Investing in a friend’s business can be rewarding but also risky. Before making the decision to invest, it is important to carefully evaluate all aspects of the opportunity. This includes assessing the business plan, financial projections, market conditions, your friend’s skills and experience, potential returns, and risks. You need to approach it just like any other investment and conduct thorough due diligence. It may help strengthen your friendship if done right, but can also strain your relationship if things go wrong. Here are some key things to consider when deciding whether to invest in a friend’s business.
Evaluate your friend’s business plan and financials
The first step is taking an objective look at their business plan. Do they have a viable product or service with strong market demand? Review their financial projections – are revenue and profit forecasts realistic? Look at funding needs and how they plan to repay your investment. Ask tough questions on their business model and plans for scaling. Look at competitive landscape and barriers to entry. Assess strengths and weaknesses. Essentially, kick the tires hard as if you were an external investor before putting in your hard-earned money.
Gauge your friend’s capabilities
Beyond the business itself, evaluate if your friend has the skills, experience and work ethic to execute on their plan and grow the business. Being a founder requires resilience, resourcefulness, leadership, business acumen and more. As an investor, you need confidence in their ability to navigate the inevitable challenges of entrepreneurship. Look at their background and track record. Discuss their vision, gameplan, and contingency options. Assess their commitment and energy level in wanting to make it a success. While supporting a friend is admirable, ensure they have the capability to convert your investment into a meaningful return.
Consider the financial upside and risks
Carefully analyze expected returns and timeline. Many startups fail, so make realistic assumptions. Ensure your friend has ‘skin in the game’ and you’re not overpaying for equity. Negotiate investment terms like liquidation preferences and pro rata rights. Define your path to future exits. Understand tax implications. Ask what could go wrong and mitigation plans. Review company valuation projections. Scenario plan for different outcomes. Make sure both parties agree on financial expectations before finalizing investment so there’s no room for misunderstandings later.
Get proper legal agreements in place
Any investment agreement between friends should be properly documented. Consult a lawyer to draw up investment contracts, shareholders’ agreement, etc. to protect both parties’ rights and obligations. Like any business transaction, handshakes or verbal promises won’t suffice. Detail the investment structure, governance, information rights, vesting schedules, restrictions on transfer, drag-along provisions etc. Clearly outline the rules of engagement upfront before disputes arise later and strain the friendship. Legal paperwork may feel unnatural between friends, but is necessary to eliminate ambiguity on the business relationship.
Investing in a friend’s business can enrich relationships when done right, but shouldn’t be taken lightly. Approach it just as you would any investment opportunity – with eyes wide open. Conduct thorough due diligence, evaluate risks realistically, negotiate proper terms, and get legal agreements in place. Making smart investment decisions and nurturing the friendship requires having candid conversations on expectations upfront.