Finance 9 November 2016

Why turning to friends and family for capital can be a huge mistake 

Paul Oberschneider
Paul Oberschneider: “What’s a more valuable asset in the long run, your business or a friendship? That’s a decision you never want to force yourself into having to make”

Paul Oberschneider is an entrepreneur, angel investor, speaker and author. Here, he talks to Business Advice readers about how important it is for startup founders turning to friends and family for capital not to compromise personal relationships for the sake of their business.

One of the major challenges almost all entrepreneurs will face at some point is the need to raise capital.

For many, turning to friends and family for capital will seem like a logical place to start, but this can be a serious mistake.

Keep it in the family?

If you find yourself in a situation where friends and family are funding your business, you have already lost control.

The problem is, the value you place on your personal relationships with these people will inevitably cloud your judgement. It makes tough business decisions even more difficult by mixing in emotion.

Nobody wants to sit down for a special occasion meal knowing you’re losing your family’s money – it will either be uncomfortable silence or raging arguments. Either way is not good.

The partnership problem

The same thing can happen when you share ownership of a business with a partner. You may start out working with a friend, and he might be a great guy, but when things go wrong or tough decisions need to be made, it is important that nothing impairs your ability to act quickly and execute change.

Equal partnerships can cripple your ability to do make quick decisions. At some point, you are likely to struggle with deadlock, so keep as much of your company’s equity as possible so there are no arguments and you can act when you need to.

How to lose friends…

In 2008 I sold off my European property businesses one-by-one for a combined $200m and I had planned to retire.

It didn’t take long before I needed a new project, however, so when I spotted an opportunity to invest in a trend-setting healthy fast-food company in London I was excited to get involved. I found the young owner, and we struck a deal to become fifty-fifty partners. It was a happy time, but our euphoria lasted for only one day.

The first problem was that my partner had started the company and had always run the show. I had also always been the majority owner when I had built up my companies, and any outside institutional investors had just let me get on with things.

Now, I was the investor, so when I showed up for work the following day ready to make things happen, our relationship became a battle—a push and pull struggle.

Another time, a good friend and I decided to buy a business together. We were equal partners. Everything was great in the beginning, but when more money was required my friend was unwilling to invest more heavily, but nor did he want to dilute his shareholding by allowing me to invest more on my own.

We quickly found ourselves in a deadlock, he screamed “f**k you” at me several times in a row, and working with him became untenable. Our friendship, whatever it had been, was over.

Falling out over a business deal killed our friendship. Today, I have to ask, why? What was a more valuable asset in the long run – the business or our friendship? That’s a decision you never want to force yourself into having to make.

The capital conundrum

So who do you turn to when you need capital to grow your business? And is it possible to maintain control?

There is a big distinction between a private equity investor or a professional investor and a friend or relative that’s ready to be your partner.

Professional or institutional investors are too busy doing deals, raising capital, and monitoring their investments for exit to want to sit next to you at your desk and question your decisions. They are busy. That’s not their job.

When I worked as a stockbroker on Wall Street many years ago, I felt guilty when I lost money for the doctors or dentists that were my clients. I couldn’t sleep at night. However, if I lost money for an institutional investor, I wasn’t distressed.

I didn’t like having lost money, but I realised these were professional investors – they’d already underwritten a portion of their portfolios to loss. It wasn’t a personal thing. Food wouldn’t come off their tables. That’s the difference between family investors and professional investors.

Don’t fear debt

Finally, don’t exclude debt as an option. Debt by its very nature is cheaper than equity. Simplistically, there is a rate of interest, you will need to pay it back at some point and of course interest payments can be a drain on cash flow. However, I would rather pay a bank interest than give a majority of my shares away any day.

Equity is the dearest thing in business, and it’s expensive. Don’t give it away, and don’t share it if you don’t have to, especially with friends and relatives.

These are people you need to see every day and the people you will eat Christmas dinner with, so keep personal relationships separate and get money from the professionals.

Paul Oberschneider is the author of new book, Why Sell Tacos in Africa?

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