When Joseph Cullen had the idea to set up a mineral exploration company, he knew he was going to need money to get the business started. But rather than going to a bank or an investment firm, he opted to go closer to home, borrowing $75,000 from a friend.

It’s a move that many entrepreneurs make. Among those who look for outside investment, around 20 per cent ask family and friends, according to data from Starling Bank, which analysed information from more than 1,200 entrants to its 2023 Start-up Awards.

Separate data from Charles Stanley’s Fortune Favours study, which spoke to more than 500 entrepreneurs, shows that 19 per cent received support directly from parents and 10 per cent from grandparents and other family to start a business.

It’s also how many of the world’s biggest companies started. Steve Jobs founded Apple with a $1,300 loan from his childhood friend Bill Fernandez, while Nike co-founder Phil Knight borrowed $1,000 to launch Blue Ribbon Sports (which later became Nike). Sara Blakely also funded her underwear brand Spanx with money from family and friends.

Despite how common it is, borrowing from family and friends can be difficult. Suddenly, relationships based on a mutual appreciation for a football club or evenings in the local curry house have an extra layer. This can take them into uncharted territory and both parties must be both aware of and understand this.

Taking a loan from family or friends means you have to be comfortable with mixing the personal and professional. Some people may not be. Decide before

Joseph Cullen, Metalsource Mining

There can also be a temptation not to treat this type of investment as formally as money from a bank or venture capital firm. But, for Cullen, they should be treated the same.

Key to that is the contract. Cullen says one should always be drawn up, no matter who the friend or family member is or how much the investment is for. And that contract should include clear and defined deliverables. The lender must also be kept up to date with how the money is being spent and when it will be paid back.

“Always draw up a contract,” says Cullen. “Don’t leave it to a handshake.”

Sarah Louise Fairburn, founder of the hamper company IMP & Maker, says clearly establishing boundaries “from the get-go” is paramount. She advises treating investment from family and friends the same as any other, with a proper business plan and investment pack.

“If you are going to outside institutions or investors,” she says, “you would have a thought-out and thorough investment pack that would show the opportunity as well as the risk. This is more important than ever when reaching out to family and friends.”

Taking investment from friends and family doesn’t only happen when founding a business. The aforementioned Charles Stanley research found that entrepreneurs continue to rely on family for growth funding, with 13 per cent turning to parents for additional investment.

For Glen Hughes, chief executive of the set-building company Tandem Set and Scenery, borrowing was the only way to access the funds he needed to scale his business. He needed to buy new machinery and equipment and so asked friends and family to invest £200,000 because, as he recalls, it was “nearly impossible” to access funds from a bank at a reasonable rate.

Hughes’s firm was already set up and making money when he went to others for investment. And he believes this is a much better time to ask those close to you to invest.

Don’t borrow for working capital. When you are sure you can generate revenue, this is the time to do it. You can convert later down the line to more traditional loans.

Glen Hughes, Tandem Set and Scenery

To date, Glen says borrowing has not caused any fractures in his relationships, in part because his business has grown, and he has been able to repay the money. He admits, though, that he would be “less inclined” to borrow from friends and family given the current state of the economy.

He also recommends “setting clear boundaries” and discussing not just what will happen if everything goes to plan, but also if it doesn’t. Friends and family must be aware of the possibility of losing the money and think about how they might react.

New ventures don’t always work out. Matt Matros is the founder of ecommerce firm Limitless and Qurate Digital Ventures among others, with two eight-figure exits under his belt. He previously borrowed “a few hundred thousand” dollars from several close friends for a venture that tanked.

Despite the ups and downs, the friendships have stood the test of time, which Matros credits to their expertise as investors.

“They recognise angel investments are binary – they either go to zero or they go to a lot of money,” he says. Other friends may not have been as understanding.

However, Matros still feels like he will “always need to make it up to them” and he wouldn’t borrow money from friends again. He says, “There are just too many sources of capital out there and not that many lifelong friends.”

Finn Wheatley, a financial expert and risk analyst at The Small Business Blog, agrees. Emphasising the crucial role of open communication, Wheatley advises that if repayment difficulties arise, it’s vital to confront the issues and discuss them, rather than conceal them.

“Together you can navigate problems before they escalate, for example by adjusting a payment plan. My advice is to make informal lending a co-operative process rather than an adversarial one defined by strict rules,” he says.

“The intent behind these types of loans is to help, not harm, relationships. But avoiding obligations or mismanaging funds risks fracturing the very support system meant to provide a lifeline.”

Money can strain relationships at the best of times. According to Chris Demetriou, a qualified accountant and the co-founder of Archimedia Accounts, having an honest discussion about needs, establishing clear terms upfront and soliciting a trusted co-signer for larger sums will avoid common pitfalls.

David Beard, chief executive of financial comparison site Lending Expert, agrees, acknowledging that borrowing from loved ones for business requires transparency from the outset.

“Share your business plans and potential risks candidly,” he advises. “Plus, formalise your agreement with a detailed document outlining the loan amount, repayment schedule and any interest you’ll pay them.”

Without these formalities in place, founders risk losing friendships. But more than that, they could be in legal trouble. Beard warns about further risks of a souring relationship including being taken to a small claims court, which is a possibility for any amount up to £10,000.

A legal contract can be verbal if you’re able to prove it. Texts, emails and social media messages discussing the loan would be enough proof you borrowed money

David Beard, Lending Expert

When it came to paying back the loan, the friend that Cullen borrowed from didn’t want the cash back.  “He ended up wanting to turn his loan into equity because the company was doing so well, so instead of paying him back we gave him 10 per cent of the company,” says Cullen.

Hughes’s repayment plan was more traditional. When he borrowed the money, Tandem Set and Scenery was already up and running, with a few contracts secured. From being a sole trader, he and his partner Leah steadily expanded the business into a limited company employing designers, carpenters, metal workers, scenic painters, prop makers and CNC operators.

“The loans were paid back over the first five years and replaced with more conventional lines of credit like hire purchase agreements for equipment as the company grew,” he says. “Fortunately, to date, I haven’t defaulted on any loans.” 

Rory O’Hare, corporate and commercial partner at Primas Law, underscores the significance of legal ramifications. He suggests that while it may appear superfluous, putting agreements into writing ensures clarity and certainty for everyone involved.

This could be especially pertinent if the loan is intended to support a start-up or see a business through an investment phase when a party providing money may later claim to have some form of beneficial ownership or stake in the success of the enterprise.

“Very few things can cause as much stress or potential for conflict between friends and family as money,” he warns.