BUSINESS

Relative risk: Keeping financial enterprise all in the family

When family members ask you to finance a business venture, it's an emotional and financial risk. Here is how to survive with minimal damage.

By Karen Caffarini, AMNews staff. May 19, 2008.

For some physicians, making a business investment decision is all relative. A relative asks them to invest in their business or a friend's business, and the physician breaks out the checkbook.

After all, that's what family is for, right?

Minimizing investment risk
Ethics of owning an outside business
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Wrong, say some experts who advise physicians to stay far, far away from the thought of ever investing in a family member's business.

Right, other experts say, but only to a point. There can be good reasons to consider investing in a business proposition. The key is that you, and the family member, treat your investment like a business deal, not an all-in-the-family favor.

Investing in any small business or venture is risky enough, but family deals in particular make some financial advisers and family counselors cringe. A physician who wants to placate a relative may skip important steps in starting a business.

Many physicians are familiar with the hands-out pressure, in part because the wisdom that says doctors are flush with cash hasn't caught up with today's financial realities. An Oregon surgeon contacted for this article said he was amazed at the number of loan requests he received from family, friends, and even minor acquaintances, early in his career.

"There often is family pressure; a lot of dynamics often are involved with family requests," said David Sebastian, financial adviser with The Physicians Wealth Management Group in Parsippany, N.J. "In the end, though, it's all about risks. Can you afford to take the risk?"

But the biggest risk may not be financial, but emotional, said Ben Utley, president of Physician Family Financial Advisors in Eugene, Ore. "If [physicians] say no, they have to deal with the emotional hardship of their decision.

"How much will the relative dislike you? Will they still come over for Thanksgiving dinner, and will the kids still play together?"

One option to these sorts of requests is to just say no, gently but firmly, to any relative, both financial advisers and family counselors say.

But experts also say that agreeing to invest in a family member's plan can have its rewards. If the venture sounds intriguing, if the relative is proven in his or her field, or if saying no is not an option in the interest of family harmony, experts say you should at least go into the deal with eyes wide open. If done the right way, there is the possibility you could do well by doing good.

"Investing in family can be gratifying. Some physicians get gratification just knowing they did the right thing and that they were able to do it," Utley said.

If you're approached

But doing the right thing can become very, very wrong for everyone involved if physicians don't do the same due diligence on a relative as they should do with anyone else, experts say.

Start by requiring a business plan, financial advisers say. Draw the line between a charismatic appeal and a business appeal. Ask what is the case for the business venture and how long the payback period will be. Make sure there is a predetermined strategy and exit clause in the event the investment enters shaky ground. Get everything in writing, even if it is an informal memorandum.

Advisers also recommend having a buy-sell agreement that spells out what happens in the event of the "4 D's" -- death, disability, divorce or disenchantment.

Bruce Primeau, a financial adviser for physicians with Wade Financial Group in Minneapolis, stressed the importance of doing your homework. He said you not only have to look at who is asking you for money, but what they want to do with it.

If, for example, a relative wants you to invest in a restaurant, "do you know what the statistics are that the restaurant will be around in three to five years? A person will point out what a great site the restaurant would be on, but has anyone done the homework?" Primeau said.

Utley provides his physician clients with questions they should ask themselves and their potential business partner before taking on an unconventional investment.

Among the questions:

Has the relative tried other, more conventional, means to get money, but been denied? That could raise a red flag, Utley said.
Could you be just a lender, with less investment and risk, instead of a partner? The answer would give you an idea about the offering party's motivation and a clue about how the deal would be handled. Giving a loan for a set amount of money is a viable alternative that should satisfy the family member without breaking the bank.
If the business doesn't survive, could you face a lawsuit, and expensive legal bills that come with it? If this is a possibility, seek legal advice before entering any agreement, Utley said.

Physicians also need to determine how much they are willing to spend, how much they can afford to lose, and where the money is coming from. Would a financial commitment hurt the physician's immediate family?

"I'm more afraid for people looking for that home run -- that big payback from a big investment," Sebastian said.

Lori Shelef, PhD, a family counselor in Clearwater, Fla., said the transaction needs to be structured and businesslike, with a note, and the lender must be paid back with interest, even if it is a small amount. "Much family grief comes from loaning money. If you have an official note, if things turn bad or sour, you have a legal way to deal with the problem."

The physician also needs to understand what the relative is hoping to accomplish, and what the physician is hoping to get in return. In many cases, the goal may be more than money. It can also be about fulfillment, sense of accomplishment, or a demonstration of love and support.

"I always ask my clients what their motive is in buying a business, " Utley said. "Is it truly for profit or is it to occupy a spouse or educate a child in the world of business? There are better ways to do both."

In the end, after weighing all the pros and cons, a physician may realize she or he can not offer financial support. So how do you say no without hurting someone's feelings?

Dr. Shelef says there's no need to feel bad when turning down a family business proposition.

