Things to Consider Before Investing in a Friend’s Business

Author: Jesse Santana, Sr. Vice President, Commercial Loan Officer 05/26/2023

Any investment requires research and planning to make informed decisions about what best fits your financial situation. When the investment happens to involve a friend’s business, it’s important to remain professional in your thoughts and actions to ensure you make sound financial decisions that aren’t influenced by the personal relationship. Below are several key points to consider before investing in a friend’s business.

Think Like a Professional, Not Just a Friend

An effective method of responsible investing is to approach the decision as if you are dealing with a stranger. In essence, allowing your personal relationship to influence your choice can quickly lead to misunderstandings or conflicts. Avoid these obstacles by taking time to research the idea or concept of your friend’s business.

What is this business offering customers? Is there current demand for its product or service? How qualified is your friend in order to be successful in their endeavor?

It also makes sense to be extremely clear about the terms of your investment. This includes setting reasonable predictions for the return on your investment and what terms will apply if your friend intends to reimburse you. You should put this in writing and review it with your friend so there are clear expectations on both sides of the table.

Another factor to consider is what type of investor you intend to be. Are you just providing a loan to your friend, or will you have an ownership stake in the venture? Keep in mind that if you have an ownership stake over a certain percentage, a lender may ask about it when you try to secure other financing.

Research the Business Plan

Any legitimate entrepreneurial venture requires a detailed business plan. Smart investing dictates that you can review a business plan to determine financial projections, current and expected revenue streams, and a competitive analysis of the market. For example, if your friend is planning to open a coffee bar, the plan should contain details such as the location, the expected amount of overhead expenses, and whether your friend has accounted for what is going to make their product stand out from competitors.

Set Boundaries

A particular challenge faced when thinking of how to invest in a friend’s business is ensuring that boundaries are clearly defined. In essence, you both must do your part to keep business discussions and decisions separate from social functions.

Regardless of how close you both are, it’s important to remember that you are an investor, and you need to be informed or have access to the details surrounding the performance of the business. However, discussing these details in a social setting can potentially blur the boundary and cause unwanted complications.

Only Invest What You Can Afford

Keep in mind that even the most well-planned business models sometimes fail due to factors outside of the owner’s control, such as economic downturns, supply chain issues, or a decrease in customer demand. In addition, if your friend’s business is a start-up, be aware that most ventures rarely turn a profit in the first year or two of operation.

In other words, you not only need to be prepared for a marginal or zero return on your investment, but also consider what you can truly afford to spend without counting on a return to help you afford your other expenses. The key to knowing these answers lies in having your own personal detailed budget.

Consider Lending Advice Rather Than Money

Remember that money isn’t the only way to support a friend’s business. You can also assist in other ways, such as handling their business social media accounts, helping at promotional events, or simply being a sounding board for their decisions. In addition, your personal financial situation may dictate that it is not in your best interest to invest money.

As with any investment consideration, the key to proceeding lies with advance preparation and research. Add to that the friendship dynamic, and it makes sense to follow these tips as you consider investing in their business.

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