Small business funding: Pros and cons of 3F funding (family, friends and fools)

Finding the right small business funding is crucial to successfully launching and sustaining a new venture. For many entrepreneurs, funding for small businesses begins with a familiar source – family, friends and the "fools" who believe in their vision, known as the 3Fs.

Understanding these early financing options and how they compare to other funding sources is more important than ever.

Given the relatively recent boom in new businesses and digital funding platforms, having a primary funding source is more relevant than ever before. One viable source is the 3Fs.

But before you accept money from your nearest and dearest, make sure they aren't expecting an immediate return on their investment. Instead, it's better to assume your family and friends are prepared to finance you with money they might lose. Pointing this out will help you to avoid conflict at a later date.

In this blog, we look at some of the pros and cons of starting a business with money from the 3Fs: family, friends and fools.

Understanding your small business funding options

When it comes to financing your small business, the "3F" method is just one of many options available to you. Understanding the full range of funding possibilities can help you make informed decisions that match your business goals and plans for growth.

Beyond the 3Fs, you can explore:

• traditional bank loans

• government grants

• crowdfunding platforms

• angel investment

• venture capital

• small business loans from other lenders

Each option comes with its own set of requirements, risks and benefits and, often, a combination of funding sources is the key to long-term success.

Knowing where 3F funding fits within this broader landscape lets you appreciate its unique advantages, while also considering when and how to transition to more structured forms of financing as your business evolves.

Getting started with 3Fs funding for small business

The pros

Easy money (for you)

When you're in the first stage of thinking up your idea, who'll 'buy in to' your project? Your family and your good friends, of course! All you have is an idea. This could be advanced or still rather unformed.

Having a prototype of your product or service is still some way off. As an entrepreneur in the making, your role is to convince your family and friends so you can raise some money from them.

Remember: even though you're dealing with your loved ones, always speak like a professional. Also, don't forget about the lengths your loved ones go to by offering you their money.

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Peace of mind when starting out

The 3Fs method of funding means starting will be (a little) more accessible. You'll know your new business has the funds to get up and running. Consequently, you can focus on developing your product or service and won't have to worry about your cash flow just yet.

Ultimately, the money you have at the start will form the basis for getting additional financing, including banks.

Confident investors

Family and friends won't say no if you can offer them some guarantee of a return on their investment. However, they're supporting you because they love you and they want your project to succeed. They'll also want your new business to launch, even if it means they're directly involved.

This is a tremendous morale boost for an entrepreneur: unconditional support, financial assistance and help from people you know, love and trust. Your family and friends are doing this so they can share the very start of your project with you.

Flexible investment

If you're credible and enthusiastic, talk to your family and friends like a professional. They aren't going to ask for your financial track record or written guarantees before they invest. It means the money they do invest won't be heavily scrutinised.

Reimbursement on your terms

You can set your repayment terms just as you wish. So, if you can't offer your investors a cash refund, it's always possible to provide a refund in kind if they agree. For example, imagine you've started producing organic wine. You could give some of the initial batches to your 3F investors.

The cons

Financial disputes

When everything is going well for a business owner, financial problems don't tend to raise their ugly head. However, if things start to go awry, let's not forget that many new businesses go bankrupt early on. Only a select few succeed.

If your new business doesn't get off the ground or goes off the rails, this can put strain on family relationships and old friendships.

The risk of being unprofessional

Even if your family and good friends have loaned you money and are helping you with true devotion, you can't afford to behave in a sloppy or unprofessional manner. In the short term, this can lead to failure. So, you have to think of these people in terms of who they are: investors.

Interference

This risk is one that many entrepreneurs and new businesses know only too well: interference.

Family and friends may think they have the right to interfere when it comes to running your business. However, they might not have the knowledge or skills to do so. You can counteract this risk by being transparent.

A lack of information

Your friends and family may feel worried if they see that your new business isn't going to plan. They might also feel like that if you appear to be fed up with it.

However, they might not have the courage to ask you what's going on. A lack of transparency and information can lead to tricky situations that you then have to handle.

Forgetting who the 3Fs are

Just because you're a passionate entrepreneur setting your idea in motion, you can't afford to forget that your investors are part of your intimate circle. That is, family and friends who have put a lot of effort into helping you.

Occasionally, they may have taken risks when it comes to their own wellbeing. It means you shouldn't be frivolous when remembering who your 3Fs are.

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Olivia Thomas explores the current small business funding market and the different lenders and products available. She also explains how to increase your chances of being approved and what lenders look for in a successful application:

Practical tips for managing small business funding from the 3Fs

Securing funding from family, friends, and "fools" can be a great way to kickstart your small business. But it's essential that you handle these relationships professionally so you avoid any potential pitfalls.

Here are some tips for how to do that:

• Create clear agreements: Draft a written agreement that outlines the terms of the funding, including whether it's a loan, an equity investment or a gift. Set out the repayment schedules, ownership stakes and expectations to make sure everyone is on the same page.

• Be transparent about the risks: Discuss the potential risks of investing in your business, including the possibility that your investors could lose their money. Setting realistic expectations helps build trust and prevents misunderstandings later.

• Communicate regularly: Keep your investors informed about your business's progress, challenges and milestones. Sharing updates – even when things aren't going as planned – shows accountability and keeps relationships strong.

• Separate personal and professional boundaries: Treat your 3F investors as you would any professional backers. Don't assume that the arrangements are informal simply because of your personal connection. Make sure all interactions remain respectful and business-focused.

• Document all transactions: Keep a record of all funds received and repayments made. This not only keeps things organised but also serves as proof of good faith and diligence in case disputes arise.

• Set realistic terms for repayment: Work with your investors to establish a repayment schedule that fits with your business's cash flow. If cash isn't an option early on, consider alternative forms of reimbursement, like credit on your product or service.

• Define roles and expectations: Clearly outline whether your investors will have an active role in the business or remain silent partners. Setting these boundaries early prevents any unwanted interference or confusion later.

• Show appreciation: Acknowledge the trust and support your family, friends and early believers are offering. This could be as simple as a thank-you note, a share of your early success or regular gestures of gratitude.

• Plan for next-stage funding: Use the 3F funding as a foundation to position your business for future financing from banks, venture capital or other professional sources. Demonstrating how you've managed initial funding responsibly will boost your credibility with later-stage investors.

Key takeaways

You don't have a handbook to make sure that your new business and investor relations will be successful. However, here are a few tips to think about:

• When borrowing money, make sure loan conditions are clear and in writing.

• Investors must have a clearly defined role: will they play an active part in the company?

• Communication must flow and be transparent.

• Relationships must be professional.

• You might want to have a repayment schedule in place. 

Relevant resources

• How to raise money for your start-up

• A guide to securing small business funding from a bank

• A guide to securing small business finance from lenders other than banks