My younger sister quit her job (in a recession, no less) to start a new company. She asked if I’d be willing to loan/invest $10,000 to help get her business, a cupcake shop, up and running. While I do have some money to play with, I’m not sure I want to take the risk, especially since my sister is not the savviest when it comes to money management. I love my sister and think she has a great idea, but how can I play this safe?
Who doesn’t love a cupcake? But, investing in a business, especially a start-up, is one of the highest-risk investments you can make. Half of new businesses fail in the first five years, according to the Small Business Administration. If the cupcake shop ends up going south, you not only risk your investment, but your relationship with your sister as well.
Before you make a loan, be sure to:
1. Research The Market
Your sister may have a great butter frosting recipe, but what about her business plan? What’s the market size and competition? This is your chance to make an educated guess about whether your sister’s idea is actually a viable one. Listen to her pitch and ask other friends or business contacts that work in that same market. What do they see as barriers to entry? What do they struggle with? What are the opportunities? The resource center at local libraries may also offer helpful market reports. By the way, if she doesn’t have a solid plan, let that be a good sign you shouldn’t hand her any money yet.
2. Know How Your Money Will Be Invested
Will your sister use your $10,000 towards purchasing an oven? Pay the first few months of rent? Purchase insurance? Or some couture aprons, perhaps? You should know where your money is going and maybe even have a say in those decisions.
3. Be Clear On Your Role
Speaking of having a say, are you funding your sister as a silent investor? Or would you want to play a decision-making role in your sister’s business, too?
4. Find Out Who Will Manage The Business
Your sister may be a great “ideas” person, but as you said, she’s not that fantastic when it comes to money. Find out how she plans to delegate the responsibilities of the business.
5. Make Sure There’s Other Money At Play
Are you the only investor? Has your sister convinced others to jump on the cupcake wagon, too? It’s generally a good sign when a business has several investors who believe the business will thrive, including banks. Make sure your sis is digging into her pockets, too—at least 10% or 20%.
6. Put The Deal In Writing
Once the decision has been made to invest, get it in writing. To avoid tension, have a third party, preferably another investor who’s not a friend, draft the terms and play mediator. This may be a job for a lawyer. The National Venture Capital Association (www.nvca.org) offers free sample legal documents, such as term sheets and investor rights agreements. You can draft up terms for a personal loan at VirginMoneyUS.com as well, for a fee. As for the return on your investment, that’s something you’ll need to figure out with your sister. Just get it in writing!
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