest.

If your investment is in exchange for equity, review the terms. Is this a financial transaction only, or will you have access to and input into business operations?

A handshake isn’t enough, even with – or especially with – lifelong friends. Make sure it’s all written down if you choose to invest so there’s no confusion down the line.

Read also : How a 141-year-old Ohio moving company became America’s oldest black-owned business

Always, always study the business plan

Review the business plan to see if your friend has thought through all aspects of the business.

A thorough business plan must include financial projections, current revenues, five-year projections, and a detailed market analysis that outlines competitors and potential barriers.

“You have to do your due diligence even if you’ve known the person all your life,” Dimitrios Mano, an entrepreneur, said via email. Mano co-founded Bloom Express, an online CBD marketplace, in 2019 with a close college friend while the two were still in school.

Apart from his co-founder, Mano has not approached his friends or family for a business start-up loan. The duo relied on their personal savings and income from their daily work.

“I’ve seen friends ruin 20+ years of friendship over irrelevant business arguments and family members completely cut ties with each other over a slight disagreement,” said Mano. For him, the investment was not worth the potential personal cost.

Also see: Employers are hiring again – but which pay wages that keep up with inflation, and which don’t?

Communicate, but set limits

The lines between business and personal affairs can quickly blur when investing in the business of a loved one. Although clear and frequent communication is essential, it is important to draw boundaries.

When Mark Aselstine co-founded Uncorked Ventures, a now-defunct online wine club, with his brother-in-law, the duo set strict rules early on.

“We decided early on that we wouldn’t say anything to each other that we wouldn’t say to our nieces or nephews,” Aselstine said via email. The two relegated cases speak at morning meetings, rather than the occasional outing. “[We] had a rule not to talk about it at family events [and] dinners. Having those dividing lines, but open communication was key.

Don’t invest money you can’t afford to lose

“Don’t think you’ll make a fortune if you help a friend,” Rao says. In fact, don’t expect to make any money at all.

About 20% of businesses close in the first year, according to data from the Bureau of Labor Statistics. And most startups never offer positive feedback.

“Ask yourself if you’re okay if you lose all the money you invested in your friend’s startup,” Amanda Sanders, founder of Authentic CEO, said via email. Sanders has been on both sides of the equation – as an entrepreneur and an investor.

“If the honest answer is yes with no ill will towards your friend, then the relationship is likely to remain strong regardless of the business outcome,” she said. “If your answer is conditional, the outcome of the friendship will likely depend on the company’s investment.”

Related: Loan money to a family member? Don’t raise those red flags with the IRS

Offer support, expertise rather than money

Money isn’t the only way to support a friend’s business. You can offer time, expertise and connections.

Participate in pop-ups and events. Manage their social media accounts. Distribute flyers to spread the word. Be a sounding board for ideas and problems.

Or just show up with takeout once in a while, Sanders said.

“Having a friend interrupt your endless work schedule and bring the food, fun, and fireball (part three is optional) is very important for maintaining sanity.”

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Kelsey Sheehy writes for NerdWallet. Email: ksheehy@nerdwallet.com. Twitter: @KelseyLSheehy.

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