Long before banks are willing to loan money, often when you first have an idea, you raise money from friends and family to start your business venture. Many a long-term successful venture begins this way, with an equipment budget gifted from grandma and supplies expenses from your dad in exchange for a little ownership. Even on slightly larger scales, this is one of the most common ways businesses raise their initial capital. After all, if your friends and family won’t give you money and assistance, you’re unlikely to get it from investors you don’t know or banks that just want to see your collateral.

There is, however, downside that comes with raising money from those closest to you. If your business isn’t quite as successful as anticipated, although everyone said they understood the risk, you could still end up with tense or broken relationships with those you care the most about. If you’re planning on working with your loved ones to raise money, it’s a good idea to formalize the business relationship and set clear expectations. While raising money, share the risks, the business plan, and the rules of the investment in writing. Even this won’t prevent all relationships from going sour if things go poorly, but it will help you weather the ups and downs of the business.

When raising money, family and friends tend to put money into businesses in three different ways, each with their own expectations and associated paperwork.

• Gift: During fund raising, gifts are wonderful because there’s no expectation that you pay the giver back. However, you want to make sure it’s clearly documented in writing that the money is given as a gift and not as a loan and there’s no expectation of repayment. While raising money, if you receive larger gifts, there may be tax consequences, so be sure to talk to an attorney or accountant on the best way to mitigate those before completing the transaction.

• Loan: Loans from friends and families can be structured in a number of creative ways to allow the business to grow while still providing an expectation of return and interest to your family. Whatever terms are agreed on should be clearly documented, including when repayment should start, how much should be paid each month, and what interest rate is being charged. A simple promissory note is a fairly easy document to get when raising funds using loans and can protect you from misunderstandings when you finally draw your first paycheck.

• Equity: When you give someone equity to raise money, you don’t have to pay them back but you’re bringing them on board as a business partner. People who have invested in your business are, effectively, your bosses, so you’ll want to set very clear expectations around the business, decision-making, and what happens to the business’s assets in the event of closure. A business attorney can help you draft these documents and ensure you’ve thought through different situations.

If you’re raising money and need to ask for help, always be prepared with a through, well-thought-out business plan that includes financial projections, assumptions, a risk-analysis, and a marketing plan. While you’ll probably make your initial pitch to raise money sitting around the kitchen table and they’ll make their decision to invest or not based on their trust in you, make sure they have and review a copy of your plan and have signed the appropriate paperwork before taking their check.

For help drafting the appropriate documents for raising a round from friends and family, reach out to the experienced attorneys at Chase Law Group, P.C. by giving us a call at (310) 545-7700. We can help you navigate your initial investment and help protect your business from stumbling into other legal pitfalls along the way.