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The Cold, Calulating Way to Invest in a Friend's Business

Entrepreneurs understand that when it comes to funding a venture, friends can be a good and even willing source of capital. The money is available quickly, probably at decent terms and the board meetings aren't too fractious.

But what's the view from the other side? Should you even consider investing in a business being started by a friend, spouse, child, neighbor or church elder?

Before answering, read a cautionary tale of woe from Whitney Johnson, herself a professional VC, who went in on a friend's business. "My husband and I lost a painful lot of money. It was devastating," she writes on HBR.org.

Johnson's goal is not to discourage friend investing, but rather to advise an analytical, unemotional approach.

She offer these three tips:

  1. Set clear boundaries. Just because a friend is involved, don't short-change yourself on terms. You have a fiduciary responsibility to your family (assuming you are putting family capital as risk), so negotiate an amount of risk-versus-reward that you are comfortable with.
  2. Establish rules of engagement. The tendency is to say, "We'll figure this out as we go along." But no VC would ever give money on that basis, and you shouldn't either. The startup needs a clear business plan, details on roles and responsibilities of the officers, and a written understanding of who has ultimate veto power.
  3. Accurately assess your partners. A SWOT analysis (Strengths, Weaknesses, Opportunities, Threats) is usually performed as a business sizes up its market position. Johnson recommends doing a similar analysis on the friend you are investing with. Does she manage people well? Is she a strategic thinker? Can she perform under pressure?
Johnson's new bottom line on buddy bankrolling? "Friendship-cum-philanthropy comes second; financial savvy and safety, first."

Have you invested in a friend and regretted it ever since? What went wrong, and what did you learn from the experience?

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(Photo by Flickr user AMagill, CC 2.0)
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