"Some people have a hard time saying no, but no is a very good word," Dr. Shelef said. If the physician is investing money in hopes of repairing a fractured relationship with a relative, communication and positive reinforcement would be better alternatives than loaning money.

A tale of two physicians

For a cardiologist in Indiana, investing in two franchise pizza restaurants was a positive move. Not only have they been profitable, but he was able to use his financial resources to help his brother-in-law become a successful businessman. For an surgeon in Oregon, investing in a friend's homebuilding venture, at the behest of his wife, was a financial disaster that's still reverberating.

Neither doctor wished to be identified for this article.

The cardiologist ignored two pieces of advice he got from financial professionals: Don't invest with family, and stay away from franchises, which can be expensive.

"Financial advisers only tell you as much as they know. And for them, that's stocks and bonds," the cardiologist said.

Helping a family member was foremost on his mind, "I am an only child, and my wife has only one sibling -- her brother," he said.

However, he did many of the things financial experts recommend. He took into account his brother-in-law's pedigree -- an MBA and previous experience running a food supply company. He visited the franchise's headquarters, tasted its food and looked at information about its success rate. He got his lawyer involved and signed formal documents. He set it up so if the venture fails, he loses only his investment.

So far, the cardiologist says, the franchises are profitable under the everyday eye of his brother-in-law.

The Oregon surgeon had gotten used to being asked for money from acquaintances -- former high school classmates and even an employee. He has no trouble turning them down.

But he succumbed to family pressure to invest in a spec home -- one built before a buyer is secured. The builder, a friend, had done a lot of home remodeling work for several area physicians, and the surgeon had known him for about six years. The friend had never built a house, but the surgeon figured the remodeling work was sufficient experience. Unfortunately, there were cost overruns and problems with the subcontractors. Then the booming housing market went bust.

"Now I'm left with a project that cost more than we thought, and we'll get back less than we thought. I might get back some money, but I'd be surprised if I did," the surgeon said.

To make matters worse, the surgeon did a handshake deal, with no exit strategy. "I know [the friend] to be an extremely honest and hard-working guy, and he provided detailed estimates on the house. In this regard, the venture seemed quite safe."

The surgeon eventually retained a lawyer and is no longer a co-signer on the loan. He said he learned from his mistake. "I tell people now that they need to put constraints on others. We as physicians don't really do that. We don't do any bargaining, but we should." The surgeon and the contractor are still friends, although the bad business deal has made matters awkward.

While financial advisers will advise, ultimately it is the physician who must decide to invest or not.

Physicians are the ones who will need to see the relative at weddings and family reunions, or in the home. They are the ones who will need to mend any hard feelings that saying no might unleash.

Sebastian said physicians need to do what they think is best in their situation, and for some, that could be giving in to the entrepreneurial whims of a relative to save family peace, provided they can afford it.

"If spending the money won't hurt you financially, and it would help someone you care about, then in some cases it's best to just go ahead and do it," Sebastian said.

ADDITIONAL INFORMATION:

Minimizing investment risk

When it's not an option to say no to a family member who asks you to put up money for a business, or if you are intrigued by what is being offered, financial experts say you can help safeguard your investment by following these steps:

Ask for a detailed business plan with cost estimates, payback numbers and timeline, and an exit strategy. You might have an accountant or financial adviser go over the paperwork to make sure all possibilities are covered.
Get everything in writing. Never do a handshake deal. While a lawyer can help guide you through this process, an informal memorandum will suffice in many cases.
Determine the risks involved, and ask yourself if you can afford to lose some, if not all, of the money you invest. Don't assume that only invested capital is at risk. If a relative already has gone to a bank or other financial institution and was turned down, that can be a signal for you to stay away.
Make sure that the person seeking the money has experience and training in the type of business he or she wants to open, and that the person does not have a poor history when it comes to business ventures.
Invest in a business you care about. You will want to keep an eye on your investment to make sure it is doing well.
Determine if you could be sued as part of the venture. For instance, could you be named in a personal lawsuit if someone becomes ill after eating food in a restaurant you invested in? Protect yourself so you won't be held personally liable.
Consider whether there are any other risks involved. Does the investment compete with the interests of others close to you? Does it go against your role as a physician?
Take your time in making a decision. Generally, good deals don't go away anytime soon.
To protect an investment you've already made, create a paper trail of cancelled checks, credit card statements and other paperwork. See an attorney, if you haven't already done so, to establish your property rights, in the event the business deal turns sour.

Ethics of owning an outside business

The AMA's Council on Ethical and Judicial Affairs does not have a policy on investing with family, but it does have guidelines on ownership of outside, nonmedical businesses: "It is within the spirit and intent of existing policies to frown on physician involvement in certain enterprises that go against sound health decisions, such as ownership of a tobacco store. From the ethical perspective that the Council on Ethical and Judicial Affairs takes, such involvement would undermine physicians' professionalism."