Yahoo Finance How investing in friend's business turned into the 'most painful experience' in man's life
The Aussie man lent his friend more than $50,000 and it eventually cost him the friendship and his long-term relationship.
When Lee* was approached by a good friend to invest in an expansion of her event management business he was excited at what he thought was “a more novel investment”. Instead, it ended not only his friendship but also his long-term romantic relationship.
“Even beyond the money, it was the most painful, upsetting financial experience of my life," Lee said. “Unquestionably.”
He had previously invested in businesses run by friends and family before, spending about “$20,000 to $30,000” he said. This time, however, buoyed by his comfortable financial situation, Lee invested more than $50,000.
Other friends also invested, which he said made it more attractive.
“This investment carried something beyond potential monetary gain,” said Lee. “It was something you’re potentially doing with a friend, with other people you find interesting.”
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Communication was sparse from the start, but initially, Lee let it go.
“Part of me was thinking, oh, maybe she’s really busy… I'm sure when these events run, it’s absolutely non-stop,” he said.
“It was probably a good couple of months before I started to panic. And that’s when I was contacting, emailing, and still getting nothing… I think I only got one or two emails over months and months.”
“And then there was just like a phone call months later saying, ‘Essentially, it’s all gone. Is there anything I can do?’"
Lee said he felt “completely betrayed" and "certainly that friend is thoroughly lost.”
The catastrophic fallout
That friendship, however, was not even the worst relationship outcome. The friend whose business he had invested in was female, which became a problem for Lee’s significant other.
“Even though on one level, it’s purely financial, it is a significant relationship, period," Lee said of his investment.
“When you’re investing a large amount of money with a friend, that just elevates the nature of the relationship."
The hefty investment triggered a row with his partner that eventually ended their long-term relationship.
“If you have partners and other family [who] might know the friend too, you’ll be surprised [how] it may affect that dynamic,” Lee said.
'Formalise everything, no matter how well you know each other'
Lee said while he did have a contract with his friend, “it was possibly not the most professional contract, and that probably came back to bite me… but because I saw her as a friend, I don’t think I expected to get duped on the legal side”.
Experts told Yahoo Finance that anyone looking to invest should treat an investment in a friend or family’s business as diligently as any significant investment.
“A lot of the time with friends, they like to keep things informal because they might have known each other for 10, 15, 20 years.” said lawyer Agita Antoon from Double Eight Legal.
“‘He’s like my brother, she’s like a sister, I trust them, I don’t need to get into an agreement’.
“But business is business, and a lot of people do lose friendships and relationships over money. So formalise everything in an agreement, whether it’s a loan agreement or shareholder agreement, or something that sets out exactly what the terms are.”
Antoon says investors should insist on seeing a business plan because “even if you’re not an expert, it gives the person seeking the capital that confidence to say I know what I’m doing, I’ve done all this research”.
Trouble starts when you don't communicate
Christopher Fong is the founder of Xoogler.co, a community that connects ex-Google staff including matching entrepreneurs with investors, and of Xoogler Ventures, which has invested in over 100 startups.
He said investors tend to be more accepting if they lose their investment in an individual business — and whose investments are often highly diversified — if founders keep them updated.
“If you are able to send regular reports and have good transparency with investors, your friends or family shouldn’t actually be upset… it’s when you don’t communicate on a regular basis, that’s when the trouble starts happening," he explained.
Financial adviser Grace Bacon from RSM Financial Services said even if business owners do follow the right steps, a relationship may not survive a bad investment. She said it’s “very difficult” to separate “financial decisions from emotions… when things go bad, relationships are likely to be damaged.”
She said investors need to be clear about why they’re investing in a close friend or family member’s business.
“Is this a financial decision where you are hoping to make a gain? Or is this simply a gift to help someone out and there is no expectation of returns?" she said.
She said one of her clients invested in a friend’s startup, expecting a solid return to help her with her retirement savings. The business failed.
“In the end, she lost her funds and the relationship between her and her friend became very sour," Bacon said.
Lee revealed he is still open to investing in a friend or family’s business, but he “would make sure the stakes are lower. I certainly learned a lot.”
*This name and details of the story have been changed.
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