Investing With Friends and Family

November 1, 2009

Going into business with friends may seem like a great idea. Physicians are often asked to help fund a startup business. But these ventures often disappoint, and when they do, relationships can be ruined.


Physicians are often asked by relatives, friends, or friends-of-friends to help fund a startup business, purchase a property together, or buy an investment product that requires a high minimum initial investment.

These may sometimes seem like sweet deals, and you might think that investing with people you know beats giving your money to a stranger. But these ventures often disappoint, and when they do, relationships can be ruined.

“Every week I get calls from Utah residents who have lost money by investing with friends, family, or neighbors they trusted,” Salt Lake City attorney Mark Pugsley wrote in a column for a local newspaper last fall.

Many times, those calls come from physicians who failed to diligently investigate what they were getting into, says Pugsley, who specializes in securities and fraud litigation for Ray Quinney & Nebeker.

“Investing with people you know may be comforting, but it has no bearing on whether an investment is sound,” he argues. “In fact, I would recommend investing with people you do not know; it takes the emotion and friendship out of the equation and helps you focus on the merits of the opportunity. Most people do not like to sue their family and friends - it makes family reunions and church functions too uncomfortable.”

A few years ago, Gregory Rosenfeld, a neurosurgeon in Hickory, N.C., joined a couple of friends in what seemed like a promising retail startup venture.

“We were supposed to be silent partners, and this other guy that they knew was going to run everything,” Rosenfeld recalls. “He seemed like a nice, personable guy.” But when that nice, personable guy was out of town one weekend, Rosenfeld happened to go through some bills in the office and found evidence of a substantial amount of debt that he and the other partners knew nothing about.

The partners caught the problem and replaced the manager, but the incident was a wakeup call for Rosenfeld.

“Knowing the people involved sometimes gives you a false sense of security,” he says.

As Rosenfeld learned, when you take that leap with friends or loved ones, you’re carrying extra baggage from the start, says Elinor Robin, a psychologist and mediator in Boca Raton, Fla. If you’re willing to carry that load, there are a few things you can do to avoid the most typical horror stories, experts say:

First, make sure you are actually making an investment as opposed to a gift or a loan.

“I advise people not to make loans - it’s either a gift or an investment,” says Robin. If it’s a gift that you don’t expect to be paid back, chances are you’ll keep the amount to what you can easily afford to lose, she says. If your venture truly is an investment, then it needs to satisfy all the due diligence of your other investments. If it’s a startup, insist on seeing the business plan, any outstanding loan documents, and a private placement prospectus, if there is one.

Also, purchase a professional background check on all principals in the business. You may think your friend has already done this, but you may be wrong.

And set a target for how much you’ll spend on these types of investments so that no single investment can seriously hurt your financial future.

Scott Shane, an entrepreneurial studies professor at Case Western Reserve University, recommends that startups account for no more than 5 percent of your net worth.

“About 35 percent of startup investors go into these deals without seeing a business plan, checking references or, talking to customers,” Shane says.

Don’t forget there’s a high failure rate for startups and that no investment is a sure thing, even established ones.

While some physicians feel obligated to invest when friends and family come calling, remember you always have the option of saying no.

“It’s much easier to keep your money in the first place than to try to get it back” from an investment scheme gone bad, says Pugsley.

The next time Rosenfeld invested in a startup, the idea was his own. He saw a presentation by a fledgling company called WiSpots, which aims to put touch-screen computer kiosks in physicians’ offices, offering free Internet access and health information for patients in waiting rooms. Rosenfeld now sits on the WiSpots board, along with CEO and founder Kevin Flannery. And while Rosenfeld found the company on his own, several of WiSpots’ other investors are friends or family members of Flannery’s.

“I have my own money invested in this, as well as hitting up a lot of family and friends,” Flannery says. He said the process has been painful, and payback has been slower than initially forecast, but the idea still has a lot of potential.

“Everything takes longer than you think it will in a startup,” says Rosenfeld. “It’s a leap of faith.”

Indeed. But even leaps of faith should be taken with your eyes wide open.

Managing the relationship

Thinking of investing with someone close to you? Here are some tips from psychologist Elinor Robin for managing the relationship while you manage the investment:

  • Start with values. Do you and any other investors share the same values regarding the investment? If you’re buying a property, for example, is everyone in it for the long run or will one partner want to spruce things up quickly for a fast sale? Try to anticipate conflicts.

  • Write it down. When in the early stages of planning your venture, write something down that lays out how the partnership will operate. Get everyone involved to sign it. Robin advocates creating a partnership charter that goes beyond a typical buy/sell agreement and discusses details of how the business will be run, how much input is required from each partner, etc.

  • Create an exit strategy. No one wants to talk about divorce on their honeymoon, but you must create an exit strategy early on. Write down what happens if any partner wants out. “If you can’t do it now, how will you resolve things when you come to an emotionally charged moment in the business?” says Robin.

Janet Kidd Stewart is a freelance writer based in Marshfield, Wis. As a contributing columnist for the Chicago Tribune, she writes a weekly, syndicated retirement column called “The Journey” that appears in Tribune newspapers across the United States. She holds a bachelor’s degree and master’s degree from the Medill School of Journalism at Northwestern University. She can be reached via physicianspractice@cmpmedica.com.
This article originally appeared in the online November 2009 issue of
Physicians Practice.