A start-up company will often use different sources of financing to raise the capital needed to launch its project. After the entrepreneur’s personal investment, one of the main sources of financing for a start-up business is the financing provided by the entrepreneur’s family and friends, also known as “love money”.
One of the advantages of love money is that family and friends do not invest in order to make a profit, but rather to help the entrepreneur launch his business. This usually results in an interest-free or low- interest loan granted without any securities in favor of the relative or friend.
There are, however, some risks associated with love money that should be considered. Given the relationship of trust between the relative and the entrepreneur, it is common for the loan to be granted without a signed written document providing for its terms and conditions. This approach is strongly discouraged. In the event of a conflict between the parties, a loan contract drawn up in clear and precise terms generally prevents a long and costly dispute.
In addition to a loan, financing can also be made in exchange for the issuance of shares in the entrepreneur’s company. In other words, the relative becomes a shareholder of the start-up company. Depending on the class of shares issued to the relative, he may be granted rights in the company, namely the right to vote or the right to receive dividends. However, it is possible to remove or modulate these rights by creating several classes of shares, having different rights. This approach is particularly interesting for the entrepreneur who wants to limit the participation of friends and family in the company.
Love money is a quick and flexible financing option for a start-up company. Nevertheless, it is essential that the entrepreneur take the necessary precautions to protect both his business and his relationships with his family and friends.
By Georges Jebara