Be cautious before investing in a friend’s business

Ben & Jerry’s was started by childhood best friends. Four grad school buddies founded Warby Parker. A long friendship-turned-partnership brought Clear to TSA security lines across the U.S.

Yes, stories of successful business partnerships between friends exist. But for every Ben and Jerry, there are countless Janes and Joes ticked off at their college roommate for stiffing them on a business loan.

Mixing business and friendship can tank a relationship. So, if a classmate, colleague or childhood friend asks you to invest in their business, you need to look at it from all angles.

Think like a professional investor

Don’t let your personal relationship cloud your business judgment. Evaluate the request as if it was coming from a stranger.

Does the business offer something unique? Does it fill a need in the market? Does the founder have business acumen? Do they have experience in the industry?

You also need to know the terms of your investment and what you’re getting in return. If your friend is asking for a business loan, discuss the repayment timeline and interest.

If your investment is in exchange for equity, review the terms. Is it solely a financial transaction, or will you have access to and input on business operations?

Always, always study the business plan

Examine the business plan to see if your friend has thought through all aspects of the business.

A thorough plan should include financial projections, current revenue, five-year projections and a detailed market analysis that outlines competitors and potential obstacles.

“You have to do your due diligence even if you have known the person your whole life,” Dimitrios Mano, an entrepreneur, said through email.

“I have seen friends ruin 20-plus years of friendships over irrelevant business arguments and family members completely cut ties with one another because of a slight disagreement,” Mano said. For him, the investment wasn’t worth the potential personal cost.

Communicate, but set boundaries

The lines between business and personal affairs can quickly blur when you invest in a loved one’s business. While clear, frequent communication is essential, it’s important to draw boundaries.

When Mark Aselstine co-founded Uncorked Ventures, a now-defunct online wine club, with his brother-inlaw, the duo set strict rules at the onset.

“We decided at the beginning that we wouldn’t say anything to each other that we wouldn’t say to our nieces or nephews,” Aselstine said through email. The two relegated business talk to morning meetings, rather than casual outings. “(We) had a rule to not talk about it at family events (and) dinners. Having those dividing lines, but open communication was key.”

Don’t invest money you can’t afford to lose

“Don’t think you’re going to make a fortune if you help a friend out,” Rao says. In fact, don’t expect to make any money at all.

Roughly 20% of businesses close within the first year, according to data from the Bureau of Labor Statistics. And most startups never deliver a positive return.

“Ask yourself if you are OK if you lose all the money you invested in your friend’s startup,” Amanda Sanders, founder of Authentic CEO, said through email. Sanders has been on both sides of the equation – as an entrepreneur and an investor.

“If the honest answer is yes with no ill will toward your friend, then the relationship is likely to remain solid regardless of the business outcome,” she said. “If your answer is conditional, then the outcome of the friendship is likely to be conditional on the business investment.”