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Investing in a friend or family member’s business may seem like a great way to support a loved one while potentially making a profit. However, there are legal risks involved in such an investment. While the relationship may be personal, you should approach your investment as a business transaction with proper documentation and legal advice. This article will explore the legal risks inherent in friend and family investments.
1. Lack of Due Diligence
Due diligence involves researching and analysing the business to determine its:
- financial health;
- risks; and
- potential for growth.
Investing in any company without proper due diligence constitutes a significant risk. This is especially true when you may feel like you know or trust someone already and feel uncomfortable conducting a thorough investigation of their business. However, it is essential to remember that you are carrying out due diligence against the company, not your friend or family member.
It is crucial to thoroughly examine the company before investing any funds. This may involve:
- reviewing financial statements, legal documents and contracts;
- conducting market research; and
- assessing the competition.
2. Disagreements and Conflicts
Investing in businesses with close friends or family can create personal conflicts and disagreements. Even with the best intentions, disputes can arise over business decisions, finances and money management.
Nobody wishes a business investment to end up harming personal and emotional ties. However, any company can fail, and it is worth being aware that a business failure can be more challenging to navigate if a friend or family member owns the company.
For example, any business failure may create a difficult situation where you must either support the friend or family member or cut ties and pursue legal action to recover your investment. This can be incredibly challenging if the person is a close friend or family member, leading to strained relationships and hurt feelings.
It is, therefore, essential to establish clear communication and expectations before investing any funds. This may involve creating a formal business agreement or contract that outlines roles, responsibilities and expectations. An expert lawyer can help make a legal agreement that can help prevent or resolve conflicts.
LegalVision’s Buying a Business: Guide to Negotiating Terms allows you to protect yourself by understanding which key terms to negotiate when buying a business.
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3. Lack of Control
Investing in a friend or family member’s company may also mean having limited control over the business. Depending on the investment structure, you may not have a significant say in business decisions or management. This will be a concern if your friend or family member mismanages the business in a way that reduces the value of your investment.
Understanding the level of control and repayment terms you have as an investor is essential before investing any funds. If you desire a high level of control, you may need to negotiate this within the legal document recording your investment.
4. Not Seeking Professional Advice
You should only invest in a business after obtaining expert advice on its financial, tax and legal consequences. However, many potential investors fail to get professional advice when investing in a friend or family member’s business due to their personal connection with the owner.
Unfortunately, engaging in a friend or family member’s business without this advice puts you at risk of a poor deal. Worse still, you may be in a poorly run business, unable to extract your investment quickly. Therefore, obtaining expert advice from lawyers and financial advisors before putting pen to paper on business or equity investment is crucial.
Most experts advise you to treat the investment like any other business transaction. It is essential to approach the decision whether to invest with a level head and, as above, to ensure thorough due diligence.
Key Takeaways
Investing in a friend or family member’s company can be a rewarding experience, but it is vital to consider the legal risks involved before doing so. Conducting due diligence, establishing clear communication and expectations and consulting with a lawyer can help mitigate legal risks and protect your personal and financial interests.
It is worth considering the potential impact of your personal relationships before investing. Consider how the investment may impact your relationship with the person and whether the business failing will strain or end that friendship or relationship.
If you need assistance investing in a friend or family member’s company, our experienced business sale lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Many startup founders seek initial funding from family members and close friends rather than accredited investors. This is because family funding usually involves more patience and trust than money from outside investors.
An investment usually sees an individual obtain a share of the company, whilst a loan is purely a promise to pay the money back (at an agreed interest rate).
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