8 Questions to Ask Before Investing In A Friend’s Business
August 16th, 2021 | Related To: Firstline Securities Limited
Firstly, congratulations on having an enterprising friend! We should all encourage and support entrepreneurial
endeavours; this is how we’ll truly grow as a nation. That said, you don’t want to lose a friend because of money. Worse yet if you lose both your friend and your money. Painful.
To avoid that worst case scenario, we’ve listed some questions you should ask your friend (or family member) before you decide whether to invest. Some of these questions may not be applicable dependent on the dollar size of the request or the characteristics of the business but regardless of who is making the request, at least one of these should be asked. In other words, not even your 10-year-old niece should get a free pass.
It’s a delicate balance to both be supportive and ask (what could be) some tough questions, but you can do it. They’ll likely be nervous to ask you for this support and anticipate rejection. Or perhaps it’s the opposite and they’ve come to expect assistance. In that scenario, you definitely need to get the answers to most, if not all of these questions.
So let’s get into it, in no particular order (except for question 1):
👉Question 1: What exactly do you mean by “invest”?
Four of the most common colloquial meanings behind “invest in my business” are:
- To gift money (donation / sponsorship)
- To lend money and have only the principal returned (interest-free loan)
- To lend money and have the principal returned plus some more on top (interest-bearing loan)
- To give money in exchange for some level of ownership (equity)
What is your friend asking for? For the purposes of the rest of this article, let’s assume they weren’t requesting sponsorship.
👉Question 2: Do you have a written business plan explaining the business, its market, its risks, its plans for profitability etc and can you share it with me?
At this point, some of you may have to follow this question up by assuring your friend that you have no intention of stealing their idea and will not share their business plan with anyone, not even your mother.
The purpose behind this question is for you to gauge their readiness and preparation for this endeavour, even if it’s an already operating business. What they share with you doesn’t have to be fancy, it could even be an explanatory email rather than a many-page document. But everything can’t just be in their head.
👉Question 3: What will the money be used for specifically and how will it help the business?
This question provides helpful context of the general health & financial status of the business. Lending money to pay salaries paints a different picture to lending money to purchase assets.
👉Question 4: What’s the biggest risk that you face with the business, and could something happen where I lose my money?
If they don’t have a cogent understanding of the risks they face, then they’re not asking you to invest, but to gamble. You want them to be frank and honest not just with you, but with themselves. Responses that include words like “guaranteed” and “fool proof” are red flags.
👉Question 5: What will be the return on my investment? Will it be a set interest rate or dependent on how the business performs? If it’s the latter, how are we going to calculate what I will receive and what do you project I will earn?
Profit-sharing models increase the complexity of an investment so these would be preliminary questions that will build into further discussions. The aim with all these questions is to get clarity so as to manage your expectations and avoid misunderstandings.
👉Question 6: Will I get a document evidencing my investment and its terms and conditions?
The form doesn’t matter so much here; focus on the content. Whether it’s written on a copy book page, typed in an email, or signed in front of an attorney, you should require proof of your investment. It’s a request for an investment in a business and though you’re their friend / loved one, you shouldn’t be treated any less professionally than a third-party investor would.
👉Question 7: How are we going to separate the personal from the professional?
There’s a lot to unpack in this one and it’s a question that you have to answer yourself as well. Would you be comfortable with them giving you an update on your investment during a beach lime? How often can you ask questions about not just your specific investment but their overall business, and how detailed can these questions get?
You should decide the manner and method of your communication.
👉Question 8: When will I be repaid? How can I exit the investment?
This is a two-pronged question in preparation for the arrival of a worst-case scenario. What happens when the date of repayment comes, and your cousin can’t pay you back? It’s best to talk this through upfront. When in the heat of a bad situation, behaviours may well change, but at least you’d have the benefit of having discussed this before when clearer heads prevailed.
And we could go on. How much money have you put into the business? Am I going to be the only investor? Have you borrowed money before and successfully repaid it? Will you be doing this full-time? Do you have other partners in the business and how much control do they have? Do you want me to take an active role in the company as well?
It’s a non-exhaustive list but you don’t want to overwhelm them with questions or critique. This process works best when you look at it as an investment opportunity. Significant wealth creation happens via these entrepreneurial endeavours and being part of a business, in any respect, is a rewarding experience. Before he was Bill Gates, he was just a guy in his parent’s garage, as the story goes.
Your friend or family member has not come to you to beg,
they’ve come to ask you to be part of their financial journey.
And if you’re thinking “Somebody always asking me on a journey!”, let’s flip the script and say: you’re lucky to be part of such a thriving personal network where family and friends are trying new things, taking considered chances and growing themselves and their communities. Look at you, in the thick of it!